Latest GDP Report Shows U.S. Recession Was Deeper and Recovery More Anemic Than Previously Thought

• As expected by IHS Global Insight, real GDP growth in the second quarter of 2011 was a meager 1.3%, after an apparent stalling of the economy in the first quarter (0.4% compared with the previous estimate of 1.9%).
• Revisions to the prior years’ data point to a significantly deeper recession. Real GDP growth in 2008 was revised down from 0.0% to -0.3% and in 2009 from -2.6% to -3.5%. The peak-to-trough decline in GDP during the recession is now 5.1% instead of the previously reported 4.1%.
• The data revisions show a stronger initial bounce back from the recession. In particular, growth in the first quarter of 2010 was revised up from 3.7% to 3.9% and in the second quarter of 2010 from 1.7% to 3.8%.
• Now the Bad News: Since the second quarter of last year, U.S. growth has averaged only 1.6%. And while there was a weak “bounce back” from the first to the second quarter of this year, some of the second-quarter 2011 growth may have been due to one-off factors, such as strong defense spending and a bounce from bad weather, which will likely not spill over into the third quarter.
• Combining a deeper recession with the anemic recovery, real GDP has not even regained its previous peak yet.
• There is little doubt that, since the summer of 2010, U.S. growth has faltered—the only question now is how much weaker could things get and how long will the (very) “soft patch” last. Prospects for a second-half pickup are fading fast.

Second-quarter GDP growth came in at 1.3%, an anemic performance although not a big surprise (we had been expecting 1.6% growth as of a week ago, which we revised to 1.3% after the durable goods report on Wednesday). Consumer spending was almost at a standstill (up just 0.1%), while government spending (down 1.1%) was again a drag on growth as declines in state and local spending and federal nondefense spending offset a bounce in federal defense spending.

Domestic fixed investment was a plus for growth, with equipment and software spending up 5.7% (albeit up less sharply than the first quarter's 8.7% increase). Business structures spending advanced 8.1%, driven by surging spending on drilling in the oil and gas sector. More favorable weather than in the first quarter helped generate a small increase in residential construction. Foreign trade was a plus, with export growth at 6.0% outpacing import growth at 1.3%. Inventories had little impact on growth, adding a couple of tenths to GDP growth.

The big surprises were in the historical revisions. These deepened the recession substantially. The fourth quarter of 2008, right after the Lehman failure, now shows an 8.9% annual rate of decline in GDP (previously 6.8%), and now represents the worst single-quarter decline in GDP since the 10.4% drop in the first quarter of 1958, exceeding the 7.9% decline in the second quarter of 1980. The revisions then made the initial rebound a bit faster (with growth running just below 4% in the first and second quarters of 2010), but then showed the recovery losing momentum over the second half of 2010 and tailing away to just 0.4% in the first quarter of 2011 (previously 1.9%) and 1.3% in the second. Although the second quarter was disappointing, the revisions mean that it actually shows stronger growth than the first.

The figures now show more starkly than before a recovery that looked rapid at first, helped by inventory re-building and fiscal and monetary stimulus, but simply fading away as those supports weakened, since the private sector (especially the consumer and the housing market), burdened by the excesses of debt and overbuilding from the boom and bust, was unable to play its traditional role driving the recovery forward.

The new GDP data help clear up one puzzle, but create several others:

• The much deeper recession in GDP fits better with the extreme decline in employment. Previously, it had been hard to understand why employment fell as much as it did during the recession. GDP and employment are now in better sync. Of course, this realignment means that productivity improvements were not as spectacular as the data currently show.
• There was virtually no weakening in GDP growth in the second quarter of 2010 despite all the fears at that time of a double dip. The upward revision to GDP growth for that quarter is partly due to the fix that BEA has made to its seasonal adjustment procedure for petroleum imports, which previously had been artificially depressing growth in that quarter.
• The same fix to petroleum imports took a chunk out of growth in the fourth quarter of 2010. This means that the previous petroleum imports distortion was making it look like growth was accelerating from the second to the fourth quarters of 2010; the revised data show growth decelerating over that period.
• The puzzle over first-quarter 2011 growth has deepened. Growth is now shown at only 0.4% (previously 1.9%). This does not match up with the evidence from surveys (e.g., ISM), employment reports, and manufacturing production, which showed the economy starting the year with a good head of steam. Yes, there was a decline in defense spending and, yes, there was bad weather that hit construction early in the year, but even so the first-quarter weakness looks odd.
• In the second quarter of 2011, the GDP figures show a drag of only 0.1 percentage point from motor vehicle production. Given the known disruption emanating from Japan, this is a surprisingly small effect—it reflects motor vehicle GDP declining just 4.7% at an annual rate, reversing only a fraction of the first quarter's 59.2% increase. But unit vehicle production numbers from the Fed show light-vehicle production down 25.9% at an annual rate in the second quarter, reversing all of its first-quarter increase. The GDP decline in motor vehicles looks too small.

The GDP figures show an economy barely crawling forward. Unfortunately, there is little in the recent evidence to suggest that the economy was gaining momentum as the second quarter ended—June retail sales were weak, as were June durable goods orders, and the Fed's Beige Book report was soft. The Michigan consumer sentiment index tumbled in July, while the corresponding Conference Board measure edged just slightly higher after tumbling in May and June.

And the economy now faces a major headwind from the prolonged stand-off in Washington over the federal debt-ceiling. While we still anticipate that cooler heads will prevail and that the federal government will not actually default on its debt obligations, nobody can be sure how the drama will play out. At the very minimum, the willingness of consumers and businesses to take risks while the unedifying spectacle has been playing out has surely diminished. That hurts consumer spending on big-ticket consumer durables, hurts their willingness to move ahead with house purchases, and hurts businesses willingness to hire and make major capital investments.

Our hope—as of a month ago—that third-quarter growth would bounce back above 3% no longer looks realistic, even though we should still get some help from a rebound in vehicle production. IHS Global Insight now expects that growth in the third quarter will come in much weaker than previously expected—probably less than 2% and possibly less than 1%. Assuming that the budget impasse in Washington is resolved soon and that the worst-case scenario is avoided, there is a decent chance that growth in the fourth quarter could be stronger. However, a weak economy will only make the tough decisions on the budget even more difficult and the case for fiscal austerity in the near term even weaker. The current fragile state of the economy also means that the Fed is likely to remain on hold for a very, very long time.

by Nigel Gault