Review: US Economy Contracts In 4Q/2012

The positive tone to the equity markets and other risk-based assets may provide a degree of cover to developments within the real economy but it cannot totally negate the fact that our nation’s economy continues to move along with all the speed of a pack mule.

In fact, Uncle Sam just reported that the old warhorse, that is our domestic economy, contracted in the 4th quarter of 2012 by 0.1%. Let’s navigate and take a harder look at what might be weighing us down.

The Bureau of Economic Analysis release highlights:

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — decreased at an annual rate of 0.1 percent in the fourth quarter of 2012 (that is, from the third quarter to the fourth quarter), according to the “advance” estimate released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 3.1 percent.

The decrease in real GDP in the fourth quarter primarily reflected negative contributions from private inventory investment, federal government spending, and exports that were partly offset by positive contributions from personal consumption expenditures (PCE), nonresidential fixed investment, and residential fixed investment. Imports, which are a subtraction in the calculation of GDP, decreased.

Be mindful that private inventories were a primary driver of the 3.1% GDP increase in the 3rd quarter. Averaging 3Q and 4Q, we get a less than robust reading of 1.5%.

In regard to federal spending, be mindful that the sequester takes center stage on our economic landscape on March 1st when a mere $1.2 trillion in spending cuts will start to kick in. Yes, that is only 30 days from now. This is what happens when deficits are run into the trillions and trillions of dollars. At some point the spending must stop and the bills come due.

What about inflation? Any signs of that?
The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 1.3 percent in the fourth quarter, compared with an increase of 1.4 percent in the third. Excluding food and energy prices, the price index for gross domestic purchases increased 1.1 percent in the fourth quarter, compared with an increase of 1.2 percent in the third.

If we were to exclude everything, then prices would not have changed at all. You do not eat, do you? What about health care? I only saw another increase of approximately 30% in my health care premiums this year. But that must not be an input. Those premiums have increased an unsightly 65% in the last three years. Inflation? Try hyper-inflation!!

In positive territory, we saw growth in the following areas:

Real personal consumption expenditures increased 2.2 percent in the fourth quarter, compared with an increase of 1.6 percent in the third. Durable goods increased 13.9 percent, compared with an increase of 8.9 percent. Services increased 0.9 percent, compared with an increase of 0.6 percent.

Real nonresidential fixed investment increased 8.4 percent in the fourth quarter, in contrast to a decrease of 1.8 percent in the third. Equipment and software increased 12.4 percent in the fourth quarter, in contrast to a decrease of 2.6 percent in the third. Real residential fixed investment increased 15.3 percent, compared with an increase of 13.5 percent.

A benefit from a small bump in holiday sales and housing certainly helped our mule limp along. But where is the big drag on the mule? From Uncle Sam himself and his cousins scattered across most cities, states, and towns in our nation.

Real federal government consumption expenditures and gross investment decreased 15.0 percent in the fourth quarter, in contrast to an increase of 9.5 percent in the third. National defense decreased 22.2 percent, in contrast to an increase of 12.9 percent. Nondefense increased 1.4 percent, compared with an increase of 3.0 percent. Real state and local government consumption expenditures and gross investment decreased 0.7 percent, in contrast to an increase of 0.3 percent.

Why such a decline in government spending? Well, when demand is dragged forward as it has been over the course of the last four years and the can gets perpetually kicked down the road, the basic laws of economics ultimately kick in. (A large part of the decline in government spending emanated from within the defense sector.) The end of the road along which we have kicked the can eventually starts to appear on the horizon and the games played to cook the books and impact the economy have a lessened effect. Many municipalities are struggling to keep their heads above water so to speak.

Add it all up and an economy that is plodding along at call it 2% will not do much in terms of generating meaningful improvement on the unemployment front. With the sequester kicking in, do not be surprised if growth actually trends down from here and the economy “grows” closer to 1%. If we can call that growth.

What will the Fed do? Look for Big Ben Bernanke and his minions within the Fed to keep the liquidity flowing and asset prices pumped up so they can tell everybody how great things are. Problem is the people out of work and struggling to make ends meet really do not care about the equity markets. They need a job and a good one at that. The labor participation rate continues to languish at a 30-year low.