Monday, August 1, 2011

Washington Shoots the Economy In The Foot

The debt deal has pretty much cinched the possibility of continued high unemployment and slow growth for the foreseeable future. More importantly, the possibility of a recession around the corner just increased as well. Here's why.

Let's break GDP down into its components.

Consumer spending: Consider this chart which I posted last week:


The YOY percentage change in PCEs during this recovery has been the weakest of any in the last three expansions. The reasons are obvious: high unemployment increases consumer cautiousness and lowers confidence. There is nothing in this deal to increase employment in any meaningful way. While the deal makers will argue this eliminates the uncertainty surrounding the debt deal and therefore will lead to increased hiring, they are wrong. The problem -- as indicated by the chart above -- is the weakest demand of any recovery in the last three recoveries. That means we need to increase demand to get the economy going.

Also note that PCEs account for 70% of overall GDP growth. Both gross domestic investment and government spending account for 15% of overall growth (as a net importer, this category subtracts from overall GDP). That means investment must increase at a substantial annual rate to overcome the weakness in PCEs. However, we've seen this number stall over the last four quarters as evidenced by this chart:


Gross private investment rebounded nicely from the recession, but has since slowed substantially. Part of the rebound was due to companies playing catch-up -- they restarted projects delayed by the recession. But as those projects have been implemented and as residential investment continues to lag, we've seen this component slow as well.

And now we have a debt deal that will cut government spending. First, here is a chart of total real government spending for the last five years:


We see the three quarter increase starting five quarters ago, but we see a large drop for the last two quarters.


For the entire recovery, state and local spending has been dropping, creating a drag on overall growth. However, now


We also have a decrease in federal government spending as well.

So -- let's review.

Consumer spending is weak, gross private domestic investment is stalling, we're still a net importer and government spending is dropping. No component of the GDP equation is showing any sign of a meaningful increase in the near future. Simply put, we've doomed ourselves to periods of slow growth.