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Cuts in government spending push economy to edge of another downturn

The recession ain’t over yet, fears of a ‘double-dip’ rise
By Masao Suzuki |
August 1, 2011
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San José, CA - On July 29, the Commerce Department released its report on Gross Domestic Product or GDP for the Second Quarter (April to June) of 2011. GDP, which measures the value of goods and services produced in the United States, rose at only a 1.3% annual rate, much slower than most mainstream economists expected. Even worse, the First Quarter (January to March) economic growth was cut from an earlier estimate of 1.9% to just 0.4%.

Slow economic growth of less than a 1% annual rate in the first half of the year shows that the economy is on the edge of going into another downturn. Household or consumer spending all but stalled in the second quarter, growing at a 0.07% rate. This is not surprising given the high and rising unemployment rate, which reached 9.2% in June. There was also almost no increase in the sales of new homes in the first half of the year, as high unemployment and a huge overhang of foreclosed homes cut into new home sales.

U.S. net exports (exports minus imports) were also almost flat, increasing at less than two-tenths of one percent (0.2%) annual rate. The ongoing financial crisis in Europe slowed economic growth there, while rising inflation in Asian nations led governments to raise interest rates, slowing their economies. The Japanese economy suffered from a tsunami and melt-downs of nuclear power plants. These economic problems abroad cut into their purchases of exports of U.S.-made goods.

Spending by U.S. businesses on new plant, equipment and inventories of finished goods also slowed sharply as compared to a year ago. This was mainly due to a drop in the buildup of inventories, as spending on new plant and equipment has remained low except for a spurt of equipment purchases in the first half of 2010. Corporations are sitting on record amounts of cash (nearly $2 trillion), but are not spending it on new plant and equipment or hiring back workers.

Last, but not least, there were actually drops in government spending in both the first and second quarters of this year. The biggest drop was in federal government spending, especially in the first quarter (January to March). In the first half of the year, federal government spending on goods and services fell at about a 0.64% annual rate, the biggest drop in ten years. In both quarters, state and local governments also cut spending. Almost all state and local governments have to balance their budgets, and the loss of federal stimulus moneys is leading to spending cuts.

In addition to the dismal GDP report for the first and second quarters, the Commerce Department also revised their reports for previous years. Estimates of GDP were revised down for both 2008 and 2009, showing the recession to be worse (as measured by GDP) than was previously reported. This downward revision pulled the estimate of the most recent GDP below the previous high in GDP, meaning that it is too soon to say that the recession is officially over.

While GDP or production was revised down, the report also said that corporate profits were revised up, by 8.3% in 2009, and 10.8% in 2010. While the labor market is still down almost seven million jobs since the recession began, and production (measured by GDP) is almost, but not quite back, corporate profits are up almost 14% from their pre-recession peak, after adjusting for inflation.

With economic growth so weak, there is a growing chance of a so-called “double-dip” where the economy starts to fall again before it reaches its previous high point. The biggest danger comes from the bipartisan effort in Washington, D.C. to cut federal government spending. With the economy already on the edge of another downturn and the other engines of economic growth (consumers, businesses, the rest of the world, and state and local governments), sputtering at best and going down at worst, this effort to cut the federal government deficit by cutting spending will make the economy even worse than it is today and could lead to another disastrous downturn.