Double Dip Drama

So far this month, politicians on Capitol Hill have been breathing sighs of relief as various manufactured fiscal crises have been averted at the last minute. And at first, it looked like the economy has been humming along just fine despite the DC drama. However, today it looks like earlier assumptions may have to be thrown out the window. Believe it or not, the early Commerce Department Fourth Quarter economic report actually showed the economy contracted by 0.1%

So what happened?

First, federal defense spending fell at an astounding 22.2 percent annual rate in the quarter, which subtracted 1.28 percentage points from GDP growth. That was in part a reversal from the unusual 12.9 percent gain in the third quarter. But when the two quarters are averaged together, the defense sector was a drag on the economy in the second half of 2012 —and that’s before a “sequester” of automatic defense cuts goes into effect this year if Congress doesn’t act to avert it. The volatility in defense spending —and consequences for economic growth- -are a reminder of the impact that may be seen in the future as federal spending cuts go into effect.

The second major drag on growth was from businesses inventories. Firms drew down their inventories by more than $40 billion, which subtracted 1.25 percentage points from GDP growth. In effect, by selling goods sitting on their store shelves and in their warehouses, production in the nation’s farms and factories was not as high as one might expect given consumer spending.

The good news, though, is that the effect from inventories should go away in future quarters; businesses can’t simply run down their inventories forever. final sales, which adds inventories back in, rose at a 1.15 percent rate. [...]

GDP is the broadest measure of economic output, aiming to capture the value of goods and services produced within U.S. borders during a given time. The data over the last three years paint a portrait of an economy stuck in a pattern of steady growth, neither break out into a sharp enough pattern of expansion to push down joblessness nor to fall into a new recession.

Still, there are some reasons for concern in 2013. While consumption spending held up in the final months of 2012, that was before an increase in the payroll tax took effect in January. And negotiations over the sequester could result in steep cuts in defense and other government spending in the months ahead, putting further downward pressure on GDP.

Now this is an early estimate, and the Commerce Department may revise this figure as more data comes in. And it looks like one-time events like inventory drawdowns and wild swings of military spending temporarily threw the GDP out of whack. Excluding inventory, real GDP sales actually rose by 1.1% last quarter.

However, we still can't feel too sanguine about this. The report also suggested that Washington's austerity fetish is harming economic recovery. While much of what happened last quarter may be temporary blips on the radar screen, we may also be seeing real warning signs going forward.

So why did we see slight contraction in the GDP? In large part because spending cuts -- federal, state, and local -- shaved more than a full percentage point off GDP growth.

I realize the right doesn't want to hear or believe this, but when Washington spends far less -- in this case, the cuts focused on defense -- it takes capital out of the economy and undermines growth. It is, as a practical matter, a form austerity, which helps hit the brakes on the economy. This is Economics 101 and yet Republicans continue to insist that it is the only policy they really care about.

It's something to keep in mind as the Beltway's preoccupation with debt reduction, not the recovery, continues unabated. It's also a reminder that the automatic sequestration cuts may very well push the nation closer to a recession this year.

For nearly four years, Europe has been ravaged by fiscal austerity. As European governments, especially in "The Eurozone" (where the Euro is used as currency), have been slashing their budgets, unemployment has skyrocketed as GDP plummeted. Many economists have been chiding "The Eurozone" for engaging in way too much austerity that's only exacerbated their "Great Recession"... And they've been warning us not to repeat this mistake.

Yet despite this, Republican Congresscritters like Nevada's own Mark Amodei keep calling for more "drama" in the form of government shutdowns and "Fiscal Cliff" budget slashing. Remember that this is essentially the American version of "Eurozone Austerity". And the more we engage in this activity, the more likely we are to actually fall into "double-dip recession".

Senate Majority Leader Harry Reid (D-Art of the Deal) seems confident that Republicans will cave (again) on "The Fiscal Cliff". Now, many economists are hoping his recent words will soon come to pass. Even when inventory is excluded, GDP still only grew by 1.1% last quarter. And if we fall "off the cliff" this year, we may see at least 0.7% worth of GDP growth shaved off this year. Can Nevada's & America's economy truly handle any more fiscal drama?