Celebration is Premature: The Economy is Still Contracting

Over the last two weeks, the main-stream media and the stock market have greeted new economic data released by the Commerce and  Labor Departments with enthusiasm. Although these data show that the recession is not deepening as fast as it had been during previous months, they still show that the economy is contracting.

  • GDP Numbers. On July 31, the Commerce Department's Bureau of Economic Analysis released preliminary GDP data for the second quarter (March through June) of 2009. These new data showed that the economy contracted at a 1.0% rate of decline during the second quarter. This was considered good news because the economy has been contracting at a 3.9% clip over the last year. Leading the decline was a 29.3% rate of decline in residential investment, an 8.9% rate of decline in business investment, and a 1.2% rate of decline in consumption expenditures.
  • Unemployment Numbers. The other "good news" was released on August 7 by the Department of Labor's Bureau of Labor Statistics. The data for July showed the unemployment rate decreasing from 9.5% in June to 9.4% in July. But at the same time the new data showed that 247,000 more jobs were lost in July, including 76,000 jobs in construction and 52,000 jobs in manufacturing. So how did unemployment and jobs both fall at the same time? The answer is that the labor force shrunk from June to July. The labor force is not a constant; people are entering and leaving it all the time.
The best news for the economy in recent months is an improvement in the trade deficit.  Most of this decline has been driven by the reduction in consumer spending and the reduction in business investment, exports decreased at a 7.0% during the second quarter, but imports diminished even more (at a 15.1% rate).  The trade deficit continues to require Americans to borrow roughly a billion dollars a day from abroad to pay for our consumption, but a year ago it required us to borrow two billion a day.  Unfortunately, further declines in the trade deficit will be difficult to achieve because nearly two-thirds of the deficit is now with China, a country that is implementing a beggar-thy-neighbor trade policy that Peking University Professor Michael Pettis calls "Smoot-Hawley-with-Chinese-characteristics."  As a result, our trade deficit with China has been growing steadily since February.

Although GDP may increase slightly due to increased government deficit spending during the third quarter, that won't mean the recession is over. The government borrowing and spending that might produce such a rise cannot be sustained. As the government's debt grows (in proportion to GDP), foreign lenders demand higher and higher long-term interest rates when they lend to the United States government. Eventually a crisis is reached where the continuing government borrowing cannot be continued.

The only way to achieve sustainable growth is through increased business investment. Not only does increased investment result in increased demand for American products, but it also results in production of new products and the development of more efficient technologies. These new products and technologies, in turn, cause increases in manufacturing employment and consumer incomes, and thus increase consumption. That's why the 8.9% rate of decline in business investment during the second quarter and the 19.6% rate of decline over the past year are especially disheartening.

Instead of doing things that would enhance business investment, Obama's proposals (including his cap and trade climate bill) threaten to increase business costs, thus discouraging business investment. Also his various giveaways, paid for through government borrowing, tend to raise long-term interest rates for business borrowing. In general, Obama's policies are discouraging, not encouraging American business investment. They are contributing to the high unemployment rate.

If President Obama had competent economic advisors, he would be doing things that would lead businesses to increase their investment. For example, he could lower the corporate income tax. Such action would cause businesses (both American and foreign) to build new factories in America, factories that would implement the most efficient modern technologies.

What the new statistics really show is that American unemployment is in an economic depression which will probably continue until something happens that causes American business investment to increase.

The authors maintain a blog at tradeandtaxes.blogspot.com, and co-authored the 2008 book Trading Away Our Future: How to Fix Our Government-Driven Trade Deficits and Faulty Tax System Before it's Too Late, published by Ideal Taxes Association.