Insights & Advice


Economy Reverses Course

It’s now official; the nation’s Gross Domestic Product sank into negative territory in the third quarter by 0.3 %. On the surface, that’s not much of a decline but compared to the previous quarter’s 2.8% positive growth rate, it was as if the economy hit a brick wall. It marked the worst economic contraction since the third quarter of 2001. The sharks are definitely circling the economic rowboat.

Since GDP growth is by definition a lagging indicator (telling us where we’ve been rather than where we are going) the results of the fourth quarter should be a real headline grabber. A recession is defined as two straight quarters of declining GDP growth so the “R” word won’t be official until the October through December quarter results at the end of the year. Yet, none of us need to wait for that. By now everyone is fully aware that the economy is spiraling downward at an increasing rate thanks to the impact of the credit, housing and financial crisis.

Since consumer confidence hit a record low last month it came as no surprise that third quarter disposable income dropped at an annual rate of 8.7% while the nation’s businesses cut back on everything from heavy equipment to computer software. In an effort to provide some cushion to the faltering economy the Federal Reserve Board cut rates yesterday to 1%. That was their ninth cut in a row and second in just October. They also gave a decidedly gloomy forecast of the nation’s economic future.

“The pace of economic activity has slowed markedly, owning importantly to a decline in consumer expenditures,” said the Federal Open Market Committee statement at the end of the Fed’s two day meeting. “Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by reducing the ability of households and businesses to obtain credit.”

In deciphering the “Fed Speak” of the five paragraph statement, it is clear to me that the Fed believes the overall economy (not just the financial community) is in real trouble so much so that inflation is off the table as a threat. San Francisco Fed Chairman Janet Yellen said in a prepared speech that recent economic data is “deeply worrisome” and the economy is likely to contract “significantly” in the fourth quarter. Worse still, consumers and companies are not going to be able to borrow their way out of trouble this time. Many economists, echoing that fear, are forecasting unemployment of 8% in 2009 from the present 6.1% rate while predicting an extensive recession.

As our own economy falters so does those of our global trading partners. As a result, U.S. exports which had been one of the few bright spots in our economy have faltered, growing only 5.9% from last quarters 12.3% pace. Central bankers and government officials in developing countries have warned their constituents to prepare for the worse. Many foreign economists are also predicting recession in Europe and Asia. Two countries, China and Norway, cut rates in tandem with the U.S. yesterday and many more are expected to follow that lead.

The commodities-rich emerging markets could be in for a really rough ride. The rapid deflation of commodity prices over the last few months as a result of declining global demand could spell a long, hard winter for countries such as Brazil, Venezuela, and even Russia. Many of these countries have seen their currencies, bonds and stock markets decline dramatically in the last few weeks as investors bail out of anything leveraged to the world’s economies.

So where does that leave us, the American job holder? Clearly there will be fewer of us in the near future and as I have written previously, lean times are immediately ahead. Some positives might be that a new president will bring fresh perspective and hopefully some new ideas to stimulate the economy. Congress is already working on another stimulus package to jump-start the economy. There is a promising new plan afoot that might directly address the problem of over 3 million problem sub-prime mortgage holders. The U.S. Treasury is now attacking the credit problem from nine different angles while the first funds of the now-infamous $700 billion rescue plan is expected to enter the markets this week. And finally I believe the Fed’s Chairman Ben Bernanke is prepared to cut interest rates to zero if he has to. So even if we do face a rough time there’s lots of help coming from all sides.

Posted in Macroeconomics, The Retired Advisor