The good-bad news in second-quarter GDP

Poised for a Rebound. WSJ Editorial
The good-bad news in second-quarter GDP.
The Wall Street Journal, p A10, Aug 01, 2009

The bad news in yesterday’s second-quarter GDP is that the recession was even deeper than previously thought. Or should we say that is the good-bad news. Because that pain is now largely past, the very steepness of the decline means that the economy is now poised for a sharper rebound, or at least it should be if the history of recessions is any guide.

The economy contracted by only 1% at an annual rate in the quarter, but the Bureau of Economic Analysis report was even more interesting for its growth revisions in previous quarters. Last year’s third quarter was revised downward by a remarkable 2.2-percentage points, to a negative 2.7% rate. This means the recession began in earnest in July and August, which follows the spike to $145-a-barrel oil and the collapse of Fannie Mae and Freddie Mac, and it accelerated in September with the fall of Lehman Brothers and its aftermath.

To put it another way, the 2008 financial panic quickly—almost instantaneously—triggered a panic in real goods, which sent the economy tumbling down. The rapidity of that reaction is a perverse compliment to the flexibility of U.S. producers, who reacted almost on a dime to the rout in the financial system. Companies pared back production to liquidate their inventories so fast that the bottom fell out of the economy in last year’s fourth quarter and the first part of 2009.

We’ll never know for sure, but it seems probable that the recession that formally began in late 2007 would have remained far less destructive had our financial plumbers done a better job of preparing the shaky financial system for the rough weather. Last year’s commodity spike—a reaction in part to reckless monetary policy—and Washington’s failure to build financial firewalls after the fall of Bear Stearns look to be major culprits in making the recession worse than it needed to be. This is where we’d most fault Ben Bernanke’s Federal Reserve and Hank Paulson’s Treasury.

The encouraging news is that the Adam Smith washout of recent months has now set the economy up for a comeback. The need to rebuild inventories of everything from cars to furniture will by itself help to lift GDP for the rest of 2009. The housing market looks to be bottoming, which means residential construction will also make a contribution to growth. Net exports (less imports) added some 1.4-percentage points to GDP in the second quarter and should also provide a lift the rest of the year.

What didn’t seem to make much difference is the “stimulus.” Transfer payments did climb sharply by 7.4% in the quarter, reflecting the likes of jobless insurance. These payments offset declines in worker compensation, but they didn’t do much for consumer spending, which declined by 1.2% in the quarter. In any event, these transfer payments are temporary and thus do nothing to promote the investment and risk-taking that are the only way back to steady growth and prosperity.

With a recovery on the way, the real question is whether we’ve laid the groundwork for such a durable expansion. Having been down so long, the economy should be in for a nice, long ride up. Even the Great Depression was followed by a notable rebound—until the bill for its government excesses came due in the mid- and later 1930s.

In this recession, Washington has reflated the economy with record spending and monetary easing that couldn’t help but spur some recovery. The issue is what happens when the price of that reflation comes due in higher taxes and higher interest rates. Political uncertainty also continues to hang over risk-takers, and on that point it has been fascinating to see the latest Wall Street rally coincide with the political troubles of ObamaCare. If it collapses, we might see Dow 10,000.