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Good News Lurks Beneath the Bad GDP Number

By Paula Dwyer
January 30, 2013 12:27 PM EST

Calm down. Yes, the U.S. economy surprisingly shrank in the fourth quarter at a 0.1 percent annual rate, weaker than any economist had forecast in a Bloomberg survey. As measured by gross domestic product, the volume of all goods and services produced, economic output was the lowest since the second quarter of 2009.

The median forecast of 83 economists surveyed by Bloomberg called for a 1.1 percent gain in GDP. For all of 2012, the economy expanded just 2.2 percent, a small improvement over 2011's anemic rate of 1.8 percent.

But let's look under the hood. The overall number disguises strong consumer spending and business investment in equipment and software, which zoomed upward. 

You could even say the strength of consumer spending and business capital expenditures is the bigger surprise, more than the contraction. Why? Because the fourth quarter also featured a bitter presidential contest and a Washington battle royale over the fiscal cliff, both of which dampened consumer and corporate confidence. 

The healthy consumption and business investment pictures were bolstered by another report out today showing that the labor market continues to heal. Companies took on more workers than expected in January, with an increase of 192,000, according to the ADP Research Institute.  

Two factors were largely responsible for the poor GDP showing: a steep decline in government spending, especially on defense, and in the growth of business inventories. Combined, they took 2.6 percentage points out of GDP.

To a lesser extent, a drop in exports also contributed to the slowdown, but only by 0.25 percentage point. Exports fell at a 5.7 percent annual rate, the biggest decline since the first quarter of 2009. 

The 22 percent fall in defense spending last quarter was the biggest since 1972, following the Vietnam War. Altogether, government outlays dropped at a 6.6 percent annual pace.

Inventories grew at a $20 billion annual rate, down from $60 billion in the third quarter. Most of the slowdown was due to Hurricane Sandy, according to Bloomberg News, which severely disrupted supply chains and manufacturing activity. 

At the same time, however, corporate spending on equipment and software climbed at a 12.4 percent pace, contributing 0.86 percentage point to growth. Residential construction increased at a 15.3 percent rate. For all of 2012, homebuilding climbed 11.9 percent, the most since 1992.

The Federal Reserve will almost certainly see the contraction as a sign that it should keep its bond-buying activity on track. The Fed is likely to reiterate, after today's Federal Open Market Committee meeting, that it will keep short-term interest rates near zero until unemployment, now at 7.8 percent, falls to 6.5 percent.

For lawmakers, the takeaway should be that this isn't a good time to let the sequester ax -- the $110 billion in ruthless across-the-board cuts -- take effect on March 1, as current law dictates. Doing so would risk another quarterly contraction and, voila, the U.S. enters another recession. 

Someone please explain to me: Why do Republicans lawmakers and economists insist on immediate cuts in federal spending when -- and the latest GDP report underscores this -- the economy would suffer? In any other country, that would be called shooting yourself in the foot.   

(Paula Dwyer is a member of the Bloomberg view editorial board. Follow her on Twitter.)

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