The Perfect Storm

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illustration by paul vismara

Contrary to the conventional wisdom conveyed in an election year by a hyped media, the U.S. economy over the past seven years has enjoyed good growth and excellent productivity gains.

Fundamental performance in the second quarter of 2008 registered a real GDP expansion rate of 2.8 percent and year-over-year growth of 2.1 percent (adjusting for inflation). Real GDP growth provides important perspective for three reasons: It quantifies economic momentum that could bridge the tumultuous housing-value collapse and energy price threats to our wallets and psyches; it sets the all-important springboard from which our 2009-10 economic predictions are cast; and it establishes parameters for sorting truth from fiction in evaluating economic policies — past, present, and future.

Indeed, such policies have been the key to explaining the extended period of prosperity from 2002 to 2008. This 7- to 8-year U.S. business expansion is double the historical norm of 3 to 4 years. As of October 2008, despite waves of economic deceleration, mounting uncertainty, and the seizing up of financial markets, there’s still a chance the national economy can limit this second-half-2008 recession to a relatively mild, two-quarter contraction. Why? Largely for the same reason that the first years of the Kennedy and Reagan terms paved the way for the extended prosperities of the 1960s and 1980s, respectively. The common denominator is that both administrations proposed and presided over very significant reductions in income-tax rates. Tax-rate reductions spurred individual and business enterprise. Tax cuts augmented a willingness to work harder, longer, and smarter. Reduced tax burdens unleashed massive amounts of capital for new savings and investments. Moreover, the United States became a real growth engine for foreigners.

The expression “When you tax something, you get less of it” has a more inspiring counterpart: “When you cut taxes on something — incomes, for example — you get more of it.” This axiom captures an elemental economic and fiscal-policy truth. When President Bush and the Legislature slashed tax rates on earnings, dividends, capital gains, and estates (especially in June 2003), Uncle Sam’s budget deficits soon shrank from half a trillion dollars annually to just under $200 billion. Tax cuts revived business activity and generated burgeoning tax revenues to all levels of government, as well.

Federal budget deficits would’ve been transformed into large surpluses, had Washington not spent like drunken, uncontrollable sailors between 2002 and 2008.

Nevertheless, facts are facts. The economic truth is that the U.S. stock markets rose to record heights, as did U.S. auto and truck sales. U.S. job growth, worker productivity, and real earnings also rose to record levels, and the unemployment rate fell to the lowest average in three decades. No other advanced western economy enjoyed comparable prosperity. Between 2002 and 2007, the U.S. economy gained several percentage points of the western world’s share of total GDP and exports.

Basic Forecast Assumptions

The starting point for 2009’s economic forecast is, however, the recession of 2008. Although the second quarter’s real growth of 2.8 percent is considered respectable, the fact remains that whenever real quarterly GDP growth slides below 3 percent, unemployment rates rise. This is why U.S. jobless rates have risen rather steadily to 6.1 percent in September 2008 from a low of 4.5 percent in the prior year. Moreover, advance estimates for the third quarter show a -0.3 percent rate of contraction with an even more severe slide in the final quarter of 2008.

A weakening economy becomes vulnerable to domestic and international shocks, be they of an economic, financial, or psychological nature. Since mid-year 2008, many factors are compounding weaknesses in the U.S. economy. Painfully high energy prices have sapped the discretionary purchasing power of households. Higher transportation costs quickly translate into accelerating prices for consumer staples such as food, clothing, services, and imports. Anxiety over the likely demise of Bush-era tax cuts (post-2010) suggests that steep tax hikes will clobber household budgets, causing retrenchment in spending decisions by firms and individuals. Consumer spending is 70 percent of GDP. Superimposed on these worries is the recent depreciation of most family savings, retirement plans, and other investments.

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