US Economy Shrinks By 0.1%, Big Blow To Recovery

For the December 2012 quarter, the world's largest economy USA has posted negative GDP growth for the first time after the June 2009 quarter. Cuts in defence spending and a decline in stockpiles saw the US economy contracting by 0.1% for the fourth quarter of last year. The last such occurrence in 2009 was in the wake of the financial meltdown in the country.

The drop has taken the markets and economists by surprise, as it was widely expected that the US GDP would grow by 1.1% in the said quarter. While a slowdown was expected, a drop was definitely not on cards.

The European Union (EU), a major trade partner of the US, has been battling a debt crisis for a while, which has led to a contraction in the EU’s economy too. As governments of European nations are forced to adopt austerity measures, the demand in the region has been hit significantly. This has naturally impacted its trade partners, the heat of which is reflected in the on the fourth quarter US GDP. However, this may be a temporary impact as the US GDP in 2012 overall expanded by 2.2% as compared to 1.8% growth in 2011.

The primary reason for the decline is that the country has seen the deepest cut in its defence spending in the last 40 years. Besides, there is also decline in its stockpiles – organisations cut their inventories as they took production cuts. US exports were lower in the quarter. According to the US Federal Reserve, Superstorm Sandy, which struck the East Coast in October 2012, also hit the GDP.

Increase in employment rates is generally seen as a marker of improvement in an economy. On this front too, the US economy has nothing positive to report so far, with hiring stalled. The unemployment rate has been stuck at 7.8% for the last 3 months, which means that the economy is not producing as many jobs as are required to keep it growing. On an average, the country has produced about 1.5 million jobs a month for the last 2 years, which is insufficient to reduce unemployment in the world’s largest economy.

Despite these negatives, there are many positives in the economy. Consumer spending and business investments have shown increased activity, and the housing market too is showing some recovery for the first time since 2005. Going ahead, how consumers spend their money will be very crucial as Social Security Tax has increased in January 2013. The White House has allowed the Social Security Tax cut to expire in January itself, but has capped the income taxes on most Americans. The expiration of the temporary tax will impact the salaries of employees, leaving them with lesser money to spend.

The Fed has pledged to keep the interest rates near zero to boost economic growth. However, it has expressed confidence in the economy and will continue with a monthly USD 85 billion bond buying stimulus plan.

The drop in the US GDP spells a big blow for the world economy, which has been striving to recover since 2008. The European debt crisis has hit the globe severely, with the GDP of emerging countries like India and China showing slower growth in GDP in CY2012. The fresh entry of USA into this league can further impede the slow limp back to normalcy.