Economy ‘fell off a cliff’ at end of ‘08

The U.S. economy shrank at a 3.8 percent rate at the end of last year, in its biggest contraction since the deep recession of 1982, the Commerce Department reported Friday.

The economy decelerated sharply in the wake of a severe financial crisis that broke out in September, sending virtually every sector plummeting at rates not seen in a generation.

Consumer spending, which usually barrels ahead in the U.S. even during recessions, fell by 3.5 percent after dropping by a similarly large amount in the summer. The rare retrenchment by American consumers — the final destination for much of the goods made in the world — set off a bloodbath in sectors ranging from manufacturing to personal services.

The rate of decline was breathtaking in some areas, with business investment in equipment and software plunging by 28 percent, housing investment nose-diving by another 24 percent after more than two straight years of decline, and production of big-ticket goods falling by 22 percent. The drop in investment spending was the biggest in half a century.

The broad fall-off in the domestic economy mirrored huge drops in economic activity in most other countries around the world, where many nations have followed the lead of the U.S. into severe recessions. The sudden collapse of global growth and trade was reflected in a nearly 20 percent fall of both imports and exports in the Commerce Department report.

“The global economy fell off a cliff in the fourth quarter,” said Richard Berner, chief economist at Morgan Stanley, the result of a worldwide shutdown of vital credit markets that largely continues to this day. “The full impact of the tightening in credit is still playing out, so it’s too soon to expect a reversal. Global activity has just begun to fall.”

The free-fall in the economy is particularly dangerous because it is occurring simultaneously nearly everywhere, increasing the likelihood it will be self-perpetuating, economists say. It may be difficult, they say, for central banks and legislatures everywhere to break the downward momentum and get growth going again.

In the United States, the only sectors that showed any growth were government — with an increase in federal spending offsetting a small decline in state and local spending — and business inventories, largely the result of an unwanted accumulation of unsold goods as consumers cut back on spending.

The increase in federal spending is a help to the economy, and it likely will continue to rise with the enactment of a more than $800 billion stimulus package next month. But the buildup of unwanted stockpiles is not helpful, as businesses have to shut down production and try to work off those inventories for several months. Already, the shutdown of activities has led to widespread layoffs.

Moreover, the buildup of inventories made the economy look stronger than it actually was during the quarter. Without the $6.2 billion increase in inventories, the economy would have shrunk even further by 5.1 percent, according to the Commerce Department.

“The economy is weaker than it appears” because the inventory overhang will have to be worked off before business can start growing again, said Jay H. Bryson, global economist at Wachovia Securities. “Indeed, the rise in inventories in the fourth quarter suggests that the economy will contract at a faster pace in the current quarter.”

While the fourth-quarter contraction was smaller than many Wall Street experts had predicted, the prospect of an even bigger drop in economic output early this year set off a downturn in stocks Friday. The Dow Jones Industrial Average fell 148 points to close at 8,001.

“The downward momentum has accelerated in the New Year. The first half of the year will look much worse,” as increasing joblessness adds to already dire credit problems to crush consumer spending, said Sung Won Sohn, professor at California State University, Channel Islands. Consumers are “the largest piston in the economic engine,” he said, and without them “it will be difficult for the economy to stabilize and grow.”

“The role of the government is extremely crucial,” Mr. Sohn said. “Considering the catastrophic consequences of doing too little, too late, a massive fiscal stimulus is needed as soon as possible to slow the downward spiral.”

President Obama vowed to push forward with his $800 billion-plus stimulus program, which cleared the House this week.

Story Continues →