The Q4 GDP: Conservative Economics in Action, On To The Budget Battles

A Very Economically Conservative Quarter
The headline was scary - the US Gross Domestic Product contracted by 0.1% in the fourth quarter of 2012.  While this is just ever so slightly below the zero line, we are technically halfway to a new recession (traditionally defined as two consecutive quarters of contraction, although, in modern times, more complex definitions have been used) after what has been a less than stellar recovery from the last deep recession.

The recession more or less started in the first quarter of 2008 and lasted for 18 months.  During that time period, the size of our economy contracted by 4.6%.  This may not sound like a ton, but bear in mind that under "normal" circumstances, the economy needs to grow by 1% just to keep up with population growth and that contraction of the economy disproportionately impacts working class workers in industries like manufacturing, construction and retail and entertainment services, as belts tighten.

During the 18 month recession, unemployment skyrocketed from 5.0% to 9.5% (it would eventually peak after the end of the recession, in October 2009 at 10.0% - it is normal for unemployment to peak slightly after the recession ends, as companies don't start hiring until several months after business picks up) and 7.5 million jobs were lost, meaning that that the actual percentage of people working dropped even more than the official unemployment rate would tell.

Since then, the recovery has been painfully slow, against the norm for recessions (although, many would argue, not for recessions born of deep financial crises) and against the predictions of many, including myself, who expected a more "V-shaped" recovery.  Average growth in the 3+ years since the recession ended has only been 2.3%, which would be okay if the starting point was a healthy economy, but nowhere near sufficient to relieve the pain caused by the recession.  Unemployment has fallen to 7.9%, lower than the peak certainly, but way above pre-recession levels.  There are STILL 3.2 million less jobs now than when the recession started 5 years ago.  And it wasn't until the fourth quarter of last year that the GDP surpassed its pre-recession level.

This gap would make the fourth quarter GDP contraction very troubling.  But, looking at the internals, things aren't as bad as they appear on the surface.  This quarter is actually a positive argument for economic conservatism and austerity, if you look under the covers.

You see, while the overall GDP contracted by 0.1%, private sector GDP rose by 2.6%, while government expenditures at all levels fell by 2.7%.  In other words, the private sector is in recovery, as evidenced by rising corporate earnings and corresponding rising stock prices.  It is government that is shrinking.  Most of the reduction is coming at the state and local level, as governments are forced to balance their budgets and (with California as a big exception) are largely turning to reducing government spending as opposed to raising taxes to make ends meet.  There has also been some reduction of federal expenditures and some modest cuts from prior budget deals take effect and we lap the tail end of the stimulus spending.

So why is this a good thing?  Employment in the quarter is actually the strongest it has been in a long time.  You see, while the overall economy contracted, just over 600,000 net jobs were added in the quarter, even more than that in the private sector.  In other words, at least for this quarter, the reduction in government spending did not have a dampening effect on the thing that matters most to the average person - available jobs.  Private sector hiring more than made up for public sector austerity.

This model seems destined to play out to some degree on the federal level as well.  Sequestration cuts take effect automatically on March 1st and the Republicans have been pretty clear that while they would like to replace the defense cuts, they have no interest in punting on the amount of the overall cuts.  Good for them - I hope they stick to their guns.  We have to solve the budget deficit one way or another and while we can argue the balance between tax hikes and spending cuts, doing something is better than doing nothing.

Also in play is the federal budget - the current continuing resolution lapses March 27th, which means that if Congress does not pass some sort of budgetary measure to fund the government, the government will shut down on that date.  Republicans, having had to give ground on the tax cut debate, since tax rates were slated to go up automatically, are not in a giving mood on the budget.  They, after all, hold the cards this time around - no budget can pass without the consent of the Republican-majority House.

With the debt-ceiling discussion wisely out of the way (sanity did prevail, as I'd hoped, on that topic, with the GOP agreeing to suspend the debt ceiling at least until mid-May, long after the budget battles), federal spending will be front-and-center in Washington.

These debates will play out over the next 1 to 2 months.

Rebuilding a Second-Term Cabinet
President Obama has some work to do.  Much of his first-term cabinet has left or is leaving.  Let's review the status of the key cabinet-level department head positions:

State Department
Hillary Clinton, as we all know, has moved on.  This is one that the President doesn't have to worry about as former Senator John Kerry has already taken the top job at state, confirmed easily by a 94-3 vote in the Senate.  He took office February 1st.

Treasury
Tim Geithner has already departed, officially resigning January 25th.  President Obama has nominated Jack Lew as his replacement.  Lew have his hearing in the Senate, but is widely expected to be confirmed, although he has generated some controversy.

Defense
Leon Panetta, President Obama's second Defense Secretary (his first, Robert Gates, was a keeper from the Bush Administration) is still in office but has asked to leave as soon as a successor can be confirmed.  Chuck Hagel just had his grilling this week before the Senate.  The majority of Republicans are expected to vote no for their dovish fellow Republican, but most expected that all 55 Democrats and Independents will vote for Hagel and that few enough Republicans will want a filibuster fight that he will ultimately be confirmed.

Attorney General
Eric Holder is staying, at least for now.

Interior
Ken Salazar has announced his desire to leave office in March.  President Obama has yet to nominate a successor.

Agriculture
Tom Vilsack has not announced his second term plans, but appears to be staying, at least for the time-being.

Commerce
This has been the most difficult cabinet position for President Obama.  Gary Locke, Obama's third nominee in his first term, finally took office in March of 2009, but stayed only 2 and a half years, basically competing the census and then departing.  Obama's second Commerce Secretary, John Bryson, lasted a mere 8 months, resigning after a bizarre incident involving a hit-and-run car accident and a stroke.  For the past 8 months, Rebecca Blank has been acting Commerce Secretary, awaiting an appointment and confirmation.  President Obama has yet to nominate a new Commerce Secretary.

Labor
Hilda Solis has already left office on January 22nd, leaving the post open.  President Obama has yet to name a replacement and most of his top picks from the world of labor are sure to generate controversy from Republicans.

Health and Human Services
Kathleen Sebelius appears to be staying, at least for now.

Housing and Urban Development
Shaun Donovan appears to be staying, at least for now.

Transportation
Ray Lahood is still in office but has announced his intention to leave when a successor can be confirmed.  President Obama has yet to name a successor.

Energy
Stephen Chu just announced this week that he will also be stepping down.  President Obama has yet to name a successor.

Education
Arne Duncan appears to be staying, at least for now.

Veterans Affairs
Eric Shinseki appears to be staying, at least for now.

Homeland Security
Janet Napolitano appears to be staying, at least for now.

So, to wrap it all up, of the 15 federal departments (I'm excluding "cabinet-level" positions that do not run a federal department) here is where President Obama stands:

Staying on from First Term: 7 (Justice, Agriculture, Health & Human Services, Housing & Urban Development, Education, Veterans Affairs and Homeland Security)
Nominee Already Confirmed: 1 (State)
Nomination Made But Not Yet Confirmed: 2 (Defense, Treasury)
Nominee Yet-To-Be-Named: 5 (Interior, Commerce, Labor, Transportation, Energy)

Clearly, the President has some work to do to rebuild his team.  This is doubly important given the significant budgetary changes to these departments likely to come down the pike with both sequestration and the continuing resolution battle in March.  Having interim leaders is not the best way to go ever, but is particularly bad when there are big changes coming.

Expect a flurry of nominations in the next few weeks as well as a lot of hearings and votes on nominees.  The President has named his most critical team (generally State, Defense, Treasury and Attorney General are considered the most critical positions in the cabinet), but there is much work left to do on the rest of the team.

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