The U.S. economy contracted slightly in the final months of 2012, as defense spending plummeted and businesses depleted their inventories, in a surprising development that could presage economic troubles to come.
Gross domestic product fell at a 0.1 percent annual rate in the fourth quarter, the Commerce Department said Wednesday, far below the 1.1 percent gain that analysts had forecast. The number will be revised extensively in the months ahead as more complete data becomes available, but if the number stays in negative territory, it would be the first contraction for the U.S. economy since the second quarter of 2009.
The good news is that the biggest factors in the decline arent expected to repeat themselves. Underlying growth in consumer and businesses spending was reasonably strong: Personal consumption expenditures rose at a 2.2 percent annual rate, while business spending on equipment and software rose at a gangbuster 12.4 percent rate. Housing continued a bull run, with residential investment rising at a 15.4 percent annual rate for its seventh straight quarter of expansion.
The contraction was caused by two overwhelming factors, and they were doozies.
First, federal defense spending fell at an astounding 22.2 percent annual rate in the quarter, which subtracted 1.28 percentage points from GDP growth. That was in part a reversal from the unusual 12.9 percent gain in the third quarter. But when the two quarters are averaged together, the defense sector was a drag on the economy in the second half of 2012 and thats before a sequester of automatic defense cuts goes into effect this year if Congress doesnt act to avert it.
A drop in business inventories was the second major drag on growth. Firms drew down their inventories by more than $40 billion, which subtracted 1.25 percentage points from GDP growth. With companies focusing on selling goods already sitting on their store shelves and in their warehouses, production in the nations farms and factories was not as high as one might expect given consumer and business spending.
But businesses cant simply run down their inventories forever, and that bodes well for future growth. Final sales, which add inventories back in, rose at a 1.15 percent rate.
A third and smaller factor in the contraction was a sharp decline in exports amid a slower world economy. Overall, trade subtracted 0.25 percentage points from the growth rate.
Overall, it was a bad quarter for the U.S. economy, but not nearly as bad as the overall negative number would suggest.
The economy ended 2012 on a very sluggish pace, even though onetime factors put the number below the trend, said Kathy Bostjancic, an economist at the Conference Board.
GDP is the broadest measure of economic output, aiming to capture the value of goods and services produced within U.S. borders during a given time. The data over the last three years show an economy stuck in a pattern of steady growth thats not strong enough to significantly push down unemployment nor weak enough to sink the nation into a new recession.
Still, there are reasons for concern in 2013: While consumer spending held up in the final months of 2012, that was before the payroll tax break expired in January, siphoning income from workers paychecks. And if negotiations over the sequester force steep cuts in defense and other government spending in the months ahead, GDP could suffer a steeper decline.