2020 Worst Since 1946

Real GDP growth rose only 4% in the fourth quarter after surging at a 33.4% pace in the third quarter. The slowdown left growth for the entire year 3.5% in the red. That is the weakest growth that we have seen since millions of soldiers returned from WWII in 1946. Fighting the pandemic should be equated with that of fighting a war that must be won. Growth appears to be slowing even further in the current quarter as the virus mutates.

The Federal Reserve has been consistent in saying that the course of the virus determines the course of the economy. The Fed added a phrase to that sentence in its assessment of the economy yesterday: “progress in vaccinations.” We are in a race between the spread of more contagious (and possibly more lethal) variants of the virus, and reaching herd immunity with vaccinations. The economy cannot fully reopen until the virus is wrestled to its knees via a combination of vaccinations, masks, testing, tracing and therapeutics.

The composition of GDP growth in the fourth quarter revealed the uneven impact that the virus is now having on the economy. Consumer spending slowed dramatically as a surge in spending on health care offset a drop in spending on goods. The drop in spending at grocery stores, liquor stores, restaurants and bars was especially dramatic when the saving triggered by the CARES Act ran out. Hunger and homelessness intensified before another round of aid was agreed by Congress in the last days of December.

Business and residential investment were drivers of overall growth. Investment in new equipment drove a double-digit rise in investment in the fourth quarter but failed to bring investment back above year-ago levels, which were already dismal. Even before the COVID crisis, business investment had slowed to a crawl in 2019 in response to the trade war with China. We lost more than 200,000 manufacturing jobs in 2019 before the crisis hit, a fact that too often was lost in the political rhetoric regarding the economy.

Residential investment surged at a 33.5% pace in the fourth quarter after jumping at more than a 60% annualized rate in the third quarter. A pickup in single-family home buying and building drove those gains. The single-family housing market is the only sector that has fully recovered and then some from the crisis, as those who could afford to took advantage of record-low mortgage rates and bought first and second homes.

Inventories continued to be rebuilt in the fourth quarter after draining rapidly during the first half of the year but ended 2020 down quite significantly from the pace of inventory accumulation in 2019. Everything from supply chain disruptions to the push by retailers to reduce inventories to mitigate fire sales accounted for the weakness.

The trade deficit widened in the fourth quarter and the year as a slowdown in exports failed to offset the influx of imports. Much of Europe went into renewed lockdowns as the virus surged again, which undermined the recovery in U.S. exports. Global trade still recovered much faster than many expected for the year as the trade deficit essentially finished the year unchanged.

Government spending fell in the fourth quarter. Losses were experienced at the federal, state and local levels but hemorrhaging at the state and local levels dominated declines. The contraction in state and local government spending underscores the need for transfers to the states in the next aid package. The risk is that we repeat the mistakes coming out of the 2008-09 recession, when austerity measures exacerbated cuts in state and local employment.

Bottom Line
The economy technically emerged from recession in the fourth quarter, with two quarters of growth now behind us. That provides little comfort to the nearly 10 million workers who are still out of work, the millions more who are self-employed or working part-time because they can’t get enough hours or those who have dropped out of the labor force to care for children not at school. This is a point that Federal Reserve Chairman Jay Powell emphasized in his comments following the FOMC meeting yesterday. We are still down by as many jobs (even more on a numerical vs. a percentage basis) than we were during the height of the 2008-09 recession, one year after the onset of the pandemic. Recent data on initial unemployment claims suggest that we likely lost ground again on employment in January.

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