Forget the slowdown in the US – the UK is the real worry

Markets got a bit of a surprise yesterday.

The US economy shrunk at the end of 2012. Everyone had expected it to grow by more than 1%. Instead, it slipped back by 0.1%. It was the first slip in three years.

That sounds like a disaster. But markets barely reacted.

So what’s going on? And what does it mean for your money?

Here’s why the shrinking US economy isn’t a disaster

Why did the US economy shrink in the last quarter of 2012? And why weren’t markets horrified by the news?

Let’s look at the reasons for the slump first. Firstly, defence spending dived by more than 20%. That knocked 1.3% off overall GDP growth. Secondly, inventories knocked another 1.3% off.

Those were the main factors driving GDP lower. And there are good reasons to consider them both as one-offs.

The slide in defence spending comes down to the threat of automatic spending cuts kicking in. If US politicians can’t reach a deal on the cuts in the next month or so, there will be some hefty cuts to government budgets. And the defence budget will be the hardest hit.

As Robin Harding and James Politi note in the FT, the last three months of 2012 marked the first quarter of the US fiscal year. So “the Pentagon had every reason to spend carefully, especially as it knew sequestration might bring a big cut in its budget”.

As for the drop in business inventories, all this means is that companies were selling stuff that they had in the stock room, and not replenishing it. Disruption to supply chains caused by Hurricane Sandy probably won’t have helped.

If corporate shelves are now bare, they’ll have to build up stocks in the current quarter. In other words, a drop in this measure is often followed by a rise, and vice versa.

Meanwhile, other aspects of the GDP figures did better than expected. Consumption grew more rapidly, and investment by both businesses and households was up too. This also suggests that consumers and companies haven’t been as rattled by the prospect of the ‘fiscal cliff’ as politicians like to argue.

“Frankly, this is the best-looking contraction in GDP you’ll ever see,” said Paul Ashworth of Capital Economics. “If this really was the start of a new recession, like the ones in 2001 and 2008, then we would expect to see GDP excluding defence and inventories falling too. Instead the growth rate is accelerating.”

America’s two massive advantages

Here’s what it comes down to. The US economy is still fragile, no doubt about it. The political squabbling over ‘cuts’ does have the potential to cause problems and panic in the short term. Debt is still a massive issue as well, and it’s going to be a much tougher long-term problem to deal with.

Of course, these problems are no different to the ones facing the UK and Europe. These countries all have huge levels of government and private debt, and no one is in agreement on the best way to deal with the problems.

But underlying all this, there are two obvious bright spots in the US economy that simply aren’t there in the UK or Europe. The first is the shale gas bonanza. Americans have cheap energy. The British, the Europeans, and even the Japanese, don’t.

This is a significant advantage. It helps consumers, it attracts businesses, and it’s inspired a gold rush in those states that are sitting on shale. We looked at this earlier in the week: The best way to profit from America’s cheap energy boost.

The second big advantage is the housing market. The US property market is still shaky. But it’s already suffered a brutal crash. You can’t say that for the UK. And other than in Ireland, where property prices have pretty much halved, you can’t really say it for Europe either.

So, as we’ve noted many times before, the spectre of a property crash is no longer hanging over the heads of US politicians, central bankers, and consumers, like a ten-tonne sword of Damocles.

The US housing recovery has been priced into many sectors, but there are still some ways to get in on the act. David Stevenson took a look at ways to play the rally a couple of weeks ago in MoneyWeek magazine – subscribers can read his piece here: American property has turned the corner – the time to buy is now.

The point is, these two factors give the US a headstart in the race back to the ‘old normal’. There might be another slide in US GDP this quarter, there might not be. It all depends on how they cook the books, and how the fight over spending goes.

But it doesn’t matter. By comparison to other developed economies, it’s going to look a lot better. And this is what concerns me most. So far, the financial crisis has very much been a case of “we’re all in this together” – one developed economy looks as bad as any other.

If the US pulls away, that’s going to leave the UK in particular looking very flaccid indeed. It’s one thing having a lacklustre economy when everyone else’s is rubbish too. It’s quite another when you start to stand out as the ‘problem’ economy.

I think 2013 could be very uncomfortable indeed for the UK and the pound. We look at why in more detail in the latest issue of MoneyWeek, out tomorrow.

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15 Responses

  1. 31/01/2013, P.E. Dant. wrote

    The past tense of the verb “shrink” is “shrank” not “shrunk” (which is the past participle). Journalists should not need to be told this.

  2. 31/01/2013, chris wrote

    Spot on.

    The threat is still from the governments wasting these advantages but at least they do have them. Meanwhile in the old world….

  3. 31/01/2013, jockey wilson wrote

    Quite right, the actions of the BoE are extremely harmful to this country. Its bail-out policy of zirp and QE is causing the economy to stagnate. Instead of clearing out the garbage of defunct companies and the over-indebted, its policy is allowing them to persist, thereby continuing the grotesque misallocation of capital. By not allowing property prices to correct downwards it is causing stagnation: banks don’t like lending against overvalued property (unless a whacking great deposit is available) and most people aren’t keen to buy a house at an inflated price. It is clear the BoE has no long term plan other than printing. [PE Dant - I'd recommend using a semi-colon to join your sentences as the latter refers to the former]

  4. 31/01/2013, David Britton wrote

    It isn’t right that only Ireland in Europe has had a property crash. I don’t know about other countries but I know for sure that both Greece and Spain have suffered huge falls in property prices.

  5. 31/01/2013, norman wrote

    i see the point of your article, but to me thats taking the view that stocks are still on the road to recovery. maybe if the DOW was still around 11 or 12000 then maybe, but its near enough right back to its ALL TIME top. to be at that level ,things have got to be jolly rosey indeed surely, without any threat of bad news whatsoever, especially considering the previous top itself was reached under such circumstances.

  6. 31/01/2013, Russell G wrote

    Lets compare like with like here. If you look at US house prices drops in dollar terms and UK house price drops in dollar terms then both have fallen virtually the same amount since peak (about 30%). The only difference is that in the UK sterling has taken much of the hit.

    For reference, here are my figures with sources:

    UK High (Q3 2007) – £184,131 from Nationwide HPI
    UK Latest – £162,924 from Nationwide HPI
    GBP:USD exchange rate in Q3 2007 ~2.00 from Yahoo! Finance
    GBP:USD exchange rate now ~1.57 from Yahoo! Finance
    US House Price Index High (Q2 2006) – 189.93 from S+P CS HPI
    US House Price Index Latest – 135.67 from S+P CS HPI

  7. 31/01/2013, Lumino wrote

    “It’s one thing having a lacklustre economy when everyone else’s is rubbish too. It’s quite another when you start to stand out as the ‘problem’ economy”

    Yeah… as investors the latter is by far preferable! When they were all lacklustre MoneyWeek was complaining how that meant we couldn’t export etc etc

  8. 31/01/2013, Boris MacDonut wrote

    #6 Russell. The Nationwide figures are pointless,they only look at mortgaged houses. Only 40% of homes are mortgaged. CEBR has House Prices nesarly back to the pre crash levels. Land Registry has them at close to £250k for England and Wales.

  9. 31/01/2013, Mike wrote

    http://www.landregistry.gov.uk/media/all-releases/press-releases/2013/market-trend-data-december-2012
    Is says that they are £162,080. Does someone want to remove Boris’ entry?

  10. 31/01/2013, John Junius wrote

    I like P.E. Dant’s name – very apposite!

  11. 31/01/2013, Ellen wrote

    It looks like we are entering a window of opportunity, if we could work out whether we are looking at inflation or deflation. In theory, I think your piece is highly enlightened except that Mr Benanke is a loose cannon and so, it is difficult, to keep faith in the US.

    I think Nixons (and Arthur Burns) monetary policies of the 1970s is relevant to where we are today. If it is, we are in for a rocky ride on interest rates and inflation!

  12. 01/02/2013, Teresa wrote

    Does anybody still believe government GDP statistics? It’s like government inflation figures.

    I don’t see the point in discussing them.

  13. 01/02/2013, crickster wrote

    yep, they should of got the interest rates up and let house price collapse, but instead printed funny money and put off the inevitable for a while longer, BOE were wrong, but I suspect severely leant on by 11 Downing st

  14. 02/02/2013, Pusser wrote

    @10. John Junius
    [I like P.E. Dant's name - very apposite!]
    I had to look that up. So little time- so much to learn.

    ……………….

    Re BOE andor Government. With reference to both or either making mistakes my view is that a mistake is an accidental action.

    Both these institutions are deliberately doing what is best for themselves and the government and not for the country and or taxpayer.

    Hasn’t this really been the case in the last forty years for the most important decisions.

    It is also ironic, again in my lowly view, that all the country’s problems are caused mostly by all the people I help pay to go to university. How can so much intelligent produce such so few, if any, positive results.

    P.E. Dant – You can have a ball with this one.

  15. 02/02/2013, Critic Al Rick wrote

    @14, Pusser

    Perhaps ‘intelligence’ needs redefining.

    Quote Einstein:
    “The true sign of intelligence is not knowledge but imagination”

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