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

Britain can only look on in envy as America shrugs off its latest contraction as a hiccup. And things are set to get worse for the UK, says John Stepek. Here's what that means for you.

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.

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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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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.