Here is something I have been talking about for a year. Think the Economy Is Bad? Wait Till the States Cut Back.

Struggling as we are with the housing bust, the credit crunch, shrinking consumption, rising unemployment and faltering business investment, we can be forgiven for thinking that all the big shoes have dropped. There is another one up there, however, and it is about to come down.

State and city governments have yet to shrink the economy; indeed, they have even managed to prop it up. They have quietly maintained their spending at pre-crisis levels even as they warn of numerous cutbacks forced on them by declining tax revenues. The cutbacks, however, are written into budgets for a fiscal year that begins on July 1, a month away. In the meantime the states and cities, often drawing on rainy-day savings, have carried their share of the load for the national economy.

That share is gigantic. At $1.8 trillion annually in a $14 trillion economy, the states and municipalities spend almost twice as much as the federal government, including the cost of the Iraq war. When librarians, lifeguards, teachers, transit workers, road repair crews and health care workers disappear, or airport and school construction is halted, the economy trembles. None of that, or very little, has happened so far, not even in California, despite a significant decline in tax revenue.

“We are looking at a $4 billion cut to public schools and deep cuts that will result in thousands of Californians losing their health care,” said Jean Ross, executive director of the California Budget Project, offering a preview of coming hardships. “But the reality is we have not pulled money off the streets yet.”

Quite the opposite, the states and municipalities have increased their spending in recent quarters, bolstering the nation’s meager economic growth. Over the past year, they have added $40 billion to their outlays, even allowing for scattered spending freezes and a few cutbacks in advance of July 1. Total employment has also risen. But when the current fiscal year ends in 30 days (or in the fall for many municipalities), state and city spending will fall, along with employment — slowly at first and then quite noticeably after the next president takes office.

Sometime next year, the decline will reach an annual rate of $50 billion, Goldman Sachs estimates. “It is a big reason to expect a weak economy in 2009,” said Jan Hatzius, chief domestic economist at the firm.

The $90 billion swing — from more spending to less — could be enough to push down a weak economy to zero growth or less, because state and city spending has accounted for as much as half of total economic growth since last fall.

Economy In Recession

It’s time to end the fantasy that the economy is still growing.

It is perfectly clear (or at least should be perfectly clear) that the US is in recession. The only reason the first quarter GDP is positive is that the GDP deflator was a shockingly low 2.6%.

1st Quarter GDP Deflators
2004 Q1 – 3.8
2005 Q1 – 3.9
2006 Q1 – 3.4
2007 Q1 – 4.2
2008 Q1 – 2.6

Last 4 GDP Deflators

2007 Q2 – 2.6
2007 Q3 – 1.0
2007 Q4 – 2.4
2008 Q1 – 2.6

Is there anyone who thinks those deflators are reflective of prices? For more on prices please see CPI Numbers For April: Spotlight On Energy.

This administration is pulling out all the stops so as not to report a recession in the last year of his term.

It’s even worse than it looks given the first 2% of reported GDP is a complete fabrication of reality. I make this claim based on hedonics and imputations of assumed transactions that do not even take pace. The two biggest adjustments the BEA makes are the presumed amount of rent one would collect if homeowners paid rent to themselves.

Believe it or not the BEA factors in rent people are presumed to have paid themselves and adds that number to the GDP.

The second big absurdity is the value of free checking accounts that the BEA thinks should not be free. The value of free checking accounts is also added to the GDP.

The Debate Is Over – We Are In Recession

No matter how you slice it, we are in recession. Furthermore, it is 100% guaranteed that the next administration will have the BEA go over the numbers to backdate the recession and blame it on Bush.

That makes the whole GDP/Recession thing a freaking joke, at least from a reporting standpoint. From a practical standpoint, state and local spending are going to be a huge drain on GDP headed forward. Things are going to get a lot worse before they get any better.

Mike “Mish” Shedlock
Click Here
To Scroll Thru My Recent Post List