A Sign of Better Days to Come

Story Highlights:

• Q2 US GDP was revised up to -0.7% annualized from the previous estimate of -1.0%.
• Cumulatively, recent GDP reports and other measures of consumer spending show personal consumption is more stable than folks think.
• Contrary to popular opinion, the overall GDP decline has been mostly due to businesses curbing investment and spending.
• The US still lags the world a bit in recovery, but the improving world will pull the US along, not the other way around.

Revised Q2 US GDP data released Wednesday showed the US economy shrank less than previously estimated—down -0.7% instead of down -1.0%. And much better than the big annualized 5.4% and 6.4% drops in Q1 2009 and Q4 2008, respectively. In general, a lot less bad than most would have thought six or even three months ago. And amazingly, though folks still fear consumer spending won't rebound—and stall recovery—consumers and renewed growth abroad are likely to lead our economy in the right direction.

The truth is, through this and every recession, it's common to read stories about the "death" of "the consumer." Data show overall personal consumption today hasn't fallen off a cliff as folks widely feared it would. (Nor do we know who this one "consumer" is.) In fact, consumer spending is more stable than most think. Spending on things like clothing, new cars, and jewelry has indeed fallen, but it's normal for folks to rein in discretionary spending during a downturn. And these types of items account for a relatively small portion of overall consumption, while spending on services like health care and housing account for the lion's share. Most of the goods we buy tend to be boring, inelastic staples (think toothpaste, paper towels, and soda), and we keep shelling out for those even when times get tough.

Consumer spending just didn't fall that much this downturn. Instead, the overall GDP decline had much more to do with businesses curbing investment and spending. From Q2 2008 through Q2 2009, total real economic activity slumped -3.8%. Personal spending actually fell just -1.7%, while business spending fell -20.0%. (And this pattern is repeated in most recessions—personal spending stays relatively stable while other areas fall much bigger.) The good news? As we saw in last quarter's positive earnings surprises, firms got leaner through the downturn and therefore performed better than expected. And because consumers are still spending, they're burning through today's lean inventory—and depleted firms will eventually have to increase capital spending and production to restock shelves and meet rising demand, providing a boost to the economy.

While the Q2 revision upward is nice, it's backward-looking, and doesn't say much about what happens next. But many developed nations (Canada, Japan, France, and Germany, to name a few) are already pulling of out of recession, and overall, emerging markets are speeding up too. The US may lag the world a bit in recovery—but the US is just 25% of world GDP. The much bigger non-US world is improving and will pull the US along for the ride, not the other way around.