Correction to This Article
An earlier version of this story featured a chart on the U.S. gross domestic product that did not reflect revised data released by the Bureau of Economic Analysis. The corrected chart is shown at right.
Economy Turning Out of Steep Dive
Slow to Spend Again, Consumers Could Be Holding Up Recovery

By Neil Irwin and Ylan Q. Mui
Washington Post Staff Writers
Saturday, August 1, 2009

The nation's economic decline is moderating, laying the groundwork for growth in the months ahead, according to new government numbers. But the fine print in Friday's report on the gross domestic product also shows a key threat to that expansion.

Consumers, who account for about two-thirds of economic activity, are still in lockdown mode, reluctant to buy. The job market remains weak, and even those who still have work are fearful of layoffs and are stung by lost stock market and housing wealth. The situation is underscored by a 1.2 percent drop in personal consumption expenditures in the second quarter, which occurred despite a tax cut.

"You don't know what's gonna happen," said Evelyn Daval, a Stafford County resident who has pulled back on major purchases as her retirement savings have dwindled. "You gotta have money in the bank."

The good news in Friday's report is that the nation's steep economic downturn eased in the spring, with economic output shrinking at a 1 percent annual rate in the April-through-June period. That compares with a 6.4 percent rate of decline at the beginning of the year, itself a downward revision from the 5.5 percent decline originally reported for the first quarter.

The improvement came about, in part, because of an 11 percent boost in federal government spending, along with a more modest decline in exports (down 7 percent, compared with a 30 percent drop in the first quarter).

Stocks ended the day little changed, as hints of consumer weakness dampened Wall Street's reaction to an otherwise upbeat report. Encouraging news on the economy has sent stocks soaring, with Standard & Poor's 500-stock index up more than 7 percent in July.

New revisions to data indicate that economic output was weaker throughout the past 19 months of recession than originally reported. The Commerce Department had previously estimated that GDP, which captures the value of goods and services produced within U.S. borders, rose 1.1 percent in 2008. That was revised down to 0.4 percent.

Businesses have been cutting to the bone -- including reducing inventories of goods by $141 billion in the second quarter.

At Gina Schaefer's six hardware stores in Washington and Baltimore, for example, a year ago they might have kept a month's supply of potting soil on hand. Now they carry enough to last a week. "We've focused on not having shelves stocked with products that won't sell for six months," said Schaefer, whose stores include Logan Hardware and Tenleytown Ace Hardware. "That's just wasted inventory dollars on the floor."

Similarly, businesses continued pulling back on investments -- with an 8.9 percent cutback in spending on buildings, equipment and software.

This steep retrenchment in the corporate sector could lay the groundwork for expansion in coming months -- clearing the deck, in essence. After all, a company cannot delay replacing worn-out equipment forever.

"Businesses have made very substantial progress in adjusting their costs, inventories and employment in the last few months," said Bruce Kasman, chief economist at J.P. Morgan Chase. "That suggests we're setting ourselves up for improvement into the second half of the year."

Analysts are also expecting a boost to GDP in the second half of the year from the end of the housing bust. Residential investment has fallen for 14 consecutive quarters, including at a 29 percent rate in the second quarter.

There are some big ifs attached to that forecast, however, with the biggest being the fragile American consumer. For a sustained recovery to kick in, expanding production by businesses will need to result in a more steady job market and greater consumer confidence, even optimists acknowledge.

So far, that doesn't seem to be happening. The Conference Board's index of consumer confidence fell in July for the second month after rising sharply in the spring, with the slumping job market clouding consumers' assessments of their financial situations. Even those who have higher incomes seem to be saving rather than spending; savings rose to 5.2 percent of disposable income in the second quarter, up from 4 percent in the first quarter.

In particular, people are avoiding big-ticket items. Sales of durable goods, those expected to last more than three years, were down at a 7.1 percent rate, compared with a 2.5 percent drop in spending on nondurable goods.

That is visible at Suraphel Worku's watch and jewelry shop in the Fashion Centre mall in Pentagon City, where sales of new items have plummeted.

"People, instead of buying stuff, they choose to fix it instead," Worku said, leaning over a case of gold and diamond jewelry discounted 40 percent.

He doesn't blame them. He said he has also dramatically cut his personal spending. A movie fan, he stays home from the theater and reads books instead.

"More consumers are pessimistic about their income expectations, which does not bode well for spending in the months ahead," said Lynn Franco, director of the Conference Board's Consumer Research Center.

Federal Reserve Chairman Ben S. Bernanke has identified the troubled American household as one of the risks to a recovery. "The possibility that the recent stabilization in household spending will prove transient is an important downside risk to the outlook," Bernanke told Congress in July.

Staff writer Jonathan Starkey contributed to this report.

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