U.S. Economy: GDP Shrinks at Fastest Pace Since 2001 (Update1)

Oct. 30 (Bloomberg) — The economy suffered its biggest decline since 2001 in the third quarter, ushering in what may be the worst recession in a quarter-century and boosting the chances of Barack Obama and fellow Democrats in next week’s elections.

Gross domestic product contracted at a 0.3 percent pace from July to September, according to a Commerce Department report today in Washington. The decline was smaller than forecast and stocks rose. Even so, the economy may be in for a larger drop this quarter after the record two-decade expansion in consumer spending came to an end.

“The crisis really kicked up in late September,” Ethan Harris, co-head of U.S. economic research at Barclays Capital Inc. in New York, said in a Bloomberg Television interview. “We’re going to be looking at a very unfriendly GDP number in the fourth quarter, with a drop of 2 to 4 percent.”

The weak economy has been bad news for Republican presidential candidate Senator John McCain, who’s fallen further behind Illinois Senator Obama as the credit crisis intensified. A Bloomberg/Los Angeles Times survey taken Aug. 15-18 showed McCain with 42 percent support to Obama’s 41 percent; five weeks later, the poll showed Obama leading 49 percent to 45 percent.

“The economy is playing very well for the Democrats, especially since the financial shock hit,” said Daniel Clifton, head of policy research for Strategas Research Partners in Washington. “People just got scared.”

Stocks Higher

Stocks, which were up in futures trading earlier in the day, remained higher after the GDP report. The Standard & Poor’s 500 Stock Index rose 1.4 percent to 942.73 as of 10:50 a.m. in New York. Benchmark 10-year Treasury note yields rose to 3.92 percent from 3.86 percent late yesterday.

The Federal Reserve yesterday warned of further “downside risks” even after cutting interest rates twice this month and pumping billions of dollars into markets.

The slump last quarter was the biggest since the third quarter of 2001, and follows a 2.8 percent growth rate the previous three months.

GDP was forecast to drop at a 0.5 percent pace in the third quarter, according to the median forecast of 75 economists surveyed by Bloomberg News. Estimates ranged from a 1.2 percent rate of expansion to a contraction of 1.9 percent.

The report is the first for the quarter and will be revised in November and December as more information becomes available.

Consumer Spending Drops

Consumer spending dropped at a 3.1 percent annual pace, the first decline since 1991 and the biggest since 1980, after President Jimmy Carter imposed credit controls. The median forecast was for a 2.4 percent drop.

The 6.4 percent rate of decline in spending on non-durable goods, like clothing and food, was the biggest since 1950.

Consumers have been hit by a triple whammy: rising unemployment, tightening credit and shrinking wealth.

Unemployment is at a five-year high of 6.1 percent and may rise to 8 percent by end of 2009, according to Jan Hatzius, chief U.S. economist at Goldman, Sachs & Co. in New York. Consumer borrowing fell in August by the most on record as banks tightened credit. And the steep drop in the stock market so far this quarter has wiped about $2.8 trillion from investors’ portfolios.

Cutbacks in investments in business equipment and less spending on residential construction projects also contributed to last quarter’s contraction, today’s report showed.

A narrower trade deficit and a smaller decline in inventories prevented a deeper contraction. Excluding those two categories, the economy would have contracted at a 1.8 percent pace, the most since 1991.

Inflation’s Last Burst?

The report also showed what may be the last burst of inflation before the economic slowdown forces companies to limit price increases. The price gauge rose at a 4.2 percent pace last quarter, the biggest gain in 17 years. Costs tied to consumer spending and excluding food and energy, increased 2.9 percent, the most in two years.

The Fed yesterday cut the benchmark interest rate by a half percentage point to 1 percent, matching a half-century low, and projected inflation would ebb.

“The intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit,” the Fed’s statement said. “The pace of economic activity appears to have slowed markedly.”

Campaigns Comment

Both presidential campaigns issued statements promising policies to revive growth.

“The decline in GDP didn’t happen by accident — it is a direct result of the Bush administration’s trickle-down, Wall- Street-first, Main-Street-last policies that John McCain has embraced for the last eight years and plans to continue,” Obama said in a statement. “We need to grow our economy by creating jobs, providing tax relief for middle-class families and helping people stay in their homes.”

McCain’s economic policy adviser, Douglas Holtz-Eakin, said in a statement that “the economy is shrinking” and “Barack Obama would accelerate this dangerous course.” He said McCain’s policies would lower taxes, “clean up Wall Street, clean up Washington and create nearly 2 million more jobs” while Obama’s would “destroy nearly 6 million jobs over the next decade.”

It’s the Economy

“The economy really does matter for elections,” said Ray Fair, a professor at Yale University. A macroeconomic model he’s developed to forecast the presidential elections put the odds of an Obama victory at about 80 percent, based on the latest GDP data. Fair said Obama’s chances of winning may even be larger than that as the economy looks to have deteriorated even further since the end of the third quarter.

The National Bureau of Economic Research, the Cambridge, Massachusetts-based official arbiter of U.S. economic cycles, has yet to call a recession.

The group bases its assessment on indicators including GDP, employment, sales, incomes and industrial production, and usually takes six to 18 months to make a determination. According to the NBER, the last recession lasted from March to November 2001.

Chief executive officers from Ford Motor Co., Starwood Hotels & Resorts Worldwide Inc. and Caterpillar Inc. are among those in the past two months that have said the U.S. is in a recession.

“Finally consumers have capitulated,” James Flaws, chief financial officer of Corning Inc., said in an interview on Bloomberg Television yesterday after the biggest maker of glass for flat-panel televisions forecast fourth-quarter sales and profit that missed analysts’ estimates.

Whirlpool Corp., the world’s largest appliance maker, this week said it’ll cut 5,000 jobs, and forecast lower annual profit as the credit crunch clipped sales. Williams-Sonoma Inc., the biggest U.S. gourmet-cookware chain, yesterday forecast a third- quarter loss because sales slowed “significantly” during the past six weeks.

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