Did Washington Just Hit Our Economy?

A gigantic amount of literature on the effects of big elections on business cycles exists. The recent +3.1% surge in Q3 real GDP and its subsequent fall to -0.1% in Q4 makes me suspicious. I proceeded to investigate.

Here are my findings. All data in charts can be found at www.bea.gov

The Public Sector Story

First, I looked at the Federal contribution to real GDP growth versus that made by State & Local governments. What did I learn? Contributions from State & Local government to real GDP growth steadily rose over the last three years. These administrations appeared to gain traction from reviving local economies. In contrast, Federal spending jumped up-and-down.

The culprit? — National Defense, NOT Non-Defense spending.

What appears to happen?

These days, Defense spending hits the Second and Third Quarters of an annual budget. This alludes to a calendar-year process. Defense funding is approved, then actual funding disbursement hits a couple quarters later, where GDP accountants pick it up.

The 2012 election year provided a fresh nuance. The largest Defense contribution over the last three years happened in Q3. It was then followed by the largest Defense spending fall-off in three years in Q4.

Hmmmmm… that looks like an election-related event!

Did Defense spending get pulled forward?

Were contractors and the DoD trying to head off vast uncertainties coming from the Presidential Election and Fiscal Cliff negotiations? I have to believe the answer is YES. Two election and negotiation bottlenecks coming together must have forced deals and spending to close in front of the uncertainty. That takes care of a budget and election cycle within Washington DC itself.

Now, the Nation’s Private Economy

First, note in charts below contributions from Private Inventory clearly outweigh effects of Federal Defense. Not surprising. The private economy is much larger.

However, note in the charts Q4 was the FIRST TIME in three years of data where BOTH National Defense and Private Inventory contributions fell off.

That is suspicious!

Did businesses hold off on inventory re-stocking until the New Year, perhaps on concerns about Xmas season, the Presidential election and the Fiscal Cliff?

We will never know for certain. We do know businesses were more concerned than consumers, and it reached into capital spending and hiring sentiment. It should be no surprise businesses stayed lean on inventories. Uncertainty kills investment.

But evidence on the Private Inventory build and the subsequent fall-off is less conclusive on the effects of the Presidential Election and Fiscal Cliff. We do see a long inventory pull-down across most of 2011. This Q4 reduction is not out of line with those 2011 quarters.

All in all, I would conclude this:

Given the obvious pull forward in Defense spending, and that for the FIRST TIME in three years BOTH private inventories and Defense spending fell simultaneously, we had an election and budget negotiation event.

Call it a "politics effect" on the economy, "Federal government driving macro," or a "fresh twist in a political business cycle." It doesn’t matter.

There is something to That Line of Thinking.

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