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Don't be fooled by a strong GDP report -- America's economy is slowing down

Friday, forecasters expect the Commerce Department to report the economy grew a brisk 3.1 percent in the first quarter but don’t break out the champagne. Like a corporation with a spruced up profits statement at a critical shareholder meeting, several one-time factors contributed to this seemingly robust performance—the economy is already slowing and new crises are threatening.

In the fourth quarter, defense purchases and inventory investments were uncharacteristically weak and those rebounded in the New Year. Also, extraordinary year-end corporate bonuses and dividend payments, intended to soften the blow of higher 2013 taxes, pushed up consumer spending in January and February.

Those factors will not repeat in the second quarter, and January tax increases are finally starting to bite—consumers appear to have hunkered down, and confidence in the economic outlook is waning.

The economy is already slowing and new crises are threatening.

Higher payroll taxes and income taxes paid by the wealthy took away $165 billion in purchasing power. Working- and middle-class families adjust spending to accommodate higher taxes, but with a lag, because they need to keep driving to work and feeding their children—now car dealers and shopping malls report slowing sales.

For upper income families, changes in the tax code were extraordinarily complex, and many pay taxes on a quarterly basis on self employment and investment income. The full impact of higher taxes on their after-tax income was not reckoned until their accountants computed their first 2013 tax payment due April 15—now they will be trimming purchases too.

Along with sequestration, higher taxes will subtract more than $200 billion from household purchasing power and government spending—that will slow demand for what Americans make and GDP growth, and make jobs tougher to find.

A key element of the tax changes—reduced mortgage interest deduction—will dampen existing home sales. Aided by the Federal Reserve’s easy money policies and a surge of wealthy buyers from Europe’s troubled economies, speculative investors have been scarfing up properties in choice markets in Florida, New York City and elsewhere with cash offers that frequently squeeze out ordinary homebuyers seeking a permanent primary residence.

In several markets, prices have zoomed past what these ordinary buyer’s incomes will support; hence, speculators bets require that somehow after-tax household incomes will somehow surge permitting them to unload at a profit. That is a dubious assumption, and the speculative surge cannot end well—housing price increases will slow, plateau or could crash all together. The housing market bump to household wealth that supported consumer spending in recent months will relent.

Similarly, the Fed’s low-interest policies are boosting stock and agricultural land values—at a pace beyond what future profitability of either asset class should sustain. Either slower growing values or outright adjustments appear inevitable, and the resulting drag on consumer spending will slow the recovery.

The continuing surge of Chinese exports onto American store shelves, and weakening demand for U.S. products in recession torn Europe are dampening demand for U.S. manufactures. Japan’s weak yen policy is imposing tougher competition on U.S. automakers and other manufacturers of technology-intensive products. Already, the Commerce department reported durable goods orders fell 5.7 percent in March, indicating much slower sales going forward.

The bottom line: most forecasters expect growth to slow to less than 2 percent in the second quarter and to remain below 3 percent through the end of 2014.

Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, and widely published columnist. He is the five time winner of the MarketWatch best forecaster award. Follow him on Twitter @PMorici1.