More than half of U.S. third quarter economic growth came from private consumption as households drove their savings rate down to 3.3% -- the lowest reading in the last 17 years.

Other growth sources, such as defense spending and export sales, are equally tenuous as a result of binding budget constraints and flagging external demand.

What we have here is a very weak and unusual composition of American aggregate demand. A much broader, and stronger, activity pickup is needed to lead the U.S. economy to a steady expansion path after two consecutive quarters of negative growth.

The U.S. consumer is a spent force. During the first nine months of this year, the real personal disposable income fell at an average annual rate of 7%. In spite of that, private consumption (70% of GDP) still managed to grow in the third quarter because people continued to draw down their savings.

Most of the consumer spending went to increasingly expensive housing and utilities, transportation services and healthcare. But, ominously, households continued to cut their outlays on durable and nondurable goods.

Revive a struggling U.S. economy

That trend is set to continue. The housing demand (i.e., residential investments, another 4% of GDP) literally collapsed during the third quarter, falling at an annualized rate of 26.4%. That will further depress demand for consumer durable and nondurable goods as rising credit costs continue to contract the home buying.

More fundamentally, the variables driving directly those 74% of U.S. economy – employment, disposable real incomes and credit costs -- look as bad as ever. 

The U.S. labor market leaves 100 million Americans (38% of civilian population) out of gainful employment. Those are the people who are virtually unemployable for lack of skills and vocational training.

Things get even worse when one looks at how much of the active labor supply gets a stable employment. That’s when you can see that the officially reported jobless rate of 3.5% (for September) goes to 9.3% because there are 3.8 million people working part time because they cannot get a full-time job, and there are also 5.8 million who dropped out of the labor force because they could not find a job.

No wonder that consumer confidence has sunk to recession levels.

The U.S. business community seems to share the same view. An 8.5% annualized decline of capital outlays (18.4% of GDP) in the third quarter means that gloomy sales prospects are bringing down demand for new machinery and larger factory floors.

That, in fact, is the most reliable indicator of an unfolding recession dynamics.

It is, therefore, clear that rising defense spending and unexpectedly strong exports observed during the third quarter cannot offset the weakness in 92.4% of domestic demand (household consumption, residential and business investments).

Monetary policy should not fight a sanctions-driven inflation

Looking ahead, the U.S. inflation is the most important number to watch, because that will determine the pace of ongoing credit tightening and the ensuing process of economic activity and employment creation.  

The latest survey data suggest that prices in service and manufacturing sectors continue to rise at a steadily slowing rate. That decelerating price inflation is especially pronounced in the contracting manufacturing sector (about 10% of the economy). But even in a much stronger service sector, there is evidence of a sustained easing of inflation pressures.

Do we have a piece of silver lining here? I believe we do.

Think of this: With a GDP growth at annual rates of 1.8% in the second and third quarters, the U.S. economy is now moving along its potential and noninflationary growth path. That means that current inflation pressures are not caused by excessive aggregate demand. No, inflation is driven by soaring energy and food prices as a result of a pervasive trade warfare (sanctions) that is drastically constricting energy and food supplies.

In view of that, fighting such an exogenous inflation shock with sweeping interest rate hikes is an inappropriate use of policy instruments. The correct policy assignment should be to use specific – in this case non-economic -- instruments to restore the demand-supply balance in energy and food markets affected by ongoing hostilities.

It appears that the European Central Bank was waiting for such a political action in its much-delayed move on interest rates. That was a reasonable policy option, because credit tightening in a weakening economy will kill off aggregate demand without any meaningful inflation relief in a war-ravaged Europe.

That’s precisely what the E.U. got: a growth stagnation during the third quarter while inflation in October surged to 10.7% from 9.9% in the previous month.

To save the trans-Atlantic community from economic recession and a socio-political turmoil, Washington should stay the Fed’s hand and use other means to tame inflation by unblocking energy and food supplies.