2011 Kickoff

If you are like me you have probably already seen enough college football to last you until next Fall. But then, not many people would admit to being like me so let’s switch our attention to Brett Favre’s sexual exploits. That’s not what I meant. I meant Roethlisberger’s sex habits. No that’s not what I meant.

At this point you have either gone bowling or you are actually reading in excitement. So let me take advantage and switch to the economy and its performance in 2011. I am writing this on January 4^th so not much of 2011 is in evidence but I have noticed that the stock market has been very happy. That makes us retirees and hopeful retirees very happy. But will the fun continue?

That’s the $64,000 question and if that doesn’t date me then holy cow, what else could Edith? Those of you with short-term memories will remember that last year around this time we were very optimistic about the US economy but by spring and the unfolding of too much negative information about gyros and other Grecian statistics, we were wondering if we were in for a double dip – meaning that the US economy would fall from Grace and re-enter purgatory or even worse, you would receive a four-day visit from your closest relatives.

It took a while to climb out of that worrisome economic hole but here were again waiting for another Super Bowl and wondering if the economy will resume a clip fast enough to make a dent in the unemployment rate.   Macro is a great tool but being a practitioner of it doesn’t mean that I can forecast the economy for the rest of 2011. It is too bad that professional talking heads and journalists don’t have some humility because they get us all revved up for nothing but their own fame and wealth. They don’t know any more than we do but they sure look solemn and professional when they tell us about the future.

So if you have nothing better to do let me spend a little time explaining why I am generally optimistic but why I am not betting Betty’s Genesis on any particular outcome. What I do below is to explain why I think we might continue to recover but why there remain challenges that will impact the path of recovery. First, it seems to me that time has helped to heal the economy. While the stimulus policies helped to prevent a more severe downturn the main benefit is that the economy has mostly run its downward course. You don’t spend 10 years in rehab every time you get sick. The economy was not permanently injured by the factors that came together in 2007and thereafter to generate the recession.  The economy got punched and we adjusted to the punch. It was a hard punch so it took a while to digest. The good news is that we are on the mend.  The worst is over. The patient is on an upswing. But let’s not get too crazy.

Second, we still have some lingering problems. For example, housing experts believe that the foreclosure issue is still with us in 2011 (and beyond) and that means that housing prices may have to adjust downward another time or two. Most reports, I believe, see this as an orderly process. I interpret this to mean that housing news is 2011 won’t be good but it won’t interrupt too much the faster growth coming from other sectors of the economy.  I would expand this line of reasoning to include the broader financial system. While regulations have not addressed our problems adequately (too big to fail is one) I think time has helped to resolve the worst problems and debts are being worked off in the private sector.  As long as we don’t learn really bad unexpected news from housing or the financial sector, these sectors will only provide a small drag as we go forward.  Of course, that is one risk factor. If there are new unpleasant discoveries in the financial and housing sectors, then anything could happen.

Third, the big news item right now concerns US government debt and what our leaders in the government are going to do about it. There is the political silliness about extended the debt ceiling. Ignore that. We will not reneg on our national debt and everyone knows that. You guys have really fat wallets and the government has the ability to create infinite amounts of tax revenue at any time. So stop with that nonsense. What does matter is how we deal with reducing the debt. We REALLY need to have a plan and we have one brought forth by a commission at the end of 2010. The plan does not have to create extreme austerity forever and it does not need to create any real austerity until several years hence. But it does need to have an explicit and impossible to wiggle out of plan that reaches into the future. It must have credibility to bring government debt-to-GDP ratios back down to long-term averages.  Should our leaders legislate such a plan in the next few weeks that event will help the economy grow stronger now. Without it, we will lumber forward on the edge of a knife blade until the bond vigilantes get tired of harassing others.

Fourth – whether you call them bond vigilantes or simply grandma and grandpa – any hint of a significant resumption of the disastrous spending and saving performances of either our private or government sectors is going to lead to a economic calamity. Just like your child, presently a freshman  at Spendthrift U who cannot be given your credit card in his second semester,  our nation will not be able to find anyone willing to take the risk of lending us money – that is, buying our stocks and bonds . This eventuality will have the effect of raising interest rates, reducing the values on the stock market, depreciating the dollar and generating very slow growth – if not another recession.

So there we are.  We could have a nice reasonable story for the continuation of the recovery. But there are critical factors which include, at minimum, continued improvements in national saving and no unexpected or severe deterioration in housing or financial markets. With luck we might even see the unemployment rate begin to fall.  There is no magic to getting the unemployment rate back to 5%. In fact, I am guessing that what we call the “natural rate of unemployment” has significantly increased since firms have now found ways to reduce the employment factor in production for three years. Even with a spurt of sales I doubt they will go back to employment levels of 2007.

With households and governments taking years restoring saving balances, economic growth should not be spectacular. That is, do not expect a typical fast-paced recovery now nor in the near future.  Reality suggests that once firms become even more confident and optimistic about the future both output and employment will grow – the GDP gap will shrink and the unemployment rate will fall. This confidence will result from more time passing and the absence of negative surprises. So a gradually improving economy is possible. But those negative surprises with respect to housing, finance, and government debt policies suggest the possibility of something worse.  Time is on our side. Let’s hope our new government in Washington has the sense to minimize and not aggravate those things which will put us in reverse.