Guest Blogger 2012: What’s Ahead for the World Economy by John Manzella

Slow growth, high unemployment, political gridlock, European fallout, Chinese tension, and a bright spot in manufacturing.

Caution, volatility and uncertainty are three key words we will continue to hear in 2012. Due to slow economic growth, which is projected to hover around 2 percent, the unemployment rate likely will continue to remain in the 8 to 9 percent range this year. Prior to the Great Recession, the United States had not experienced similar unemployment levels since 1983. When including those who have stopped looking for work or have reluctantly accepted part-time jobs, the rate could be as high as 16 percent, analysts say.

Several factors will continue to put a drag on growth. For example, some estimates indicate one in five homeowners owe more on their mortgages than their homes are worth. Until home values stabilize and consumers feel more confident about their future, consumer demand, which typically represents 70 percent of gross domestic product, will continue to lag.

In addition, declining U.S. federal and state government spending will depress U.S. growth in 2012. And with the presidential election this November, we can expect continued gridlock and an inability of our policymakers to come together to execute necessary reforms, restructure entitlement programs, increase investment in education, research and infrastructure, and improve immigration laws and the tax code.

Gerrymandering, the redrawing of congressional districts to assure dominance by one party over the other, shares some responsibility. It has enabled politicians to stake out extreme positions and no longer seek approval of the moderate-voting public. This makes compromise difficult.

European Fallout

A major factor impacting U.S. growth this year will be the European debt crisis. Although this was a big story in 2011, its impact certainly will be felt in 2012.

On a cumulative basis, Europe is the source of 72 percent of foreign direct investment in the United States. It‘s also the destination of 22 percent of our exports. A disruption in U.S.-European trade and investment, as well as major European defaults, can have serious consequences on this side of the Atlantic.

The 27 members of the European Union (EU) have different economies, fiscal disciplines, democracies, histories, values, and languages. Holding together a group this diverse is difficult in the best of times. Now, due to its debt crisis, many are wondering if the eurozone, the 17 EU member countries using the euro, will survive.

An underlying problem with many EU members has been their inability to adapt to globalization. When a country recognizes the rules of the free market and globalization, and decides to abide by them, it puts on what author and New York Times columnist, Thomas Friedman, in 1999 called the “Golden Straitjacket.” But to fit, Friedman said, countries must adhere to various policies to enhance national competitiveness.

The United States began squeezing into the Golden Straitjacket in the 1980s. However, one could argue that Greece, and perhaps Spain and Italy, haven’t donned the straitjacket or, in some ways, adapted as well to globalization as the United States or several northern European countries like Germany, Austria and the Netherlands.

Stronger American Manufacturing

According to the Institute for Supply Chain Management, economic activity in the manufacturing sector expanded in December for the 29th consecutive month. Output will continue to rise as it has for decades. Surprising to many, American manufacturing value-added output has tripled since 1980, rising from $558 billion to $1.7 trillion in 2010.

However, due to new technologies and automation, fewer employees can produce much more in less time. Consequently, manufacturing employment has fallen from its high of 19.5 million in 1979 to 11.7 million last November. In December, Americans were reminded of this fact by President Obama, who said “Steel mills that needed 1,000 employees are now able to do the same work with 100 employees, so layoffs too often became permanent, not just a temporary part of the business cycle.”

In turn, labor as a percentage of a product’s total costs has decreased to approximately 10 to 30 percent, on average, analysts say. As the labor component continues to shrink, and Chinese labor rates, fuel costs and expenses related to long distance supply chain logistics continue to rise, it makes sense for some U.S. producers to “backshore” or return previously offshored manufacturing from China to the United States.

Rising U.S.-Chinese Tensions

Due to upcoming U.S. elections and the selection of new Chinese Central Committee members, including China’s presidency, expect harsh rhetoric on both sides this year to escalate as political candidates pander to their constituents. Plus, difficult issues, including piracy of American intellectual property, the protection of certain Chinese strategic sectors, and the Chinese military buildup, will continue to fuel the fire. But the currency issue will continue to remain a primary irritant.

Since July 2005, when the Chinese yuan, also known as the renminbi, was allowed to climb in value, it has risen from about 8.28 to nearly 6.36 per U.S. dollar. Nevertheless, most economists agree that it still is considerably undervalued giving Chinese exporters an unfair advantage that’s boosting the U.S. trade deficit. But much of the tension here is caused by misinformation. Why? The true U.S. trade deficit with China is not accurately reflected in conventional trade statistics. Thus, Chinese value-added, as a component of Chinese exports to the United States, is about 50 percent, according to the U.S. International Trade Commission. Others put this figure much lower.

Consider Apple’s Ipod. When imported into the United States from China, the iPod‘s value is identified at approximately $150. Yet, only about $4 of this is Chinese value-added derived from Chinese labor and components, according to the University of California. The remaining $146 represents the value of components produced in the United States, Japan, Singapore, Taiwan, and Korea. Nevertheless, $150, not $4, is added to U.S. import statistics, artificially increasing the U.S.-China trade deficit.

Long-Term Optimism

Although our economy will remain weak this year, American optimism, free market capitalism, acceptance of immigrants and a brilliant Constitution will propel the United States forward for generations to come.

John Manzella is a frequent speaker, author of "Grasping Globalization," and president of Manzella Trade Communications (www.ManzellaTrade.com), a strategic communications firm focusing on global business and today’s leading economic issues. His firm provides insight and analysis, and crafts communications programs to help clients educate stakeholders and decision makers. Services include custom publishing, public affairs, public relations, marketing, consulting, and speaking engagements.

Federal Reserve Process and Bratwurst

Isn’t it interesting that the Fed is making noises now about the process of monetary policy.  It reminds me of sausage-making despite the fact that I have never really engaged in that process. I am, however, the final consumer. I can think of nothing better than being in the Hanover train station in Germany and ordering a brat from a vendor. For about 2 euros he would quickly dispense a well-browned brat surrounded by a small hard roll – more a handle than an actual roll. Anyway, my mouth is watering as I think about those German brats. What was I writing about? Oh yes, the Fed and process!

So long as the brat tastes good and doesn’t kill me, what do I care what order they mix the meats? Or whether they stir or shake the ingredients? I don’t really want or need to know the exact percent comprised of pork and chicken? I just want the darn thing to be tasty and get me to the next train station. Most of us feel the same way about Fed policy. Most of us know almost nothing about required reserves and interest rate forecasts, and policy rules. We hope the experts know a lot about these technical things and they do their jobs well.

So why is the Fed spending so much time talking about inflation targeting and policy transparency? Why now? I believe this is a perfect example of them trying to get us to take our eyes off the proverbial ball. This is like the teenager sneaking in at 3 am getting caught and quickly asking his parents whether he should apply to IU or Purdue upon finishing his senior year of high school.

I am not trying to say that inflation targeting and policy transparency are unimportant monetary issues. But what I am trying to say is that the Fed wants us all thinking about these issues rather than observing that there is a bull in the china shop. So let’s quickly review the bull in the china shop. The Fed is a central bank and as such is supposed to supply money to the economy. Every economy needs money because money is the stuff you buy things with.  I know that you use a credit card but at the end of the month you need to send the credit card company money. Unlike regular stiffs like you and me, the Fed is given the right and the responsibility to create money. Talk about a cool job. What do you do sir? I work at the Fed and I create money. Now that is cool. Really cool.

Many critics of the Fed have pointed out that since the Fed does not have to dig up gold or do anything arduous to increase the amount of money in circulation, that this creates too much temptation to spew the stuff out as if it was JD at 2 am at your favorite local watering hole.  But there have been plenty of central banks at many times and places that have overcome the urge to spew in favor of more conservative policies. That is, despite a public outcry for more money, some central banks have simply said, nyet, and explained that their job was to make sure the economy only had enough money to meet the needs for transactions without causing unsightly inflation.

You do not have to be a mathematician to know that in the last few years the Fed has emitted enough money to sink an Italian cruise liner. It is also easy to learn that the recession was over a long time ago. It is time to be thinking about withdrawing a little of that overhang but alas there are still folks at the Fed who want the flexibility to goose the economy on and on and on.  But instead of public discussions of the pros and cons of such policies instead we get the gobbly gook of policy transparency and inflation targeting.  Gee mom I was camping with Pete when it started to rain and somehow someone spilled liquor all of me and I don’t know why I smell like a cigar. And I was at the library too.

Transparency means we get to learn more about the sausage-making. Transparency seems to mean that we will learn regularly what Fed officials think about the future. We will learn about their forecasts for policy interest rates three years ahead. Oh my God – why don’t they also tell us their forecasts for satellites falling from the sky? Take a look at any interest chart and notice the abrupt changes that come from time to time. Did Fed officials forecast those major turnarounds? Sorry Ben, but publishing these interest rate forecasts will add virtually nothing of value to the policy  rumors we get today and will most likely create even more uncertainty about the future. This will be good for the economy since over-paid consultants will now have a lot more to do and your friendly news commentators will be able to talk endlessly about the latest set of Fed forecasts of interest rates.

Since this is starting to sound too much like sausage-making let me just briefly say that the same story applies to inflation targeting.  Do you really care if the Fed announces that their inflation target is 3.2% or 3.4%? I think we all know what their public forecast is. And, of course, knowing their forecast means nothing because the Fed will distance themselves from the latest forecast the second it seems advantageous to do so. Do you REALLY think that a 2% target will mean anything if inflation this year rises to 3% and the unemployment rate remains in the 8%+ range? Again, this kind of process innovation has the potential to create much more policy uncertainty -- not less. 

  

All this confusion does little to help us with the most current challenges. Inflation and unemployment remain at the top of their ranges. Interest rates are incredibly low. The economy continues to gather steam while our friends in government in the EU and at home dither with budget debt and raise the risk of another fall from economic grace. The Fed is tilted to too much stimulus thus raising the risk of a hyperventilated economy in the midst of high unemployment. This makes me even more wanting to be at the Hanover train station ordering another one of those fine brats. 

The Fed Capitulates to Populism

Another example of macro confusion was evidenced in some of the responses to the Labor Department’s recent employment release. Apparently employment went up more than expected (200,000 jobs) and unemployment went down more than expected (to 8.5%). So what was the response? The US stock market declined and one expert said the market was not impressed by the progress. The expert went on to tell us how many jobs had been lost since 2007. Another response quoted Fed officials who said that this was evidence that the Fed ought to do more to assist housing. Apparently we need even lower mortgage rates to make sure the economy recovers.

This reveals one of two things. Either these experts live on the moon or medical marijuana is more prevalent than I thought. I hear Joe Biden is promoting legislation that would give any recipient of a new handicapped parking sticker a year’s worth of naturally grown weed. Apparently seventeen red states, including Pakistan have now indicated a willingness to commit to the Obama ticket.

As a practitioner of the arcane metaphysical enterprise called macro, I am offended by all this nonsense. Is it not possible that good news could actually be taken as good news? Of course, it was not great news but keep in mind that the employment report DID NOT say that employment tanked by 100,000 jobs and it DID NOT say that all American manufacturing jobs have moved to Haiti. It said we had a decent run of the employment numbers in December. Keep in mind that these numbers are seasonally adjusted so a decent run does not mean that Christmas came in December. It means that Christmas came as usual on December 25^th and that employment growth was higher than it usually is in December. So smile a little bit. Let’s have a little toast to jobs in December.

Okay I admit that I am always ready to toast whether the employment news is good or bad. But let’s not exaggerate. This news is sort of like me announcing to my wife that I lost 5 pounds on my latest low JD diet.  Losing 5 pounds does not mean that I can eat obscene amounts of ribeye steaks at Little Zagreb’s steak restaurant. And it does not mean that I have succeeded in restoring my body to the svelte 200 pounds I weighed when I was in Mrs. Montgomery’s fifth grade class in Coconut Grove Elementary School. But let’s face it – 5 pounds is 5 pounds and it calls for a little cheese cake and JD.

No one in their right minds expected employment to increase by 400,000 jobs and no one thinks the US economy is healed of its 40 years of economic orgies. But lighten up guys. The increase in December supports a view that the US economy is slowly mending. As such it indicates that the US is a little less vulnerable to outside shocks. Our banks are better prepared to withstand Europe’s wake and our firms are poised to expand should these new growth sprouts continue spread and continue to take hold.

The other part of this has to do with the Fed making noises about the jobs report showing that the Fed needs to do something about housing. First and foremost please make note that the Fed’s job is not to affect housing – or outdoor grills or electric cars or litter boxes. The last time I checked it was classified as a central bank whose job it is to produce a stable inflation and unemployment rate. It essentially has one tool called money growth to accomplish these macroeconomic goals. It is true that Mr. Bernanke and his buds have added some new tools lately in the crisis environment but most of those were still aimed at macro indicators and goals. If you follow the idea – not mine – that the Fed should bail out housing why be so inefficient? Why not just admit that democratic government via Congress and the Executive Branch has failed us in the US and let’s crown Bernanke macro-czar and have him direct controls that will allow him to order companies to hire workers.

You think old Lar is either trying to be funny or that he is well into the JD. But the truth is that when we ask the Fed to focus on housing it is no different from asking them to focus on manufacturing workers or refrigerators or pee pee pumps. The Fed’s charter gives the Fed no real power to focus on sectors and as such it will fail if it tries. Think of what they are suggesting the Fed do. First, some experts want the Fed to buy mortgage securities or derivatives so as to push down the interest rate on mortgages. Please – do banks not have piles of money lying around? I think so. And have you checked mortgage rates lately? Do you really think banks want to lend at even lower rates? Do you think there are families sitting around counting their money (imagine Scrooge McDuck in his cash vault) just waiting for mortgage rates to drop from 3.9% to 3.8%? No No No. Even if the Fed rams more money into mortgages and even if rates fall further they will have accomplished exactly nothing. They will have not solved the problem of the housing market that took at least a decade to create and produced a whole big enough for to drive a new Equus through.

The other thing they want the Fed to do is make it easier for people to get loans. Apparently we live in a world of only extremes. In 2006 any animal, including homosepiens, could slither into a bank and be shown the mortgage vault. Hi there, want some money? Promise to repay?  No crossing your fingers behind your back! Okay, here’s the money. Aw heck – here’s a little more money for your next cruise. Enjoy your new mansion. Then somehow after the crisis banks started asking really mean and unrealistic questions like – Do you have a job? Do you have a means to repay this loan besides prayer? So now we want the Fed (or somebody) to find a way to return to the good old days when people had the right to have loans just because they were able to spell or otherwise mouth the word “gimme”.

It is truly amazing how brazen our Fed has become. It pretends that good news is bad. And then it continues to avoid real solutions to housing problems in favor of lame and ineffective worn out inappropriate solutions. Another round of quantitative easing; another reduction in long-term interest rates; another invitation to create leverage and high risk are only going to make things worse. But the real solutions are hard and involve a little pain. It used to be that we could count on the Fed to offer sensible advice. Apparently now the Fed has become one more institution that caters to populist nonsense. 

Guest Blogger -- What do we know about Education? by Jim Gibson

Jim Gibson is Co- Founder and CEO of Adsil – Manufacturing – Technical glass film surface treatments for metal. He is founder of Leadership Daytona and President Elect Volusia Manufacturing Assoc.He has a BS Industrial Management from  Georgia Tech; an MBA from UNC Chapel Hill; and 30 hours coursework in Urban Planning at Georgia Tech.

I am pleased to be asked by the esteemed Dr. LSD to service as a guest blogger….more because the Dr. assumes you may need a rest from his blither for a week.  Whichever the case, I am here warts and all. Over the past year we have discussed the issues that have driven our country to its current position in a macro sort of way. These discussions were lively and sometimes sober enough to drive me to partake of my favorite beverage… Cabernet...and when I have a few extra pennies to spare… then the Opus brand. It beats JD any day.

The other day, while pondering the news for the first time after my 9 day long vacation at my daughters’ extended families in Charlotte NC it came to me that solutions had to be found or even we boomers will be feeling the pain sooner than we think…or maybe just moving to Panama or some other third world country where we can live in luxury in an American style town.  I contacted Dr.D and asked if he could jump out of the macro stuff for a while and get down to the core issues so we could find ways…in our own small way to... affect some sustainable solutions.

I do not write blogs but instead focus on lively letters to customers and shareholders.  So if you feel a nod coming on …wake up…there is something interesting and your comments are welcome…if not needed.

Education has been bantered around and unless somebody has been snoozing in a parallel time matrix there should be agreement on a solution for improving education.  However, what are we talking about here?  K-12? Adult? College? Trade School? Charter Schools? Content? Applied or just academic?

Should there be a national program or should that be left to the states, counties or communities?

Here are some factoids:

1. 1.       Since 1928 when records began to be kept….only 25%+ or – 1.5% of high school graduates finish a recognized four year college.  Why?  Should everyone get a college education?   Are the degrees that are offered now meaningful for the new norm (define the norm)?
2. 2.       College Board (SAT) scores began to decline in 1969…just shortly after Dr. D graduated from GT. They have continued to decline or be flat since then.  I say this because I wonder if more unqualified people are taking the test and watering down the average. Conversely, is it because the curriculum is watered down?
3. 3.       The dropout rate from high school students is also 25%.
4. 4.       Manufacturing jobs decreased in number by 35% since 1985 and were replaced with technology or some other pair of hands in an off-shore country.
5. 5.       By 2020 Hispanics and blacks will represent close to 50% of the population and the data presented above is worse for this group than for whites.  Indians (not US) and other Asians coming to this country fiercely love the right and ability to get a good education and often take it back home to compete with us. 
6. 6.       There is a green card problem here with all of the fervor about illegal immigrants…a side bar issue for further discussions with several bottles of CAB or JD.
7. 7.       During this past 35 years, the US has dropped to 8^th place in K-12 education within the G22….and still declining.
8. 8.       During the past 10 years China has risen to # 2 in GDP and India is rapidly catching China.  The other two countries in the BRIC are quickly catching up.
9. 9.       We are a marketplace that rewards creativity, technical knowledge and application, intelligence over physical power and that has the ability to see through the fast pace to come up with new ideas, solutions and applications.

 What will it mean …at the speed at which this happening… to our children? Grandchildren? Us…yes us…because the average life span for the healthy among us is 85 to 90 and it is also projected than many of the early boomer retirees will have to come out of retirement or at least work part time..doing what?

OK so we can guess a little at what this means but how do we indentify the core causes and find ways to improve the education system…or maybe even create a new one?  Without it we will become a sub-par nation in terms of intellectual effectiveness.

Was Stimulus Meant to Be Temporary or Not?

When is enough enough? The US government extended payroll tax relief and unemployment benefits again. The European Central Bank lent a ton of money to commercial banks. Everyone but Germany seems to be afraid of fixing things. When does this stop?

Larry – you just ate three servings of pecan pie to “wash down” that 72 ounce ribeye.  I know honey, don’t worry I will get on that diet tomorrow. But you said the same thing yesterday. True but then I was feeding my fever – that’s no time to cut down to two servings of chocolate cake. I gotta keep my strength up!

This is making me hungry but I am beginning to get a sense that my past worries were correct. Writing in this blog almost two years ago I tearfully agreed that some stimulus was warranted for the US and world economy but also predicted that the worse thing about stimulus is that policy makers wait too late to withdraw it. And like the fact that I have to wear expando-sweat pants everywhere I go now, waiting too late to put our countries on a diet is starting to bite.

Continuing the weight analogy, few economists are really recommending an extreme basic training approach to economic policy. If anything, the reasonable people are suggesting that we simply gain 3 pounds this week instead of the usual 5. Losing weight will come soon but not yet. That doesn’t sound severe to me. Deficits that took years to build are not going to be turned into surpluses in the next year or two. But like gaining only 3 pounds this week, it is possible to have a plan that would gradually reduce the deficits over the next 3-5 years. The surplus can come later. While that approach won’t allow Italy a chance to compete in any Iron-man competitions now, it will send the right message to everyone – including existing and potential holders of Italian debt.

Pundits were extremely loud and clear last week when they pointed out how unfair it was that we might let the tax and unemployment extensions die. One congressman could hardly contain himself on the Senate floor as he described how failing to extend would undermine fairness to the least advantaged in our society. But let’s be honest. That’s depiction is a gross exaggeration. Maybe it is a lie. Put the point in this context. It will NEVER seem fair to take this money away from the people who seem to need it the most. Never. How can you take money away from people and have it seem fair? But also remember that these specific legislations were ALWAYS meant to be temporary. How is it possible that politicians who vote for things that will be temporary are never willing to let them end? How?  My answer is that they fibbed in the beginning. It is only now that they are being honest.  They want to keep these entitlements as long as possible.

After all, how else can we help people who are unemployed or who have lower incomes? This is the part that is so ludicrous and disingenuous. Keep in mind that we elect these people to govern our country and to put in place policies to meet our national goals. It is their JOB to solve these kinds of problems. So what do they do to attack unemployment and poverty problems? They legislate exactly nothing that one might call an employment or poverty program.  Instead they give us gruel – they give us supposedly temporary legislation that spreads crumbs around on the ground that are soon to disappear the next time a flock of black birds swoop in. 

These elected officials get good salaries and benefits and do nothing that even approximates an understanding of and policy towards the main challenges of our economy. What if you went to your doctor with a pain in your chest? You told her that the pain has been there for a long time but it is really hurting now. What if she told you to take a couple of aspirins and come back in the summer? I am thinking that you could have gotten that advice and help from your local barber. You wouldn’t put up with it. Yet we let these legislators take their pay to the bank every month while they treat our most pressing national problems as if they were heartburn. Of course they cannot tell us the truth so instead they inflame us with rhetoric that heats up animosity between people in both parties who would love to see our country return to growth. 

To resolve our worst problems right now we need a medium term plan to remove temporary tax changes and entitlements. We need to supplement that with real policies aimed at the things that caused our current slow growth -- a housing bubble bursting and excessive leverage among households, businesses, and government. We do not need politicians who would rather play needless class warfare games than attend to the real issues.