November 2009
There will be more bad economic news as there is at the endof every recession. Many economic indicators are “lagging”events that often weaken further even though the overalleconomy clearly begins to recover. Job losses typically do notend until “after” profits and real GDP growth turn positiveagain, and the U.S. unemployment rate will likely peak above10 percent perhaps as late as mid-2010. Commercial realestate activity peaked long after the recession began and itwill bottom long after the recession ends. As is typical of pasteconomic cycles, defaults and foreclosures will likely persisteven though the economy is growing again. Finally, similarto the 1980s, several more small banks will fail even as theeconomic recovery matures.Some additional “bad” news should not cause alarm. It isperfectly consistent with a normal recovery cycle. “Laggingindicator” bad news is common early in a recovery in conjunctionwith improving “leading” recovery indicators that are currentlyabundantly evident.
Massive Fiscal Spending! Massive MonetaryExpansion! A Weak U.S. Dollar! Isn’t InflationUnavoidable?
Longer-term, the U.S. may face stronger inflationary pressuresdue to the lagged impact of massively accommodative policiesintroduced during this crisis. A possible severe inflation outcomedepends on many factors that will play out in the next coupleyears. In the meantime, the core inflation rate will likely recede atleast through 2010.In most recoveries, the annual rate of core consumer price andwage inflation typically declines for one to two years “after”the recession ends. It takes a period of revitalized economicgrowth before the unemployed resource markets (i.e., laborunemployment and factory utilization) tighten enough to againproduce wage/price pressures. Considering the severity of labor unemployment and idle factories left in the wake of thisrecession, it may take several years of positive economic growth(even given the unprecedented economic policies applied) beforeany serious inflation risk emerges. Ultimately, whether and whenserious inflationary pressure surfaces depends on several factorsthat can be monitored in the next couple years, including how fastpolicies are reversed, bond vigilante reactions, the speed of therecovery, the strength of U.S. consumer spending, the growth rateof the emerging world, the degree of U.S. dollar weakness, andhow fast borrowing propensities improve.We are not convinced the U.S. is headed for a longer-terminflation episode but neither are we confident an inflationaryspiral won’t result in future years. We will continue to monitorseveral factors accessing inflation risk. In the meantime, a revivalin real GDP growth with relatively stable core prices seems mostlikely during the next couple years.
Economic Policies Are NOT Working ThisTime??!?
Despite an unprecedented policy response, consumer spendingremains punk, job losses continue, bank lending is contracting,foreclosures are still rising, and a commercial real estate crisismay still be coming! If all this stimulus doesn’t work, what will?First, economic policies have long lag times, often about oneyear, and most economic policies were only introduced aboutone year ago when Lehman collapsed. Therefore, positiveimpact from the crisis policies should just now begin to show upon Main Street.Second, economic policies typically show on Wall Street beforeimproving Main Street, and there is considerable evidence theeconomic policy approach adopted in this crisis has worked onWall Street (e.g., a 60 percent advance in the stock market, ahalving of junk bond spreads, a return to a near-normal Liborspread, evidence of renewed ability to raise private sector bondproceeds, economically sensitive stock price leadership, asignificant rise in leverage loan prices, some evidence of IPOand M&A activity returning, etc.)! Those who fear “policy” isnot working should take some confidence from a widespreadshow of improvement on Wall Street.Finally, Main Street improvement is already broadly evident(e.g., positive real GDP growth, ISM surveys recovery, profitsare back, housing has bottomed, etc.).
Can A Capitalistic Economy Thrive In ACountry Where Political Power Has ShiftedLeftward Toward Nationalized Healthcare,Government Pay Czars, and Sweeping NewFinancial Regulations???
First, similar to the Bush administration immediately after 9/11,the power of the Obama movement has been importantly tied tothe “economic crisis.” In times of crisis, this country has oftengiven a blank check to its leadership as it did earlier this yearin the heat of the crisis. However, Obama administration powerand support is already diminishing, due primarily to the easingof economic crisis fears. As the economic recovery matures andfears ease even further, the ability to implement much of thecurrently debated economic/regulatory legislation will likelydiminish significantly. The current fervor over regulating pay andimplementing watershed financial regulatory changes will likelysubside substantially in 2010 if real GDP grows close to 4 percentand job creation returns as we think likely. Some regulatoryreform will certainly pass. However, what ultimately does passmay prove far less dramatic and frightening and probably farmore benign than what has been bantered about and worried overin the heat of this crisis.Second, while concern is rising about the future economic impactof an expanding “leftist” political culture in the United States,in recent years, the world has been experiencing the greatestadoption of free market capitalism in U.S. history! The explosionin emerging world economies reflects a massive expansion inAdam Smith’s laissez-faire philosophy. A mild and perhapstemporary move to the left in U.S. politics does not seem thatfrightening compared with the explosion of newfound capitalisticbehaviors around the globe! Many suggest the tax and spendpolicies of the Obama administration stands in sharp contrast
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