Colorado Economic Outlook Autumn 2010
Written by Jeff Thredgold, President, Thredgold Economic Associates
The American Economy
…confidence is lacking
The National Bureau of Economic Research (NBER), the “official” scorekeeper for the American economy, announced on September 20, 2010 that the U.S. recession officially ended in June 2009…statistically at least, if not emotionally. This determination was in line with the view of forecasting economists. The NBER had previously announced that the U.S. recession started in December 2007. What we now call the Great Recession was the deepest and most costly since the Great Depression.
Even as U.S. economic growth has returned, its pace has been weak…and moving in the wrong direction. A reasonably solid growth rate during 2009’s final quarter gave way to the lackluster pace of the April-to-June period. Why? In my view, American businesses and consumers maintain spending close to the vest as they are extremely wary of the enormous and costly expansion of government now underway.
Talk of a possible “double dip” recession has declined in recent weeks as more economic data supports the slow growth scenario. In addition, views of a more vibrant economic expansion are also muted as the “headwinds” of weak residential and commercial real estate values, high unemployment, and low confidence levels take the bloom off the economic rose.
…the record books
Unconscionable budget deficits exceeding $1,000,000,000,000 annually are in store in coming years. Even larger deficits were the norm in fiscal years 2009 and 2010, with a slightly smaller deficit projected for 2011.
You cannot tax your way to balanced budgets. Nor can you tax your way to economic prosperity. Valid moves toward deficit reduction must focus on slowing the growth rate of future government spending, particularly in the entitlement area.
Global financial market anxiety focused on the ability of southern European nations to ever repay their national (sovereign) debts could eventually find its way to concerns about enormous U.S. government debt levels. The most serious challenge facing this nation is found right here.
…staying too long
The political party outside of Congressional control typically adds to its seat count in such elections. This year is also expected to see a surprising number of long-term incumbents from both parties sent home. Bragging rights about power and the ability to deliver pork to constituents used to be a major incumbent advantage…no more.
…weak and weaker
The current rate of U.S. job creation has made only a modest dent in the more than eight million jobs lost in 2008 and 2009. To make matters worse, the U.S. economy needs to add roughly 130,000 net additional jobs each month just to meet the needs of a growing population…and to keep the nation’s unemployment rate from rising.
The nation’s jobless rate has averaged 9.7% so far this year, with only limited prospects of any major downward move before the end of 2011. Major business anxiety about the expansion of government and possibly higher taxes will limit major employment gains anytime soon.
…the job creators
The desire of the Administration to maintain the Bush tax cuts for the majority of U.S. income earners is to be commended. However, tax rates in place should also be maintained for those making over $200,000 annually.
The Federal Reserve
…remaining on hold
The most critical of all short-term interest rates—the federal funds rate—has been at a 97-year-low range of 0.00%-0.25% for 21 months. Most forecasters see the rate remaining unchanged well into 2011.
One view gaining additional footing in some circles is that the Fed should push its key rate somewhat higher in coming quarters…to perhaps 2.00%-3.00%…to lead other short-term interest rates higher. The reason? To provide net savers, including millions of retired people, a chance to boost their investment returns from savings accounts, certificates of deposit, and money market funds. Millions of retirees have seen their interest income—and their ability to spend—slashed in recent years.
At the same time, nearly one in four U.S. homeowners is “underwater” on their mortgage…owing more than the home is worth. Many mortgage lenders have tightened credit standards or had onerous new regulations imposed on them by government bureaucrats. Mortgage rates could move higher later this year and in 2011.
…time is now
Thirty-year fixed-rate mortgages on conventional loans have been below 4.50% in recent weeks, near a 50-year low. It remains a very attractive time to refinance a mortgage or to finance a new home or foreclosed property.
The Global Economy
…led by Asia
The global economy returned to growth mode in late 2009, following its first recession since just after World War II. Growth prospects remain reasonably solid, led by Asia.
China again enjoys powerful growth, led by strong export gains and massive internal spending. Anxiety about loan quality is high. India also enjoys solid growth, while Japan continues to languish.
European growth is modest at best, although Germany has performed well. Russia struggles with low business confidence and high levels of corruption. African and Middle Eastern growth remains solid. South America records positive growth, with rising optimism about the powerful Brazilian economy.
Mexico’s vital tourism sector remains under pressure, tied to almost daily stories about incessant drug trafficking violence. Canadian growth has slowed from its earlier solid pace.
The Bottom Line?
Sluggish U.S. economic growth remains likely, with no shortage of serious domestic challenges. Modest global growth also remains on tap.
What's it gonna be? Inflation or Deflation?
Let me think now…inflation is going to be a huge problem in coming years. Did you see the incredible $1,400,000,000,000 federal budget deficit last year, with a similar budget deficit this year? Did you see only a slightly smaller budget deficit projection for next year?
Have you seen that the spend-happy Congress is now running a budget deficit of $160,000,000 every 60 minutes? Have you seen projections of $1,000,000,000,000 annual budget deficits for years to come?
Have you seen how the Federal Reserve has seemingly lost its collective mind, with a near tripling of its balance sheet during the past three years…all with money essentially created out of thin air?
The net result according to many “experts” must be a big surge in inflation in coming years. That’s why I better buy gold and other “hard” assets, and reduce my ownership of any financial assets such as bonds.
That’s why gold is over $1,250 per ounce, with people who market gold saying it is “a great time” to buy gold (when have they ever said anything different?) That’s why the experts say gold is soon likely to climb above $2,000.
Let me think now…deflation is going to be a huge problem in coming years. Have you seen how residential real estate prices continue to decline? Have you seen how commercial real estate prices continue to weaken?
Have you seen how much slack there is in the labor market, which could easily place downward pressure on wages? Have you seen how confidence in Washington DC is so low?
Have you seen how U.S. inflation continues to decline? Have you seen how the Consumer Price Index (CPI) now shows prices rising only 1.1% during the past 12 months? That the “core rate” of the CPI (excluding food and energy prices) is up only 0.9% during the past 12 months, the smallest rise in 45 years?
Did you see that when Japan’s asset and housing bubble burst in the early 1990s, its economy went into eight consecutive years of deflation? Have you seen how the Japanese economy is dealing with deflation again?
Have you seen that declining prices are soon followed by declining incomes? Did you know
history suggests that escaping a deflationary economy can be more challenging than dealing with inflation?
The net result according to many “experts” must be a big dose of deflation in coming years. That’s why I better buy high-quality, longer-term, fixed-rate U.S. government or corporate bonds and reduce my ownership of any “hard” assets, like gold.
That’s why investors have already pushed bond prices so high that the 10-year and 30-year U.S. Treasury bond investment returns (known as yields) have already fallen to around 2.50%-2.75% and 3.60%-3.85%, respectively...which, excluding a few weeks during the financial crisis, are the lowest levels in decades. That’s why 30-year fixed-rate conventional mortgages are below 4.50%. That’s why the experts say bond prices could move even higher, with yields falling even further.
Two very different schools of thought.
Two very different investment plans.