U.S. Economic Outlook Winter 2011
Written by Jeff Thredgold, President, Thredgold Economic Associates
The U.S. Economy
While the American economy has now registered growth for five consecutive quarters, the pace of that growth has been meager, averaging a 2.9% real (after inflation) annual rate…and just a 2.1% rate during the past two quarters. Such growth trails the average 3.6% real annual growth pace of the past 30 years.
What we now call the Great Recession enters the history books at 18 months in duration, officially running from December 2007 to June 2009. Never since the Great Depression has a recession wiped out all net job gains of the prior economic expansion. Never since the Great Depression has a painful and lengthy recession been followed by such a limited growth pace.
Growth in 2011? Most forecasting economists see real growth during 2011 at a 2.5%-3.5% annual rate, with the Federal Reserve’s forecast a bit more cheery.
As before, major economic headwinds of weak residential and commercial real estate construction, soft housing values and near double-digit unemployment impair the economy. In addition, fragile consumer confidence tied to anxiety about massive government spending and unprecedented budget deficits also constrains growth opportunities.
Effective steps to reduce future growth rates of U.S. government spending are mandatory to getting this nation’s financial house in order. You cannot tax your way to balanced budgets, nor can you tax your way to economic prosperity.
Record budget deficits of the past three years, combined with projected $1,000,000,000,000 annual budget shortfalls for as far as the eye can see have, to this point, found domestic and global bond markets willing to provide massive deficit funding. However, financial market uncertainty about ongoing budget deficits and huge national (sovereign) debt levels across southern Europe must be “a wakeup call” for the U.S.
We will simply not be immune in coming years to financial market distaste and resistance to boatloads of additional U.S. Treasury debt issued to fund irresponsible levels of government spending. We must act.
American job creation is expected to improve somewhat during 2011. However, a modest improvement in net monthly job creation will do little to trim the nation’s unemployment rate, which has been at or above 9.5% for 16 months, the longest such period since the Great Depression.
The agreement to extend the Bush tax cuts for ALL taxpayers for two years, combined with progress toward more affordable government spending, will go a long way toward boosting business sector confidence. In a nutshell, rising confidence levels would enhance employment creation.
Sluggish U.S. economic performance, soft home values and major slack in labor markets have led inflation to extremely modest levels in recent months. One measure of consumer inflation recorded its lowest 12-month rise in 53 years!
While inflation is expected to remain mute during 2011, longer-term views remain split between sharply higher inflation and the perils of deflation. The former camp is buying gold and commodities. The latter camp is buying longer-term fixed-rate U.S. Treasury and high-quality corporate debt securities.
The Federal Reserve
This nation’s central bank has drawn extensive criticism in recent months for its current program to boost the economy with another $600 billion of newly created money. Such funds are being used to purchase U.S. Treasury notes and bonds, with the intent of pushing longer-term interest rates lower.
Despite such massive bond buying, bond yields (returns) have actually risen in recent weeks, reflecting concern about the Fed’s latest venture and expectations in some camps of stronger economic growth than the consensus view. The Fed’s most important monetary tool, the federal funds rate, has been at a historic low target range of 0.00%-0.25% for 24 months, with little expectation of change any time before the latter part of 2011.
Housing & Home Finance
Most forecasters see average U.S. home prices stabilizing around mid-2011, with only modest gains in home values in subsequent years. Millions of homes in—or potentially to enter—foreclosure remain the fly in the ointment.
Average conventional mortgage interest rates have risen roughly 0.25%-0.75% during the past few weeks, after plunging to their lowest levels in 50 years. For those interested in refinancing a mortgage, or financing a new home or foreclosed property, the timing remains outstanding.
Our weekly newsletter, the Tea Leaf, issue dated February 17, 2010 entitled “A Shot Across the Bow” discussed the unfolding Greek national debt situation at that time. The article noted, “The greatest threat regarding the current Greek debt solvency debate is the possible domino effect involving other nations. A Greek default on its debt, or a painful plunge in the value and marketability of Greek debt securities, would likely be followed by similar debt issues for other nations. Such a domino or cascade effect would be difficult to stop once the process had begun.”
The article also noted that “any financial support provided for Greece by the Germans and the French would effectively be seen as a similar level of support, if necessary, for Spain, for Ireland, and for Portugal, with Italy and Belgium possibly not far behind.”
The article also noted that if the contagion did spread to these other
nations, it “should also be taken seriously by larger nations, including the United Kingdom and the United States"
As is well documented, other European nations and the International Monetary Fund (IMF) did ultimately come to the aid of Greece. In addition, larger European nations set up an enormous financial fund to deal with additional problems in other nations, should they arise.
Ireland bit the dust in recent weeks, with an agreement to accept a $113 billion bailout package from other euro nations and the IMF. The Irish had already enacted painful spending cuts and tax increases as a means to address a massive annual budget shortfall.
Financial market pressures continue to build on Portugal and Spain. Pressures are also building to tear apart the fragile 16-nation euro currency and euro community mechanism, with a viable chance that one or more nations will opt out of euro membership during 2011 or 2012.
The other major pivot is China. Its efforts to battle inflation and runaway bank lending should see the world’s second largest economy slow modestly during 2011.
And so it begins…
The official release of proposed long-term changes to government receipts, spending, deductions, and deficits was provided in early December by the President’s deficit reduction commission. Commission members could not reach agreement to formally recommend the full package to the Congress for its consideration. As one might expect, a commission of 10 Democrats and eight Republicans, of which 10 are members of Congress and eight are in the private sector, found little on which to agree.
Nevertheless, the information provided by the commission was a favorable starting point for critical and necessary discussions as to how to realign government and how to limit massive and dangerous annual budget deficits for years to come. Other commission-type groups have also recently engaged in proposals to address government and limit future deficit spending.
The fact that such discussions will continue in coming weeks and months is, by itself, a positive development. For example, politicians traditionally noted that any discussion of touching Social Security was too sacred…too touchy…to even be considered—no more.
Greater media focus and rising consumer awareness of painful but vital steps necessary to deficit reduction are keys to the process. Both the political left and the political right have been critical of proposals by these deficit reduction groups, while the middle seems more willing to have a healthy debate. Isn’t that the basis of effective government…give and take on both sides?
Proposals to limit home mortgage interest deductions and to tax the value of employer-provided health care could fly IF tied to a significant reduction in income tax rates. Eliminating more tax loopholes in exchange for lower tax rates makes sense, but will be challenged by mortgage lending and home building lobbies, health care lobbies, etc.
The first order of business, and perhaps the most productive, should be for commission members and for members of Congress to stop using the term spending cuts. Slowing down future growth rates of spending is a more accurate terminology…and does not scare people nearly as much as when the incorrect phrase spending cuts is used.
Having a dialogue, beginning a discussion about emotional issues is important. Perhaps nothing of value will come from the commission. Perhaps members of Congress will do what they do best…talk and posture and pontificate…and do nothing of substance this time around.
Whose Time Table?
At some point modest changes in programs must be made, with sooner rather than later being the best timing. At some point national politicians must work together. At some point we must address the need to slow future government spending.
It is better to do so in coming months than to wait too long. One has only to look across the pond to drastic (and real) spending cuts in Greece, in Ireland, in Spain and in numerous other southern European nations to see where the U.S. road leads.
We can make difficult decisions now, under our time table. Or we can wait until such a time as global bond market players and investors simply say no to additional U.S. government borrowing—or demand much higher interest rates as an inducement for them to buy more U.S. bonds…
…the choice, for the moment, is ours.