The Blog

Uncertainty Reigns

A stormy economic forecast, at least for the first half of the year.

11:00 PM, Jan 7, 2008 • By IRWIN M. STELZER
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THE NEW YEAR has begun not with a quiet whimper, but with a very loud groan, emanating from Wall Street. Economists and analysts are rushing to revise their 2008 forecasts, and journalists are competing for page one placements with scary stories about evicted homeowners sleeping in the streets, and consumers filing for bankruptcy. Western singer Kris Kristofferson did not have fallen CEOs and other investment bankers in mind in mind when he sang about the man who "Once ... had a future full of money, love, and dreams, which he spent like they was goin' out of style," but it is an apt description of many shell-shocked bankers and investors.

They have reason to worry. Oil finally hit $100 per barrel, sending share prices tumbling, gold prices soaring in anticipation of renewed inflation, and developing nations deeper into poverty. Food prices continue their upward trajectory and, combined with gasoline prices that are due to break new records, are reducing consumer discretionary-spending power to a mere shadow of its former self. Latest surveys suggest that even soaring exports will not keep the U.S. manufacturing sector from slowing down, with falling sales of autos a particular drag. So desperate are dealers to clear inventory-laden lots that one has taken out a magazine ad offering 12-year financing to anyone who thinks he can afford the gasoline guzzled by one of the Rolls Royces sitting on his lot. Most important, last month the unemployment rate soared from 4.7 percent to 5 percent, with more industries losing than gaining jobs.

Whether all of this will produce a recession in 2008 remains less than certain. Alan Greenspan puts the odds at 50-50. Some economists rate the probability of a recession higher than that, others are a bit cheerier than the former Federal Reserve Board chairman. It is so difficult to peer through the blur created by the daily volatility in share prices and business sentiment that uncertainty is the order of the day.

With reason. We don't know whether the president will go through with plans being discussed at the White House to propose a fiscal stimulus in the form of more generous depreciation allowances for businesses, and perhaps even a corporate tax cut. Nor do we know whether the Fed's heightened concern about the extent and speed of the slowdown will prompt it to accelerate its rate cutting plans, inflation worries notwithstanding.

But there are some things we do know. Two forces have come together that are likely to change in a very profound way the structure of the financial services industry. The first is the need for many banks to rebuild their balance sheets by attracting equity; the second is the need for the sovereign wealth funds of oil-producing and exporting nations to put their cash to work. The result has been--and what we have seen so far is only the beginning--the purchase by these funds of important positions in Merrill Lynch, Citigroup, UBS, and other banks and investment firms. So far, the politicians have remained silent, lest they be accused of interfering with the inflow of desperately needed capital. Senator Chuck Schumer, the opponent of Dubai's acquisition of some U.S. ports, has been notably silent, lest he antagonize the Wall Street bankers who have bankrolled his campaigns.

We know, too, that as the greenback depreciates in value, foreign central banks are less and less inclined to keep stores of pictures of American presidents in their vaults, and more interested in diversifying their currency holdings. The dollar's share of central banks' holdings of foreign reserves has fallen from 66.5 percent to 63.8 percent in the past year. Equally important, oil-producing nations, which until now have accepted dollars-for-crude, and have pegged their currencies to the dollar, are finding it increasingly difficult to hold to that policy. The dollars they are getting, which they use to pay the large foreign workforces on which their work-shy citizens rely, buy less and less when remitted to the wives and families of these workers. That is causing social discontent of the sort that horrifies the ruling classes in the Arab countries. My guess is they will begin pegging their own currencies to a basket of currencies that includes the dollar, but in which the euro is importantly represented. A negative impact on U.S. influence in the region is one possible consequence.