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Ring in the New Year

12:00 PM, Dec 31, 2010 • By IRWIN M. STELZER
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As usual, not all the data points to one direction. The current 9.8 percent unemployment rate is expected to come down in the new year, but only gradually, as businesses remain reluctant to add permanent staff until recent growth proves durable. Still, any sustained decline in the unemployment rate is likely to buoy consumer confidence, which the Conference Board reports dipped in December, taking most analysts by surprise. Although the inventory of unsold houses offered for resale is dropping, the housing industry remains in the doldrums. Average prices continue to fall, as foreclosed homes are unloaded at distressed prices. House prices, already down 30 percent from their 2006 peak, are expected by Wells Fargo economist Sam Bullard to drop 8 percent by mid-year, not an unreasonable expectation given the recent rise in interest rates, continued foreclosures (over 1.2 million homes are in some stage of foreclosure, about 10 percent more than a year ago), and high levels of unemployment that make even those in work too nervous about their futures to consider buying a new home.

The big imponderable is whether interest rates will remain low enough to keep the economy growing. The latest round of quantitative easing -- QE2 -- coincided with, and some say caused, interest rates to rise in anticipation of increased inflation. By that reckoning, still more easing, combined with the new stimulus, will combine to drive rates up even more, slowing investment and dealing a death blow to the housing market.

We will know a lot more about that early in the new year, when the politicians decide whether to “pivot” to the more balanced fiscal policy the president promised a year ago, before deciding that austerity would have to wait until the economic recovery proved more durable. The president’s State of the Union message on January 27; the budget he submits on February 1; Republican decisions on what spending reforms to extract in return for raising the debt ceiling in the spring; congressional action on the $1.3 trillion omnibus appropriations bill to fund the government this fiscal year -- all will tell investors whether Democrats are willing to accept spending cuts, and Republicans are willing to accept tax increases as part of a compromise deficit-reduction package. The unfrosty reception accorded the suggestions of the president’s deficit-reduction commission gives reason to hope fiscal sanity might come again to the land of the profligate.  

But if the pivot to frugality remains on hold even though the economy is strengthening, the continued flood of red ink might prompt investors to demand higher rates to compensate for the risks of a depreciating currency. Experience with eurozone countries unable to bring their deficits under control without recession-inducing austerity programs has lenders on edge, and might cause a flight from American IOUs.  

Unless, of course, America proves to be the least-worst place to put their money in a world in which the risks of confiscation (Russia), capital controls (developing countries), and incompetent government institutions (Europe, Japan) are to be reckoned with.

Many thanks to all of you who have followed these pieces in 2010, and best wishes for the New Year. 

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