As readers of these piece already know, I possess neither a sophisticated model of the U.S. economy such as the ones available to the bright sparks whose mis-measurement of risk almost brought down the financial system, nor a crystal ball. All I can offer with any confidence is the observation that the data suggests we will open for business in the new year in better shape than we were at the beginning of 2010.
Investors are counting their gains: the S&P index of 500 stocks has recovered all of the ground lost since the collapse of Lehman Brothers in 2008, and then some, with financial stocks leading the way. America’s executives are also smiling rather broadly, although given the angry mood on Main Street, they are doing so only in the privacy of their boardrooms and in the company of peers in the showrooms of luxury retailers, and paying (silent) homage to Federal Reserve Board chairman Ben Bernanke for keeping interest rates low. Third-quarter pre-tax profits topped their 2006 peak as firms continued the cost cutting that has seen unit labor costs declining at a rate not seen for 50 years – bad news for the labor market. As we return to work on Monday from our New Year’s celebrations, the corporate cash hoard that has resulted from rising profits and a refusal to spend or invest sits there on the sidelines, waiting for some sign that the American consumer is coming off the couch and returning to the shops.
Christmas seems to have provided just such a sign, with bargain-hunting consumers ringing a merry tune on cash registers in malls and stores – well, more accurately, keeping the swipe-card machines busy. But retail sales were rising even before the holiday spirit took hold, and had returned to pre-recession levels. When the final figures are in they are likely to show that we enter the new year with consumer spending -- accounting for about 70 percent of the economy -- rising at a real (inflation-adjusted) annual rate of something like 4 percent. “It looks like we have transitioned into a period of solid consumer spending,” Barclays Capital economist Dean Maki told the Wall Street Journal. “That makes it hard not to be optimistic about economic growth.”
So hard that most forecasters have been busily revising their 2011 forecasts to reflect consumers’ more open-handed behavior. No longer any worries of a double-dip recession -- the economy is probably growing at a rate in excess of 3 percent going into the new year. The latest view of those brave or foolish enough to put a number to their growth estimates seems to be that the U.S. economy will grow between 3.5 percent and 4 percent in 2011. Not only is consumer spending rising, but businesses seem to be rebuilding shrunken inventories, and manufacturing activity shows signs of expanding, especially in the Midwest. Perhaps best of all, Moody’s Analytics reports that commercial and industrial lending in the quarter that just ended rose for the first time in two years, and is likely to increase by 3 percent this year. Such loans usually go to fund business expansion.
Adding to the probability of relatively satisfactory growth is the deal agreed to by the president and Congress before they fled Washington for their holiday breaks. Plans to increase taxes on incomes of families earning more than $250,000 per year were reluctantly dropped by the president, consumers were given more to spend or save by reducing their payroll taxes, businesses will continue to receive generous write-off treatment of new investments, and the spending power of millions of long-term unemployed will be increased by the extension of benefits for many whose benefits have or will run out. All in all, a new $1 trillion stimulus package to add to the 25-30 percent of the $787 billion first stimulus package not yet spent and due to hit the economy in the coming year.
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.