January 4, 2005
by Irwin Stelzer
There are two reasons why economic forecasters live dangerous lives.
The first danger lies in the unknowables -- unpredictable events of such magnitude that they swamp the variables that economists are comfortable dealing with. Consider just a few.
Last week, terrorists launched an attack on some of the facilities of the Saudi regime. Even though the attacks were largely unsuccessful, and even though they were not aimed at the Kingdom's oil facilities, the price of oil immediately jumped some $2 per barrel. No one knows whether the regime's opponents will mount more devastating attacks, and succeed in raising the risk-premium already built into oil prices. If they are, prices might well soar to recession-inducing levels.
Then there is Iraq. If the January elections go off moderately well, and if Iraqi forces begin to shoulder more of the security burden, the pressure on America's military budget will be reduced. Otherwise, it is unlikely that the president will be able to significantly reduce our budget deficit, which contributes to the downward pressure on the dollar.
Add to the list of unknowables whether the president and the congress will seriously attack the budget deficit by cutting outlays, whether the Chinese authorities will ease their currency's peg to the dollar, and whether the Japanese will intervene in currency markets if the dollar falls to the 100-yen level that just a few years ago Japan's monetary authorities considered unacceptable.
The presence of all these unpredictable events is only one of the dangers faced by forecasters. The other is the limit of economic theory, especially when it tries to deal with macroeconomic phenomena. One example.
Some analysts are cheering what they see as the return of "pricing power" -- the ability of companies to raise prices to offset rising costs or to take advantage of increased demand. Renewed pricing power, they say, will add to profits, drive up share prices, and encourage companies to invest the huge cash hoard they have accumulated. That will ensure that even if consumers stay away from the malls and pay down some of their record debt, the economy will move smartly ahead in 2005.
Not so, respond equally well-paid seers. The return of pricing power will drive prices up, triggering fears of a new round of inflation. That will force Alan Greenspan and his monetary policy gurus to raise interest rates more rapidly than they now contemplate, discouraging businesses from investing and consumers from whipping out their credit cards. That means a significant slowdown in 2005. Unless, of course, the optimists are right and the excess capacity still existing in the economy will prevent pricing power from fueling an inflationary spurt. And so it goes, like the roulette wheel, round and round, and where the truth lies nobody knows.
This divergence of views is most obvious when it comes to share prices. The Wall Street Journal, under the banner "Market Outlook for 2005? Depends Whom You Ask," points out that equally respected Ralph Acampora of Prudential Equity and Richard Bernstein of Merrill Lynch have widely different crystal balls. Mr. Acampora expects share prices to jump 20% this new year, more than double the gain during 2004, while Mr. Bernstein predicts that when this year rings out share prices will be about where they are now.
Choice is a wonderful thing in most markets, but a wide choice in the market for forecasts can be confusing. The easy answer: average all of them and use the resulting "consensus" forecast as a guide to 2005. Business Week did just that with the forecasts of sixty economists and came up with a consensus annual projected growth rate of 3.5%, with the most optimistic (Gail Foster of the Conference Board) predicting 4.6%, and the most pessimistic (Dresdner Kleinwort Wasserstein's Kevin Logan) guessing that when all the figures are in the economy will have grown at only half that rate, 2.3%, in 2005.
All of which explains my reluctance to make any guesses as to where the U.S. economy is headed. That, says my editor, is an unacceptable cop-out: your readers are entitled to your views, even if they are carefully hedged about with all these warnings.
Fair enough. The old year ended and the new year began with the American economy in good shape. Consumer confidence took an unexpected jump; GDP increased by more than 4%; over two million jobs were added, bringing the unemployment rate down to 5.4%; consumers continued to spend; and the weak dollar began to have its effect, with Europeans flocking to America to do their Christmas shopping and fill hotels at Colorado's ski resorts.
Most of the indicators point to another good year. Incomes from wages and salaries are rising faster than inflation, giving consumers a real boost in purchasing power. Equally important, America's households enter 2005 a lot richer than they were a year ago. Thanks to rising house and financial asset prices, household net worth -- the value of all assets minus all liabilities -- rose by $4.3 trillion. Combine that with the fact that the cost of servicing credit card, mortgage and other debt is lower relative to incomes than it was a few years ago, and you have consumers who can, if they choose, keep spending even if they have to borrow to do so.
Businesses are also in a position to step up spending. According to Howard Silverblatt of Standard & Poor, America's largest companies are sitting on almost $600 billion in cash, compared to $260 billion five years ago. It won't take much of an easing in world tensions, and in oil prices, to pry some of that cash mountain loose, and persuade corporate boards to approve long-postponed projects.
So I find myself at the high end of the consensus. Unless, of course… But I repeat myself.
Have a wonderful new year.
A version of this article appeared in The Sunday Times (London).
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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