From the January 3, 2010 Sunday Times
January 3, 2010
by Irwin Stelzer
Forecasting errors are largest when the most is happening in the economy, wrote Lord Burns, a former permanent secretary at HM Treasury. It is difficult to imagine more happening in the economy in 2009 than actually did, and 2010 should be no different. And predicting where the economy is heading is made even more complicated by important known unknowns, and the key role that policy will play.
The known unknowns include the possibility that Iran might explode a nuclear device, or that Israel might make this impossible. Islamic terrorists, who failed in their recent attempt to blow up an airliner over Detroit, might succeed in an attack on New York, London or some other key financial centre, or on the Saudi oilfields.
An even greater source of uncertainty is the policymaking duo of Barack Obama and Ben Bernanke — the American president and the chairman of the Federal Reserve Board. In 2009 the president poured gallons of red ink over the nation’s ledgers, while Bernanke printed money with which to buy up Obama’s IOUs. There are hints that Obama and Bernanke, or both, will reverse course this year. The president says he plans what his staff call “a pivot” early in the new year, and will announce plans to rein in spending in the long run, which of course is not quite the same thing as doing it now.
And the Fed is pointing to the various techniques it could use to sop up the excess liquidity with which it has flooded the system — when it deems the time is right. Which means that to predict the economy in 2010 we are reduced to doing what John Maynard Keynes suggested if we want to pick the winner of a beauty contest — don’t try to pick the prettiest face, try to pick the face the judges will deem the most beautiful (I paraphrase). Guess right on how Obama and Bernanke will see things, and you have a winning prediction on economic activity this year.
The safest guess is that the president and the Democratic Congress will continue to run up the budget deficit. The House of Representatives has already passed a second stimulus, which dare not speak its name, and the president will soon sign a healthcare bill that will sink the nation even deeper into debt. Then come the unlimited billions for Fannie Mae and Freddie Mac, the quasi-government mortgage agencies.
Meanwhile, the Fed has made it clear that so long as the unemployment rate stays high, the financial and housing markets remain fragile, and credit remains difficult for small businesses to come by, it will not tighten — at least not a lot. Critics of the president and the Fed argue that the policy of big deficits, continued low interest rates, and money creation has failed. The unemployment rate has risen from 7.6% at the beginning of last year to 10%, and the number of long-term unemployed (out of work for more than 26 weeks) has more than doubled, to almost 6m. Throw in mounting repossessions, hundreds of failed banks, and business’s reluctance to invest and you hardly have a testimonial that Lord Keynes would have liked etched on his tombstone.
To which the response is: because of these policies the financial system did not collapse, job losses are tapering off, the housing market is firming up and even the bloodied dollar is showing signs of strength as investors guess that the recovering economy will drive up interest rates, increasing the attractiveness of dollar assets.
My own guess is that all of this means that the wind is blowing in the direction of a continued recovery, to borrow a phrase from my colleague David Smith, and one more rapid than most observers are expecting.
Consumers unzipped their purses late in the Christmas shopping season despite the absence of the deep discounting of recent years. Share prices are up, and investors cheerier, in part because they don’t take account of inflation when toting up their gains. Factor in inflation, and it will take a further share-price rise of 25%-30% to get them even with the level of 1999.
The important housing sector seems to have bottomed out, with sales of existing homes and prices both up a bit. But here is where policy — difficult to forecast — becomes crucial. If Congress allows existing tax credits for first-time buyers to lapse, and the Fed withdraws its several supports for the mortgage market, as it says it will, mortgage rates will rise, perhaps enough to abort a housing recovery that is fragile at best. Both programmes are scheduled to end early this year, shortly before voters decide the fates of all members of the House of Representatives and one-third of senators. It is anyone’s guess whether they will risk allowing these programmes to die, and with them their careers in public office.
None of this is to say that policymaking is all that matters. Far from it. Consumers account for some 70% of American economic activity, and in the end are the ones whose reactions to policies will drive the economy. So it is good news that personal incomes and wages rose last month, and that the savings rate seems to have stabilised at about 5% — high enough to prevent a return to the negative rates of the spendthrift 1990s, but not so high as to put a crimp in the recovery.
Businesses, too, matter. Right now profits are good, and companies are sitting on a pile of cash. But uncertainty as to the cost to be imposed on them by the new healthcare “reform”, the looming carbon cap-and-trade bill, and by the impending huge boost in their tax bills, makes them reluctant to invest and to hire.
All in all, it is not unreasonable to guess that the wind will blow in a 2010 that is better for most people than 2009. Except for the congressmen who have to explain to their constituents why the budget deficit is projected to continue at levels that in the long run will threaten a wave of inflation, and for future generations that will have to bear the burden of trillions of dollars in government IOUs.
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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