Economic Commentaries

Entries for December 2010


2010 was the year of the Federal Reserve as the Chairman appeared on the air waves, undertook massive unconventional asset purchases, and stirred emotions of supporters and detractors. We think 2011 will be the year of the government as budgets at the federal, state, and local levels will stir acrimonious debate.

It is important to remember that while the agreement to extend current tax rates removes a cloud of uncertainty for a few years, it does not represent new economic stimulus. Moreover, while the payroll tax holiday and full cash expensing for business equipment is new stimulus, they are temporary as both extend for only one year. Meanwhile, a portion of the payroll tax holiday is offset by the expiration of the Making Work Pay credit from the prior stimulus program. And other stimuli from the 2009 “Recovery Act” fade away in the coming year.

On balance we calculate only about $60-$90 billion of net new stimulus from this agreement in 2011 which is a lot less than government provided in 2010. The economy will thus be more dependent on private sector growth going forward. And within the private sector demand will be all important as the inventory cycle is mature and will provide less punch to the production process.

Upon examining the condition of the private sector there are both positives and negatives. Household finances are in better shape than at any time in the past two years. The saving rate is up; debt relative to income is down somewhat; and wealth has recovered somewhat with improving equity markets. Corporate balance sheets are in great shape, and full cash expensing in 2011 should provide some boost to capital spending. Meanwhile, financial institutions are seeing fewer loan delinquencies and they are beginning to expand credit. Finally, even though China and selected emerging economies are snugging credit, economic growth should remain firm.

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Posted in: General

It is that time of year when we sketch a road map for the year ahead. Looking back at earlier road maps, we dubbed 2010 as the Year of the Fed, arguing that the Central Bank would have to remain extremely accommodative in order to promote economic recovery. We dubbed 2011 as the Year of Government as we thought there would be a focus on debt, deficits, and the unsustainability of the U.S. fiscal condition. We did not foresee the full effect of the Gulf oil spill in 2010 nor the full intensity of the Euro Sovereign crisis, the Arab spring, or the devastating natural disaster that afflicted Japan in 2011.

We are certain to miss aspects of 2012 as well, but with much humility we are characterizing it as a Year of Paralysis. We can not imagine how the U.S. and the global economy will be able to function efficiently given the onslaught of potentially monumental economic policy changes on the horizon. As it is, we do not believe the current fundamentals of the U.S. economy are very positive despite a strong second half 2011 showing.

Fiscal drag at the federal and state level is still in place and will remain so even with payroll tax and jobless benefit extensions. Export markets will feel the effect of weakness abroad. Consumers over spent in late 2011 and they will seek to rebuild saving in 2012. Business pre- spent on equipment to take advantage of expiring tax breaks, so a pull back in investment is in order. To us these headwinds suggest that growth will slow substantially in the year's first half and worries over recession will again emerge. We continue to place the odds of recession in the U.S. at 50%.

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Posted in: General