2010: A (spaced) recovery?
Unfortunately Hollywood was wrong about 2010, we are no where near to having flying cars, jet packs or robots as butlers. However, here’s what we can expect:
1) Policy:
The past year it was easy to make policy to counter the global economic meltdown because of coordination amongst the leading economies. There was no special reason for the coordination and cooperation except that it was painfully obvious that it was the only move that could be made. The real test is going to come now when the countries will have to start planning exit strategies from the current stimulus driven global economy (since governments can’t fund their recovery efforts for ever). Developed economies like the US and Britain have to be careful not to make the mistake of withdrawing the stimulus too quickly like in the case of the US in 1937 and Japan in 1997, where the ill timed change in policy (in this case a tax increase) sent these already fragile economies back into recession. In short, withdrawing the stimulus too soon= recession and deflation!
With the large US current account deficit I feel fiscal policy should remain the same for most of 2010 (with modest tightening) since a tightening of fiscal policy will happen when the tax cuts susnset in 2011. This could prove to be tricky, as this is right around the time the stimulus programs will begin to start tapering down. As mentioned earlier, if not handled with care the US can fall back into the deep dark gallows of the recension. Therefore, after a very busy crisis management 2009, 2010 should be quiet for policy makers as governments will be focusing on taking charge of their over inflated budget deficits.
2) Shape of the recovery: will it be in the shape of a V, U or a reverse square root?
The recovery of the US economy should be interesting. The recovery after a recession is traditionally strong whereas after a financial crisis it is obviously weak. Since the US was caught in the perfect storm between both, it is difficult to determine which route the recovery will take. A a lot will depend on how fiscal and monetary policy pan out.
I think it is safe to assume that the a V or U shape recovery of out of the question. The excess spending and borrowing of the past few years will take a lot more to recover than a few months of good economic news and data. I have to agree with the economists that believe that that the recovery will be in the shape of a reverse square root. This basically means that the economy will expand briskly and then taper down to an extended period of weak growth.
3) Interest rates:
In the past high interest rates were caused by inflation and their lowering ended recessions (well it was not that simple but it was pretty darn close). This time is an exception (we’ve all heard that before). At the time of entering the recession the US had a modest interest rate of 5.25%. The Fed effectively cut it to zero and aggressively bought bonds, mortgage backed securities and anything else it could to get the economy going again. However, bank loans to both businesses and individuals still continue to decline with only government backed Fannie and Ginnie Mae along with Freddie Mac are the only one to really give out credit.
Interest rates, as mentioned earlier, will have to be treated with great care. If growth is good the Fed will resist the temptation to increase rates. However, as of right now I feel that a very modest increase will be witnessed by mid 2010 and go through 2011. Depending on how interest rates will move, stocks will be impacted as well. When interest rates move up people move from ‘offensive stocks’, semi conductors, tech etc. to ‘defensive’ ones like pharma and food.
4) Housing market:
This is going to be a tough one to call. Some analysts are seeing a bottom while others are expecting it to go down further. The facts are quite depressing: new home construction is at its lowest point of GDP since the 1960′s and inventory of unsold new homes is the lowest its been in nearly 2 decades. Ive already mentioned (in a previous post) that commercial real-estate is a ticking time bomb, ready to wreak havoc. I feel that with unemployment still in double digits, housing stats will not be improving any time soon.
5) Unemployment:
Though double digit unemployment is concerning, in terms of employment numbers improving your guess is as good as mine. I expect it to peak at around 10.4% and then be in check after Q2 in 2010.
6) Inflation:
Inflation is something to be worried about in the long term. Currently there is not a high probability of any run away inflation. Basic economics states that inflation is caused when there is excess aggregate demand. However, currently the economy is dealing with excess capacity (firms are not producing to their optimal capacity) rather than excess aggregate demand.
7) Company earnings:
Pundits have been quite happy with earnings from companies and with the economy in general. Without sounding like a pessimist, though the end of 2009 did seem encouraging it is important to note that the numbers may be a little skewed as the economy went through a serious tightening followed by a widening of credit spreads. Furthermore, a lot of companies feeling the pinch were able to strip out a lot of the bad results while conveniently leaving in the non-recurring (one time) positive results.
2010 will not see the economy soar. It will consist more of policy makers trying to tackle weak demand for borrowing, fixing their balance sheets and developing strategies to ween the economy off the stimulus. It is going to be a year that needs to be handled with intense care, finesse and economic prowess.
It has been a tough year for a lot of people. Lets work hard not only to improve our lives but the lives of those around us. I hope people realize that they have a lot to be grateful for and that though things may be tough, we have it better than a lot of those less fortunate around us… On that note, I would like to both wish all my readers a very happy and prosperous new year and thank you for reading and supporting my blog.
Need May update!