This year will be important in U.S. economic history even though we don’t yet know why. It will be so simply because the events that occurred between June 2007 and the present were momentous ones stemming from fundamental forces that are far from being played out. Uncertainty dominates the situation right now and probably will continue to do so throughout the year. While no one knows what will happen, here are some pointers to help understand events as the year unfolds.
First, distinguish between the real economy and the money economy. Money is only a means to an end, not an end in itself. We don’t eat money, wear it, live in it, drive it or use it to cure disease. Food, clothing, housing, transportation and medical treatments are far more important than money.
Money is, however, an important human invention to facilitate the production and distribution of goods to fill these real needs and wants. So we cannot ignore money, but it is important to distinguish between indicators of the real economy like employment numbers and real output of goods versus measures of the money economy like the prices of stocks, bonds and real estate or exchange rates.
Both tell us something about the overall economy, but there is a danger in focusing too much on the money economy and letting that blind us to the real economy.
That happened last year as the sharp resurgence of the stock market, after bottoming in March, led some to believe that happy days would soon be here again.
Yes, there were some real-economy “green shoots” in the past six months as growth of unemployment, measured narrowly or broadly, slowed. Real output of goods and services grew slightly even though it remains below 2007 levels. Automakers had a third-quarter spurt. Consumers did buy slightly more goods and services in the holiday season than a year earlier.
But those real economy improvements exercised far less influence on the public mood than the Dow’s increase from less than 7,000 in early March to well over 10,000 in late fall. Stock prices are only weakly connected to the real economy in any case and are likely to be particularly treacherous in uncertain times like these.
Second, distinguish between primary and secondary problems. Two years ago, subprime mortgages were the most visible manifestation of economic problems. Some still see them as the core of our economic ills. But underlying issues — ongoing federal budget deficits, the too-rapid growth of the money supply, poorly conceived financial-sector regulation and unbalanced, unsustainable economic flows between our nation and the rest of the world — are far more important. As 2010 unfolds, pay more attention to these fundamental problems than to their superficial manifestations.
Yes, it will be good if rates of home foreclosure drop. It will be good if fewer banks go broke. It will be good if an overhanging cornice of dud commercial property loans doesn’t suddenly turn into a financial avalanche. It will be good if the government recovers substantial fractions of the funds plowed into financial institutions via Fed emergency measures or the TARP program. It will be good if inflation and interest rates remain moderate.
But if we don’t have effective financial-sector reform based on real-world realities rather than abstract faith, if we don’t near some consensus on the mix of spending cuts and tax increases needed to close unsustainable budget deficits over the long run, if the Fed does not demonstrate it really can withdraw the unprecedented injections of base money made over the past 30 months and if there is no movement toward a new international financial regime, particularly between the United States and East Asia, then positive trends in the domestic financial indicators noted above will count for little.
I’m not optimistic about 2010, precisely because the outlook does not seem particularly good for movement on any of the four fundamental problems — the budget deficit, financial regulation reform, money supply or international finance — in a foreseeable future that extends beyond 2010.
Pundits invoke various letters or symbols, V, W, L or the square-root sign to describe possible courses for the U.S. economy. To throw in my two cents, I think a V recovery of the kind common after many garden-variety post-World War II recession is not likely. A W-shaped double dip as in the early 1980s is possible.
What I fear, but expect most, is an L-shaped pattern like that of Japan after its real estate and stock-price bubble popped in 1989. Japan staved off a financial collapse and depression, as we did in 2008. But it did not address its fundamental problems and, flip-flopping on monetary and fiscal policies, had a decade of essentially zero growth. Many U.S. economists sneered at Japan and vowed we would never make similar errors, but so far, things are eerily similar.
As my mother frequently said, “Hope for the best and expect the worst.”
© 2010 Edward Lotterman
Chanarambie Consulting, Inc.