My mother’s familiar admonition to ‘hope for the best but expect the worst’ is a good way to approach 2011. Hope that the Minnesota, national and global economies strengthen, but don’t be surprised if the overall situation worsens instead. Here are some things to monitor as the year progresses.
Housing prices: Until housing prices find a bottom, households won’t know the true state of their finances, lenders won’t know how large their write-offs will be and investors won’t know the actual worth of sundry mortgage-backed securities they hold.
This most recent news is not good. The SP Case-Shiller home price index for October sales showed declines from September in all 20 metro areas surveyed. Compared with October 2009, all but four showed declines. The Twin Cities metro area showed a 1.9 percent one-month decline and a cumulative 2.8 percent drop over a year. In relative terms, this is not bad; 12 other cities did worse.
The problem is that declines since mid-summer reversed stability or modest gains earlier in the year. The most commonly identified reason is the expiration in June of a substantial tax credit for homebuyers. It now seems that apparent strength earlier was an artificial result of this government subsidy.
The composite year-over-year decline for the 20 cities surveyed was only 0.8 percent. In itself, such a modest decline should not have great effect on the economy. But just as Napoleon said that in war, morale outweighs all other factors, so too do consumer and business confidence in protracted recessions.
There probably is a ways to go before reaching a sustainable price floor. This is a case where a slow decline may be better than a fast one. Some argue a shock adjustment would get us through this process quicker, force everyone to write off inevitable losses sooner and lead to a quicker return to growth. But the problem is so large that such a shock would force many lenders and borrowers into bankruptcy and potentially return us to mid-2008. There is no easy out from this one.
Eurozone: Slow adjustment rather than crisis is also the better outcome in the Eurozone, but don’t count on it. There simply are too many variables at play and too many separate governments involved to ensure rational, coordinated policies. Authorities have been successful so far at dealing with relatively small problems in Greece and Ireland, but if things proceed to Spain there may be a point where bondholders panic and flee for the exit en masse. If that happens, expect bodies to pile up inside the door with Europe facing a crisis like we faced in September-October 2008. And collapse of major financial firms in Europe will affect us, make no mistake.
China: The country has done remarkably well over the past three years and its imports of raw materials have helped natural resource-exporting nations like Argentina, Brazil, Australia and Canada fare much better than the United States or Europe. The question is one of sustainability.
China cannot continue on its blistering pace indefinitely. There clearly is overbuilding of public and private infrastructure. Inflation is already apparent at the retail level, and keeping the general public tranquil always is a higher priority for an authoritarian regime than for ones that enjoy democratic legitimacy. The Bank of China has tightened the money supply in four small increments over recent months. It may have to take bigger steps. Any such monetary constraint will slow an overheated economy; that is the whole point. The question is whether authorities can pull off a proverbial “soft landing.” These are exceedingly rare and harder to accomplish when the rest of the world is in financial turmoil. Exactly how recession in China would affect the industrialized countries is unclear, but the effects would not be positive.
U.S. policy: In our own country, we face questions of whether the monetary stimulus of the Fed and the continued deficit spending amplified by the recent bipartisan tax cut deal really will spur the overall economy.
First, when the economy is already awash in liquidity that may be fueling an unsustainable stock market recovery, will continued additions to the monetary base goose business spending on new plants and equipment and increase hiring? Or are we in a “low-level liquidity trap” where business and consumer pessimism render monetary stimulus impotent? And at what point will this all rouse inflation fears that drive long-term interest rates up rather than down? The jury is out, but it may send in a verdict some time in the next 12 months.
On the fiscal side, the recent agreement mostly extends the current tax regimen and unemployment outlays. It does not add much new. It is an avoided tightening rather than a loosening. And the Keynesian theory behind such anti-recession stimulus was not predicated on an economy that had ballooned its national debt, fair economic weather or foul, for 25 of the preceding 30 years. Japan got away with it because it can finance deficits from its people’s own savings. We cannot.
All in all, 2011 may be an exciting year but probably not a comfortable one.
© 2011 Edward Lotterman
Chanarambie Consulting, Inc.