Flying Pink Unicorns

The economy will recover strongly in 2010. Nearly every economist on record is predicting a very slow recovery. Nearly every economist is wrong.

First, its not at all unusual for the huge majority of economists to be fundamentally wrong on the course of the national economy. Very few predicted the vigor of the recovery starting in 1994, following a very slow start to the recovery after the recession of 1991. Very very few predicted a steep recession following the bursting of the housing bubble in 2007-2008. And now, most economists, seeing the truly dreadful economic numbers that are coming out this year, are predicting a very slow recover, if any at all. A lot of ordinary people are wondering if the economy will ever recover strongly.

It will. Betting against America has been a losing bet for 400 years. It continues to be, particularly since we have reasonably competent leadership in the White House.

Anyway, all of the economists and ordinary people I have alluded to above are making the same fundamental mistake. They are projecting the recent past into the near future! It is my belief that this error is very common among people of all stripes, is deep in human nature, and in fact is one of the key obstacles people face regarding trying to get an idea of what will happen in the future.

Housing prices went up recently? They will continue to do so. The stock market? Ditto.

It takes vision (and guts, and insight) to predict a radical break from the recent past. After all, the recent past often DOES indicate the course of the near future. But sometimes it doesn't, and recognizing those times is crucial if you're going to be worth a crap as an analyst of any sort.

Let's see if I'm worth a crap as an analyst of the economy about now.

The reason I am predicting a strong recovery is simple; there are so many huge efforts in place to stimulate the economy. These are, in order of importance:

First, and most importantly, Hank Paulson and Tim Geithner have apparently stabilized the banking system. When's the last time you heard truly awful news about a major bank/financial institution? Been a while, hasn't it. We've progressed through a stimulus package, health care reform, Iranian elections, Michael Jackson, and so on. Its easy to forget that from September to early February the financial system was at various times teetering on the edge of the abyss. With the help of (eventually) good leadership from Paulson, under Bush, and (reasonably) good leadership under Geithner, the banking system has apparently stabilized. This was absolutely necessary for economic recovery to take root. If I am reading the treasury department website correctly, and I think I am, a total of slightly over $70 billion dollars has been repaid to the treasury, from various banks, out of $203 billion the government put in.

http://www.financialstability.gov/docs/transaction-reports/transactions-report_070609.pdf

Given where we were just a few months ago, that's an incredibly good sign for the health of the banking system.

Second, the Federal Reserve has created an absolute boatload of money. M2 is the aggregate total of all physical currency, amount in demand accounts, savings accounts and a few other areas. This is the measure that the fed currently uses to determine the broad money supply. Between September 2008 and July 2009, the fed (wisely in my opinion) increased M2 from
$7.65 trillion to $8.3 trillion, a nearly 10% increase. This 10% increase is a fairly large increase historically, and is highly likely to stimulate the economy in the short run. In so doing, the fed dramatically increased the amount of reserves held by banks. This change allows banks to make more loans. This process has begun, but not yet in a big way.

Third, interest rates have been cut by the fed, to the floor. This hasn't really mattered yet, due to the banking/credit market crisis, but as these areas continue to return to normalcy (I predict) interest rates will regain their potency to stimulate the economy, as businesses and individuals will again want to borrow to grow/expand their business, buy cars and houses (more on that later in this post) etc. With banks increasingly able and willing to lend (there has been progress already in this area, and I predict much more in the next 6 months) the low cost of capital will stimulate, as it always has.

Fourth, the Obama stimulus. It has been criticized (correctly) for being slow to really get moving. Much of the actual government spending will occur between this October and next October. This fact will turn out to be a blessing in disguise, as the spending will likely have far more knock-on effects than it would have earlier this year, because the banking system will be healthier. In any event, the stimulus will add somewhere around 1.5 points to GDP growth for the next fiscal year (beginning October 1st).

Fifth, businesses have already cut so very many workers. This, perversely, should indicate that the rate of job loss should slow, very very soon. It already has slowed, but only from frightfully high levels, to high levels. This should progress, in turn, to fairly high levels, little job loss, and then a little job gain. The sectors that have been hardest high (finance, construction, especially residential housing construction and manufacturing) have had absolutely savage, depression-like job cuts. I admit to not knowing the details at all on this point, but it seems to me that further serious job cuts in these areas are highly unlikely. Many of the weak businesses in these areas have gone out of business, the survivors have already cut to the bone. Businesses have cut jobs in many cases even faster and further than the demand for their goods/services have fallen. When demand stabilizes (which may have happened already, and in any event should happen quite soon), businesses will quickly stop cutting jobs, and then tentatively start adding a few. This process tends to build on itself in normal recoveries.

Sixth, there is beginning to be pent-up consumer demand. The sales of cars in particular dropped so steeply in 2008-2009, that the average age of vehicles in America has soared to the point where in the past car sales really picked up. This may take a little while this time around because of the credit crunch and particular worries about GM and Chrysler, but with the government bailouts in place, I predict these worries will soon be overcome. 2010 should represent a big percentage increase in car sales off of the truly godawful levels of 2009. This will boost the economy.

The same is true to a lesser extent for other consumer goods. Demand fell so far so fast, that it will likely rise soon.

With housing, I doubt this is the case. Housing prices still probably have further to fall, and I can't see a housing recovery of any kind until at least 2011. In past recoveries housing has usually led the economy out of recession, as lower interest rates entice buyers. That is most unlikely to happen this time, which is why the recession has gone on for so long (18 months and counting assuming it is not quite over yet).

However, the other elements of recovery that I have outlined should be so vigorous that a very weak housing market is overcome, and a reasonably strong economic recovery should take root sometime late this year or early next year. The naysayers, who are predicting a double dip recession, with unemployment eventually reaching north of 12%, are wrong.

Having said all this, job losses should continue for several more months, and unemployment will top 10% for certain. Its possible that everything I predict in this post could come to pass except for job growth, and that unemployment could still rise through next Spring, topping out at around 11.5%. I doubt it, but its possible. That would merely set the stage for a delayed, and thus stronger recovery, as the job market catches up to the other underlying forces in the economy.

I know I seem ridiculously optimistic to many of you, but what I am doing is not simply projecting the recent past into the near future, but instead trying to understand the forces that will shape the near future. And what I see is an array of forces constituting wind at the back of the economy, and only housing as a strong headwind. There are many, many more tailwinds than headwinds.

By all means, judge me favorably or harshly over the next year, depending on what happens. But this is, in broad outline, how I see the economy.