The Fed revised its economic outlook to suggest US output would fall 1.3-2.0% over 2009, and that the worst declines may be over. Well that does not surprise me. If you are ‘high’ on economic stimulus there is no question people are going to feel good about a stabilisation of asset prices, but at some point inflation is going to take its toll on household’s purchasing power.
The notion that “there are improvements in financial and credit markets” only highlights the fact that the Fed and other central banks have been recapitalising the banks using taxpayer money, and rather then using the proceeds to lend to households, who are already indebted, the banks have been speculating in the securities markets, driving up security prices. This will come to an end at some point soon, and we will be looking at another volatile downtrend through 2009-2010 as interest rates move higher.
US economic output fell by 6.1% in the March quarter of 2009 after a 6.3% fall in Dec-08 quarter. They are serious hits to the market, but more will follow. There is at least some recognition that this is crisis is not over. The Fed projects unemployment to rise from 8.9% in 2008 (a 25-year high) to 9.2-9.6% in 2009.
The Fed expects inflation to hold at 0.6-0.9% in 2009. I have never believed in inflation numbers because you only have to look at how they define the concept. Any measure of inflation that does not consider all asset prices, excludes the most important components like securities, food and energy, is just trying to plan delusional games betting on Chinese deflationary impacts. A sudden loss of economic capacity is going to result in higher fixed costs to all production. There is no escaping that, though if you are selective in your inflationary analysis, you can of course opportunistically consider energy and asset prices, which have been falling...but not for much longer. The reality is – inflation as defined is manipulated, so give it no heart.
Now for those of your with a sense of humour. The Fed is forecasting “modest growth” of 2-3% in 2010. Wow, that is quite a turnaround. You might be inclined to believe that there is no reason why this market cannot just turnaround like it did in years past. Afterall as long as the Fed and other central banks shore up the banking system, what it to stop Western governments from sustaining this delusion for years to come. I think there are several issues which can stop them:
3. Debt levels
The international political environment is pretty tense, but there is probably little prospect of war or further substantial military action at this point since oil prices have fallen significantly. A pandemic is a threat to consumer spending, though I would suggest any threat is likely to be short lived. It might actually be expected to affect the financial system more than the real economy. My analysis is that it will cause short term financial volatility, which will probably knock a few more financial institutions out of the market, but that the market will recover from a bird/swine flu based pandemic. We will stock up on food, hide in our houses for a few weeks as it sweeps the world, and on that basis it will die out, and become a less virulent strain.
Debt levels remain the biggest obstacle to the sustainability of the current economy. Even if tax increases can be delayed a few years, it will only result in government debt being rising to the same levels of household debt. With many households already having lost a lot of equity in their homes in recent times, causing the biggest mass transfer of wealth (as a % of GDP) in history, who would expect a recovery? This at a time when governments are moving to consumption-based taxation. Who understands the logic of these people? Well of course its a desire for short term political power, and taking every expedient step to preserve it.
Andrew Sheldon www.sheldonthinks.com