Written by Jeff Thredgold, President, Thredgold Economic Associates
Economic Consultant to Zions Bank

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The American Economy
it's about time!
The majority of forecasting economists see U.S. economic growth having returned in the third quarter, with most forecasts actually revised higher in recent weeks to reflect stronger performance. Reasonably solid growth during 2009's final quarter also seems on tap, with positive, but perhaps less robust, growth expected next year.

The 'Great Recession'…the longest, deepest, and most painful since the Great Depression, has officially been with us since December 2007. A return to positive U.S. economic growth does not suggest that problems with housing, commercial real estate, sick investment portfolios, and wobbly financial markets are finally behind us. But it remains a step in the right direction!

Unemployment
still moving higher
The 9.7% U.S. jobless rate in August (a 26-year high) is expected to reach, and possibly exceed, 10.0% in coming months. Unacceptably high joblessness is likely to be the norm during the next few years, with hundreds of thousands of jobs in construction and manufacturing never to return.

The U.S. economy suffered a net decline of 3.1 million jobs during 2008, the worst year since 1945. Even greater losses will define 2009. A volatile mixture of monthly losses and gains seems likely during the next 6-9 months.

Inflation
also moving higher
The Consumer Price Index (CPI) actually declined 1.5% during the most recent 12-month period, following the 0.1% rise during 2008, the smallest increase in 54 years. Most forecasters see the CPI rising near 1.2% in 2009, with slightly higher inflation next year.

Where we go from there is the subject of intense debate. One influential camp of economists sees major inflation pressures after 2010 resulting from highly aggressive monetary policy and massive budget deficits. The other vocal camp sees a Japanese-style deflation unfolding in coming years, tied to weak residential and commercial real estate values, major slack in labor markets, and shell-shocked consumers.

The Federal Reserve
an exit strategy
The Fed's critical federal funds rate, at an all-time low of 0.00%-0.25% since mid-December 2008, could easily stay at that level well into 2010. The Fed has engaged in one unprecedented program after another, collectively known as 'quantitative easing,' to address the near-paralysis that has frequently plagued financial markets for the past 12-24 months.

The Fed's 'exit strategy' from such actions will draw great scrutiny during the next 6-18 months. Chairman Bernanke's reappointment by the President to a second four-year term was a positive development.

Long-Term Interest Rates
appealing refinance rates
Thirty-year fixed-rate mortgages for conventional loans averaged just above 5.00% (Freddie Mac) in recent weeks. Now is an attractive time to refinance a mortgage or buy a new home or foreclosed property. Mortgage finance for higher-priced homes remains spotty in too many communities.

Unfortunately, millions of homeowners are 'underwater' on their homes, owing more than the home is now worth. This is particularly true in many Western states, Florida, and parts of the Upper Midwest.

The Global Economy
growth has returned
Most forecasters see a return to global economic growth now underway. Such growth is a welcome contrast to much of the past 12 months, when the global economy suffered its first recession since just after World War II.

Japan experienced a deep recession, with a plunge in exports to the world the primary culprit. More recent signs suggest a return to modest growth is underway. Nevertheless, economic weakness contributed to major political change, with the dominant LDP party losing control for the first time in nearly 50 years.

Chinese economic growth has also picked up speed in recent months. A return to strong growth will allow political leaders to breathe easier.

The reason? The continuing migration of millions of citizens annually from the farms to the factories had been disrupted during the past 18 months as thousands of factories closed due to sharply lower global demand for exported goods. Many of these jobs have returned. China is making solid efforts to boost domestic demand within its economy, in part fueled by its own stimulus program.

India's economic growth pace has also begun to pick up speed after substantial slowing during the past year. Stronger growth is likely over the next 12 months.

Europe's primary economic players, Germany and France, both returned to modest growth during 2009's second quarter, defying most forecasts. The U.K., hit hard during the past 18 months, has also shown more signs of economic stabilization, though solid Irish growth remains unlikely anytime soon.

Russia's political elite are frustrated with the 'one trick pony' nature of the economy. Over-dependence upon energy and commodities keeps the country exposed to economic gyrations largely out of their control.

Various South American nations have also seen signs of economic improvement recently. For too many, however, government inefficiency and rampant corruption remain part and parcel of 'doing business.'

The Mexican economy is also seeing more recent signs of stabilization after its critical tourism sector was ravaged during the past year by 'the Perfect Storm' of 1) fewer global visitors tied to recession; 2) the serious escalation in drug trafficking violence which has kept visitors away; and 3) the H1N1 (swine) flu. Resort communities will aggressively promote visitation.

More signs of optimism are also found across Canada. During the last five months, employment has largely stabilized, with a solid employment gain during August.

The Bottom Line?
The painful and lengthy U.S. recession is now giving way to a reasonable growth pace, although serious challenges remain. We also expect-mixed employment news-modest inflation this year and next with rising longer-term anxiety-extremely low short-term and attractive long-term interest rates-and a rapidly improving global economy.

$180,000,000-Every 60 Minutes

In my view, the most critical challenge facing this country over the next 10-20 years will be our ability to control federal spending. Such a challenge will be made more difficult by a President and a Congress determined to see the government assume a greater and greater role in our lives.

The largest annual budget deficit this nation ever ran was during fiscal year (FY) 2008, which ended September 30, 2008, a deficit of $459,000,000,000. The deficit for FY 2009 will be just under $1.6 trillion—$180,000,000 EVERY 60 MINUTES—more than three times last year's record.

The current Administration inherited an economic and financial disaster from its predecessor. If the calendar were such that George W. Bush was still President, the deficit this year would be similar. The consensus view of economists has been that extraordinary levels of government action (spending) late last year, during 2009, and well into 2010 was/is the lesser of two evils-versus doing nothing and letting the economy continue to spiral downward.

The Democratic wish list of more and more government; more control and greater spending for health care; more money for education; greater power for labor unions; more funding for alternative energy, while ignoring nuclear power and offshore drilling; costly penalties for carbon emission; and 'punishing' those successful Americans who happen to make more than $200,000 annually ($250,000 for joint incomes) with higher taxes on income, capital gains, and dividends is on the drawing board.

Much of the above plan is largely based upon the desirability of income redistribution, rather than incentives to create new income. The wish list, combined with the enormous costs of bailouts and financial market stabilization, has pushed projected budget deficits to dizzying levels. They are simply too much in outer years.

If at your house this year you collectively earn $80,000 but spend $160,000, life is good. If next year you earn $90,000, but spend $140,000, you can live well. This works only so long as 1) lenders are willing to lend you more money, and 2) you can handle the financing costs.

What is true at your house is also inevitably true with America, or any other nation. At some point, lenders stop lending. Bond buyers stop buying your bonds. The interest cost alone—already exceeding $1,000,000,000 DAILY—begins to overwhelm you. The Chinese and the Saudis and the Dutch and the Japanese begin to question your ability to repay.

Roll of Government
Government is not the solution to many of the challenges we face. It creates as many problems as it solves. The role of government is to help sustain some level of economic and financial 'normalcy' to allow private sector businesses and private sector individuals to prosper.

At times like these, government must fill the void to replace consumer and corporate spending as their respective confidence levels are whipsawed. As confidence returns-and it will-the best role of government is to simply get out of the way.

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