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The U.S. Economy
…growth resuming?
The American recession, into its 19th month as July unfolds, will be the longest and deepest of any since the Great Depression. A return to positive (if modest) U.S. economic growth during the July to September quarter is the consensus view of forecasting economists. Modest growth should be followed by more robust performance during 2009’s final quarter and throughout 2010.

A return to U.S. economic growth does not suggest that problems with housing, commercial real estate, investment portfolios, and financial markets are behind us. But it IS a step in the right direction!

Budget Deficits
…tooooo much
The Obama Administration’s aggressive spending will see a deficit approaching $2,000,000,000,000 in fiscal year 2009. For each dollar the government takes in, it will spend two. To the Administration’s defense, it did inherit major economic and financial challenges from the Bush Administration.

The greater issue will be how to rein in estimated deficits averaging nearly $1 trillion annually during the following eight years. The President is likely to face more opposition to aggressive spending by more conservative members of his own party.

Unemployment
…approaching 10%
The U.S. economy suffered a net decline of 3.1 million jobs during 2008, the worst year since 1945. Even greater losses will occur in 2009. However, monthly reported losses should ease as the year progresses.

The nation’s jobless rate has reached 9.4%, with additional increases in store. The jobless rate could reach 10.0% by early 2010.

Inflation
…which camp?
Consumer prices (the CPI) actually declined slightly 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 1.5% in 2009.

Where we go from there is the subject of intense debate. One camp of economists sees inflation pressures after 2010 resulting from 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 global recession. Pick your poison.

The Federal Reserve
…near zero
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 most of the year. The Fed has engaged in one unprecedented program after another, collectively known as “quantitative easing,” to address the near-paralysis that has at times plagued financial markets for the past 12-24 months.

Long-Term Interest Rates
…which direction?
Thirty-year fixed-rate mortgages for conventional loans averaged 4.82% (Freddie Mac) during most of April and May, before rising slightly in recent weeks. Mortgage finance for higher-priced homes remains spotty in many communities.

Whether the Fed will boost its purchases of U.S. Treasury notes and mortgage-backed securities in an attempt to push rates back down is the $64 question. Lower rates would help existing home prices to stabilize and clear high levels of new and foreclosed homes from the market.

The Global Economy
…2010 rebound?
Economic and financial challenges abound for both developed and emerging nations across the global community. However, significant increases in stock markets around the globe suggest the worst is behind us. For the first time since World War II, the U.S., Japan, and Europe are in recession simultaneously. Renewed U.S. economic growth, combined with reasonably solid growth in China and India, suggest the global recession could conclude by mid-2010.

Japan is in serious recession, with the economy contracting at an alarming 15.2% annual rate during 2009’s first quarter. A plunge in exports to the world is the culprit. However, more recent signs suggest some level of economic stability may be at hand.

China—which recently surpassed Germany to claim the #3 economic ranking in the world behind the U.S. and Japan—is dealing with major challenges tied to economic growth slowing from 120 miles per hour to near 75 mph. 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 slowed from near 9.0% annually to a 5.8% annual pace during 2009’s first quarter. Stronger growth is likely over the next 12 months.

Europe and the U.K. are currently buried in serious economic downturns, with the likelihood that both could be laggards in 2010 as the global economy picks up speed. Ailing financial systems and problem loans to Eastern Europe will likely constrain a rebound when it does occur.

Russian politicos are keeping their fingers crossed, hoping oil prices continue to rise. The dive in oil and commodity prices of the past year led to painful budget cuts, sharply higher unemployment, and a record decline in industrial production.

High levels of government inefficiency and rampant corruption are part and parcel of doing business in many South American nations. Such a reality is more painful when commodity prices are lower than before.

Mexico is getting hit from all sides, leading its economy to plunge at a 21% annual rate in the first quarter. This nation’s critical tourism sector has been hammered by 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 which only added to tourism weakness and other economic disruptions.

Canada remains in recession as its top customer …the U.S.…buys less. Eastern provinces deal with a weak auto sector, while the west deals with lesser commodity values.

The Bottom Line?
A serious and lengthy U.S. recession should give way to stabilization and modest growth in coming months. We also expect…unprecedented budget deficits tied to massive “stimulus” spending
…more employment pain…modest inflationary pressures this year…extremely low short- and long-term interest rates…and a sick but soon-to-improve global economy.

Nap Time

A Bit of History (from econAmerica, our book released by major publisher Wiley & Sons)

Social Security faced a funding crisis in the mid-1980s, with both major political parties in quiet agreement that something needed to be done. The bipartisan Greenspan Commission, chaired by future (and now former) Federal Reserve Chair Alan Greenspan, was created to study Social Security funding issues and make recommendations for long-term improvement.

The bipartisan recommendations that emerged provided meaningful improvement and fiscal solvency for decades to come, with most of the changes to take place in future years. A series of modest tax increases were phased in over a dozen years. In addition, the prior reality of full benefits at age 65 for all was stretched out. A later retirement age for Boomers was phased in, ranging from 65 years and two months up to age 67 for even later retirees.

Rising Pressures Today
Severe U.S. recession has sharply reduced the flow of funds to Social Security and Medicare, tied to declining payroll taxes resulting from the loss of 6.0 million jobs during the past 18 months. According to the Social Security and Medicare Trustees in a report issued on May 12, 2009, Social Security is now expected to stop running modest surpluses in seven years, one year earlier than previously estimated.

Moreover, the Social Security Trust Fund is expected to run dry by 2037, four years faster than last year’s projection. Similar changes have occurred with Medicare’s funding as well, which is in far worse shape.

Social Security tax revenues of the past 30 years have provided excess funds to be used by the Congress for hundreds of other programs. Contrary to the belief of many, excess Social Security funds are not “saved” for the future, but are aggressively spent and replaced with government IOUs, known as non-marketable U.S. Treasury notes.

The current Social Security Trust Fund has roughly $2.4 trillion in such Treasury notes, to be “cashed in” when the annual surplus concludes, tied to the impending retirement of 78 million Baby Boomers. Note: This will be an internal government accounting issue, since there really is no money. To redeem Trust Fund notes, the Government will have to raise funds (borrow) in the public debt markets or increase taxes.

President Obama has mentioned the need for entitlement program reform a number of times in recent months. U.S. Treasury Secretary Geithner noted following the release of the report that “after we have passed health care reform,” the President would then turn to Social Security.

These programs will be funded in the future, although such programs will be modified to be financially viable. Small modifications made now will provide massive savings down the road. We do not have to cut spending in any program…we simply need to slow down the growth rate…that is a major difference.

The following statement, also from econAmerica, is the second of four major developments, referred to as Silver Bullets, that drive my optimistic view of the American economy in coming years.

SILVER BULLET #2:
This nation will reach a point in coming years when politicians are simply forced by the pressure of powerful financial markets and by constant media attention to set aside political rancor and work together to solve the entitlement funding and benefit issue. We refer to this as NAP (No Alternative Politics) time.

Neither party will be willing then or able to make such changes alone. Strong political leadership will see a bipartisan commission created, with required program changes debated in a civil environment. The full Congress will likely be asked to approve changes as proposed by the study group, with no ability to make modifications. Members of both major political parties will agree to avoid finger-pointing and accusations, recognizing that a cooperative effort is mandatory.

We have been at this point before and responded. We will do so again. We simply have no alternative.

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