The Not So New Year

Year end is always an odd time. We pretend that we can wipe the slate clean and that the new year will be unencumbered by the weight of the old. We party – so I hear – and ring in the fledgling as a kind of tabula rasa open to anything.

Not so much. Not this year anyway.

Economies don’t jump from point to point, with each totally free of the consequences of its immediate predecessor. Path dependence, the inertia of past events and decisions, limits just how much novelty can emerge. Or, rather, how quickly novelty can emerge. So we should not expect much in the way of new. The trends are well set. The first few months of 2012 depend heavily on the path traveled in the last few of 2011.

With this caution in mind what can we look forward to this year?

Here in the US the media has made much of the recent spate of relatively good news. The job market looks to have shifted slightly for the better. Consumer confidence has risen steadily. Manufacturing just registered its best month in about half a year. Exports appear to be headed up. Consumers crowded into the shops over the holiday season. And even real estate seems to have hit bottom and is showing signs of a very modest recovery. Add this all together and we could arrive at the conclusion that the US economy is finally rising out of its recent rut and is about to return to a more healthy pace of growth.

We could. But we ought not to.

This string of good news has to be set in its proper context. It represents a return to very modest growth after a nasty lull earlier in 2011. A lull that had many people suggesting that we may even be headed back into recession. On reflection – and for me at the time – a recession was highly unlikely, but the middle months of 2011 left a very sour taste and may be more representative of what is in store that the more upbeat story told by the last quarter’s statistics.

That last quarter has yet to be properly measured, we will get our first glimpse of fourth quarter GDP later this month, but many of the sources of acceleration lifting growth during that period appear too fragile to be sustained much beyond the first quarter this year. This is especially true of consumer spending, which at about 70% of GDP, is crucial to the continued recovery. For all the hoopla about the uptick in consumer confidence we should be wary: it is still stuck at low levels, way below those we see during good times. It seems that consumers are shedding some of the siege mentality that has cast such a long shadow in recent years, but they are still not brimming with confidence. With wages stuck, unemployment lingering, stock prices volatile, and home prices still weak, there are no signs of the kind of support needed to keep consumer attitudes improving. Confidence may no longer be lousy, but it isn’t exactly rosy either.

This is reinforced by the ongoing effort to shed debt. If there is one defining characterization of our current economic cycle it is the effort within the private sector to downscale its indebtedness. Making this more difficult are the twin problems represented by low inflation and a horrible wage outlook. Higher inflation lifts the debt burden because debts are repaid in devalued dollars. And, obviously, people find it easier to pay down debt when their incomes are rising rather than stagnant. Given that inflation is unlikely to balloon upward any time soon, and that wages will remain a poor stepchild to profits, freeing up extra cash to pay down debt has to come at the expense of current consumption. The year end buying spree appears to have been fueled by heavy discounting by retailers coupled with the development of new frugal habits on the part of consumers. The moment those discounts end so too will the spending spree. Indeed within the past two weeks there is ample evidence that a slow down has already started and that consumption has slipped back to a lower pace.

So the outlook for demand is one of modest, unspectacular growth. This will feed into corporate budgeting and spending plans for the new year. The year end increase in manufacturing was somewhat misleading: half of all industries declined, and the bigger increases were in those where exports play a key role. Domestic activity is so-so, and export driven growth will depend, naturally, on the outlook for foreign markets. To say the least this makes for a problematic forecast. The Euro zone seems set for recession, and both the Chinese and Indian economies are showing signs of slowing. So trade may not be the positive factor that it has been recently. Further, corporate plans will now have to be set in the context not just of modest demand, but also within a very unstable political framework. It is a massive understatement to say that the farce of our political process heightens uncertainty. The political division splitting the voting public is now so large that it will not be healed in one election cycle. So we can expect repeats of the lunacy of the debt limit “debate” and the near total breakdown of consensus over what ought to be simple policy actions such as extending unemployment relief. Consumers and businesses trying to decide on what to do, and whether to spend, can only be made more cautious by the constant lurching about that now passes for leadership in Washington. So uncertainty is not diminished, nor will it be once this never ending election finally takes place.

Given this, I don’t see how the economy can accelerate. This is especially true since the fourth quarter is likely to have seen growth around 3%. Europe’s determined march into recession will harm US growth, which looks set to be slower of its own accord anyway. My view that GDP will chug along at about 2% still stands.

So 2012 is not as new as we might like. Indeed it will be more a repeat of 2011. Given where we were at the onset of the crisis, that may appear as improvement, but our inventory of unused resources is still too large for us to take much satisfaction. Our lack of nerve, our lack of leadership, and our loss of memory of sound policy are costing us dearly. 2011 was not good. 2012 will not be much better.

That’s simply not good enough.

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