2011 Economic Outlook:

Recovery or relapse?

Lindsey Piegza

Economist

December 2010

22

The Economy is Growing,

but not Fast Enough to Create Jobs

33

Rapid productivity growth

mandates stronger GDP growth

44

The employment trend has collapsed

55

Job growth likely to reach 200-250k next year

66

Retail sales are encouraging…

77

…but consumption is not accelerating

88

Household borrowing grew for 70 yrs before 2008

99

It will be years before debt is balanced with income

1010

Housing is bouncing on the bottom

1111

Flat housing starts means little GDP

contribution from residential investment

1212

Business investment is cooling, too

1313

Investment in equipment and software

was driven by pent-up demand

1414

Inventories and imports will

play a smaller role next year

1515

Retail inventory to sales ratio

1616

Inventories are topping out

1717

Inventory contribution to GDP growth

1818

What went wrong last spring?

Oil Spill

The Stock Market Drop

Policy shock – policy mistakes killed momentum as stimulus ended

• Impending tax hikes.

• Worries about health care cost increases.

• Fin-reg’s chill on lending.

Externalities hurt confidence

• European sovereign/bank crisis.

• The oil spill.

Structural change may be the root problem

• Since 1990, recovery has followed this pattern:

1. Stabilize the economy and confidence with stimulus

2. Economy stalls and interest rates drop

3. The drop in rates ignites a mortgage refi wave (1994 and 2003)

4. Refinancing supplements income. Lifts recovery to sustainability

There will be no comparable refi wave this time…

1919

How bad is it?

2020

Transfer payments as % of income

2121

Relative job growth, 2000-2010Housing boom masked deep structural problems

2222

Relative job growth, 2000-2010Stimulus to save gov’t jobs ignores erosion of tax base

*excluding decennial census workers

2323

No room for fiscal stimulus

2424

State budget shortfalls are huge

2525

Private credit is not growing

*excludes financial debt to avoid double counting

2626

S&P 500 (real $, log scale)

Deregulation

Leverage cheap

Opportunities aboundLeverage ineffective, then

Leverage expensive

Regulation returns

Returns limited

Leverage ineffective, then

Leverage shrinking

Regulation returns

Returns limited

2727

There are still positives

2828

Manufacturing job growth fastest in over a decade

2929

…and the workweek is rising

3030

Equipment orders are recovering

3131

The savings rate is high

3232

Most states doing better-than-average

Above the nat'l rate by

2 points or more Below the nat'l rate by

1.5 up to 2 2 points or more

1 up to 1.5 1.5 up to 2

0.5 up to 1 1 up to 1.5

up to 0.5 0.5 up to 1

The same as the nat'l average up to 0.5

Hawaii

Alaska

3333

Interest rate and markets outlook

3434

The Fed will wait longer to hike than in 2004

3535

Cyclical components are deeply deflationary

3636

Deflation

• Deflation is sustained falling prices.

• Sustained deflation doesn’t happen without a loss of purchasing power.

• Hence, true deflation is sustained falling product prices and falling asset prices and falling incomes.

• Deflation turns credit on its head. Rather than growing into debt, as with inflation, debts grow in real terms over time.

3737

It still adds up to QE, which drives L-T yields

3838

Inflation outlookThe Fed can (and has) ignite faster food and energy inflation, but core

inflation is grinding lower. Consumers cannot accelerate gas and food

purchases. The effect is the equivalent of a tax hike. Not productive.

Growth outlook

The slowdown came earlier than it should have. Inventory building is not

necessary without sales growth, and sales growth stopped in April.

Hopefully the pause is temporary, but we have not had a rebound without a

mortgage refi boom since 1983 and QE may be counterproductive.

Without a refi boom, time is needed to rebuild household balance sheets.

Private sector jobs are key. Time could be the only path to recovery.

As you see data ebb and flow, ask yourself if it is consistent with 4%+

GDP. If not, the unemployment rate is likely to stay high.

3939

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