The U.S. economy will be saddled with some burdensome obstacles in 2008, according to economist Michael Knetter, dean of the University of Wisconsin School of Business in Madison. Knetter, a former economic advisor to Presidents George H.W. Bush and Bill Clinton, provides his macroeconomic outlooks annually at the Northern Trust Economic Trends Breakfast. Small Business Times executive editor Steve Jagler recently interviewed Knetter about the economic outlook for 2008. The following are excerpts from that interview.
SBT: To get right down to it, we’ve got some economists saying we’re on the brink of a recession, and some are now saying we’re already there. How do you see it?
Knetter: “You know, one thing I would say is … Who cares? What we know is the economy is really slowing down. There is a fairly big correction underway. We tend to put all kinds of emotion around the ‘R word.’ What’s happened in the economy is not good. And whether we technically meet the definition of a recession … Who cares? I mean, if it slowed a lot to .2 and or .5 percent growth for two quarters, that’s still really bad.
“So, I would say there’s a very good probability, maybe at least 50/50 at this point, that there will be a period of the calendar year of 2008 where we will look back and say the economy was in a recession, but whether we do or we don’t, what is clear is there is a real credit crunch, and there’s no easy way out of that. And it’s a consequence that a lot of people like me really weren’t aware what was going on.”
SBT: It sounds like in 2008, at least in the first half, you would expect a definite softening of the economy.
Knetter: “Yeah, we’re not going to be too happy with the economy of 2008. I can say that.”
SBT: Former Federal Reserve Chairman Alan Greenspan and so many economists did not see the subprime collapse coming and underestimated the depth of the housing bubble. Is that a fair statement?
Knetter: “You know, I don’t know the answer to that. I certainly didn’t appreciate the depth of it. I think part of the problem here is that a lot of the origination of mortgages was being done by folks that are outside the purview of traditional mortgage origination, outside the traditional regulation. Whether people truly appreciated the extent of this, I don’t know. But I didn’t, and I guess … I didn’t realize how much these other entities had taken over mortgage origination.”
SBT: It sounds like it’s going to take time to come out of that. It’s not going to be healed overnight, is it?
Knetter: “No, I don’t think so. And people look to the Federal Reserve. You can’t really undo these positions. People extended credit for the purchase of a large asset on terms that really were not sustainable for the borrowers. Many parties entered into financial contracts that weren’t good contracts, and bailing those people out is not the right thing to do.”
SBT: The Bush administration’s plan is to freeze introductory teaser rates of subprime mortgages, preventing them from resetting to higher rates for five years. Some people are saying that’s just going to push the problems along into the next presidency.
Knetter: “To be honest, Steve, I haven’t really studied the details of the plan … There may be a way for government to create a template for what the resolutions could be like between lenders and borrowers, so that both parties can move on effectively. I don’t want to presume how you do that. But it seems like when we know there’s a common source to the problem here, you would think we might be able to find at least an 80-percent solution from a one-size-fits-all type of thing.”
SBT: From your perspective, you view that as a legitimate role the government can play to help solve this crisis?
Knetter: “Yeah. If they can bring parties together so they can find 80 percent of the solution … Obviously, pain’s going to have to borne by both parties.”
SBT: OK. If we could shift for a moment to the U.S. dollar. It continued to fall sharply in 2007. Some people are saying that there’s a danger it could even fall out of its status as the preferred currency of the world. From your perspective, will the dollar stop its freefall in 2008?
Knetter: “The currency values are very forward-looking markets. So, I think there will come a point, I believe, in 2008, where things will start to turn around. I think the clouds are still gathering. People still can’t see light yet at the end of the tunnel for the U.S. economy. So, for that reason right now, there will continue to be pressure on the dollar.”
SBT: Of course, Wisconsin manufacturers have benefited from a weak dollar. Their products cost less to buy overseas.
Knetter: “Absolutely. So, when you say, ‘Would you rather have a strong dollar or a weak dollar,’ I always ask the question, ‘Are you a producer or a consumer?’ If you’re a producer, you like a weak dollar. If you are a consumer, you like a strong dollar. The truth is, most of us are both. Right? In that sense, it kind of doesn’t matter. The dollar is doing what it needs to do at this point, in my opinion, to help the U.S. real economy get healthy. You don’t want a panic situation to ensue, but at this point, I don’t see that happening.”
SBT: I realize you’re not an equity analyst, but in general terms, what do see the stock market doing in 2008?
Knetter: “Calendar year 2007, it was up like 6 percent. That’s already gone, maybe and then some, actually (in early January). I would say a good outcome would be if the market finished 2008 where it started. But it may give up some value.”
SBT: With 2008 being a year of a U.S. presidential election, you can handle this next question any way you see fit. Strictly from an economic standpoint, is there a Republican you would feel most comfortable with, and is there a Democrat you would feel most comfortable with?
Knetter: “Hmmm. (Laughs). I want to be careful about answering this. I guess my answer to that, and I want to be sure that if you write about this, that’s not about who I would vote for, by any stretch. The question is only about economics, and I care about a lot more than that. You know, (Mitt) Romney on the Republican side would be the person I believe would have the most sensitivity to and understanding of the conditions that are needed for a healthy business environment. And I think much of what he did as governor of Massachusetts kind of backs that up.
“On the Democratic side, I see a lot more uniformity in the broad positions being taken by (Hillary) Clinton, (Barack) Obama and (John) Edwards. Ironically, I think many people worry more about the ramifications of Obama for the economy, and I actually worry less. Hillary Clinton may have said it best herself. She said some people are very clear about what they would want to do right out of the gate, meaning she’s got experience, she’s thought about all of these issues, and she knows what she wants to do and how to get things done. I think she does know what she wants to do and how to get things done. I’m not sure she puts enough weight on the importance of free enterprise, for my tastes. I kind of worry about the fact that she does know what she wants to do. Personally, I feel more comfortable with Obama about the economy than Sen. Clinton, and I think that’s because his mind is probably not made up. But I think he’s surrounded himself with some very good people, and I think he’s a very thoughtful person, and I believe he’s very committed to working in a more collaborative manner across both parties to find solutions. I find it very attractive that he’s not set in stone on certain things, he’s not ready to charge in with an agenda. I am very sold on his thoughtfulness and authenticity, and I think that may be really something the country needs right now.”
SBT: Again, shifting gears, are there any industry sectors that you think are poised to outperform in 2008?
Knetter: “I think large U.S.-based multinational companies are a good bet right now. I continue to believe in technology. I still think we’re leading the world there. Health care is always a good sector to be in.”
SBT: We would be remiss if we ignored the 800-pound guerilla in the room – the war in Iraq. Joseph Stiglitz, a Columbia University professor who won the Nobel prize for economics in 2001, and Linda Bilmes, a Harvard budget expert, say the real cost of the war could reach $2 trillion. Aside from the very human cost that I personally have witnessed, how much of a wet blanket is this war on the U.S. economy?
Knetter: “By some measures, right, war is good for the economy because it can increase GDP. You’ve got more people working and being paid. The problem is what they are doing isn’t anything we want to do. We don’t get utility out of that. I think the real costs of the war are huge, in that these dedicated and hard-working people could be doing something else, rather than, you know, fighting other people … To me, it always goes back to what are we getting for all the human costs and fiscal resources we’re throwing at this? And I can’t answer that.”
SBT: Relative to the rest of the country, what do you see as the strengths of the Wisconsin economy?
Knetter: “Well, I think the weakening dollar is definitely helpful for manufacturing and agriculture, and we are still disproportionately heavy in those two sectors. The fact that we don’t have near the exposure to the real estate problems the rest of the country does, and that we have heavy exposure to manufacturing and agriculture, which are tradable sectors, tells me that, relative to the rest of the country, Wisconsin should do OK in this period.”
SBT: Interesting that manufacturing and agriculture – the old economy – are actually strengths for Wisconsin.
Knetter: “Yeah. I think those things kind of work in our favor right now.”
