This bear is not optimistic about 2010


Imagine the economy as if it were a canoe drifting along a stream. The average speed of the stream tends to determine the speed of the canoe. The canoe’s speed can be increased by active paddling by those on the canoe or it can be stalled by paddling in the wrong direction or slowed by dragging anchors from the stern.

In 2010, the canoe of our economy will be mired at a standstill in terms of per capita real GDP with no improvement in our standard of living.

If we are to look ahead to forecast the economy, one approach is that the canoe will likely go at the average rate of our economy over time. Most economists have predicted economic growth to be much below the average speed of the river, indeed the seeming consensus of 2-percent real economic growth is about half of the average growth over the past two centuries.
The average growth rate of the economy (as measured by its Gross Domestic Production adjusted for inflation known as real GDP) has grown at 3.6 percent on average for over 200 years. When adjusted for population growth, real GDP per capita has grown since 1820 at 1.9 percent.
At that rate, living standards double in 38 years, or about two generations. Unlike the past, consensus among economists is that the year ahead will grow at about the same rate as our population growth, including undocumented people. The consensus prediction is for no improvement in standards of living in 2010 and that real GDP per capita will remain at a standstill. While better than in 2009, this is like our economic canoe is stuck on a sandbar without any progress toward our destination.
If the average speed of the economic canoe is 3.6 percent, why are most economists predicting about half the usual speed? After a recession, economic growth is typically well above average, yet economists do not seem to foresee a sizeable speed up of the economic river that we are on. Clearly, the recession that began in December 2007 appears to be lingering into 2010 in the minds of most economists.
Why is the economy likely to be so lackluster?

Restrictive fiscal policy

The fiscal stimulus that brought the multiyear $787 billion stimulus package last year is winding down in 2010. The mantra of both political parties just before the mid-term elections will be that they are fighting deficits. Hence, it is unlikely that a new “son of stimulus” will be passed. Surprisingly, the spend-happy congress in 2009 will reverse course this year and attempt to rein in their governmental spending. I estimate that a third of the modest growth in GDP in the second half of 2009 was due to greater governmental spending. With less growth in governmental spending in the New Year, economic growth is likely to be further attenuated.
But fiscal policy includes both governmental expenditures and tax receipts.
This is the last year of the Bush tax cuts, which continue only to the end of 2010. This is also the last year that the government will not be assessing any estate tax on decedents.

Unwinding monetary stimulus

Ben Bernanke will likely be confirmed as Federal Reserve Chairman for four more years. In 2009, Bernanke injected trillions of dollars into the economy to help jumpstart credit markets and to rescue some investment banks and insurance companies. Dr. Bernanke and other Federal Reserve governors have also kept the Federal Funds rate at nearly zero.
But this year, there will be unavoidable market-based demands to unwind the huge injection of money into the economy that has doubled the monetary base. Pressure comes from the bond markets that has already seen longer maturity bond rates rise. Pressure will also come from increased prices on all sorts of commodities and ultimately on the consumer price index.

Continued high unemployment

On the whole, economists are not fun people to have at your New Year’s Eve party as they occasionally say things we’d rather not hear. One such observation is that unemployment will increase from its 2009 peak of 10.2 percent to cross 11 percent before it really recedes to about 9 percent at year end. The problem is that whenever the economy does show signs of life or recovery, discouraged workers begin returning to the labor force and begin looking once again for jobs.
The real solution to high unemployment must be encouraging people to start new businesses or make it profitable for established firms to increase hiring such as a reduction in the nearly highest rate in the world of 35% corporate tax rates. Unfortunately, socially well-intentioned policy initiatives in Washington have had the unintended consequences of increasing unemployment.
With 10 percent unemployment likely to be a fixture of the economic landscape in 2010, consumers are cautious and business inventories will stay lean. Why hire new employees in a lackluster year? Why hire when the cost of health care for employees will rise in 2010? Why not make do with a lean workforce, keeping costs under control? The argument for a robust recovery is limited in an extended period of a jobless recovery. The prolonged period of unemployment will be like an anchor dropped over the gunwales of the economic canoe slowing its progress as it drags along the bottom of a moving river restraining progress.

Creative destruction in capitalism

Capitalism expands profitable industries and releases unprofitable industries to switch to producing things that the economy really wants. This happens every year. However, there are an unusually large number of industries that have not fully responded to the economic incentives to revise and change what they are doing.
The industries that are in secular or structural decline are well known to most: newspapers, music radio channels, DVD rental stores, domestic automobile manufacturers and dealers, all sorts of printing, and traditional mail and mailed advertisements, just to name a few.
Hiring in new industries in communication and employment in green energy industries will grow in 2010, but will be swamped by closing of newspapers, radio stations, and brick-and-mortar stores that have been supplanted by Internet sales. With the doubling of energy costs that would have accompanied the proposed Cap and Trade Law forcing emission trading, I predict that Cap and Trade will not become law in 2010. Taxing energy would be a huge job exporter to countries without the extra energy expenses. Cap and Trade would make what Ross Perot once characterized as “a great sucking sound” as the sound of jobs fleeing to seek lower costs abroad.


If the economy is seen as moving along a stream, there are at least four prominent drags on the speed of the economy. Both fiscal and monetary policy will be restrictive with higher taxes, lower governmental expenditures than most predict; furthermore, money will begin to be extruded from the economy by the Fed. Unemployment is likely to stay high, and for some of the year will go higher than in 2009 making consumers and businesses act frugally.
The National Bureau of Economic Research may eventually date the end of the recession sometime in late 2009, but there will be little to cheer about with unemployment reaching 11 percent and real GDP rising slightly less than 2 percent. Slow growth will not even match the growth rate of population.
Finally, a canoe can be tipped over. We barely missed being tipped over in late 2008 when the extent of the problems faced by banks with losses in the housing sector and the failure of credit rating agencies to detect problems in the collateralized debt obligations were discovered. In 2010, there are still rough waters for the canoe ahead with increasing credit card defaults, many bankruptcies of commercial properties, or difficulties arising from foreign wars. Yet I expect these choppy waters will be safely navigated.
While real GDP rose slightly in 2008 and may rise slightly in 2009 when the fourth quarter’s growth rate is known, per capita real GDP declined in both 2008 and 2009. The forecast of a standstill in per capita has something to recommend itself as no further worsening is better than decline. Nevertheless, when we look back at 2010, we will have the feeling that we a missed opportunity for improvement in our standard of living, much of it due to governmental actions.

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