News Column

Economic Outlook: January 2010

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The worst may be behind us, but real growth not likely until 2011

As we close one of the most economically challenging decades of the past 40 years, we are now facing the uncertainties and challenges of a newly started decade in which both US and European economies will be transferring some of their influence to fast-growing emerging economies.

Most GDP forecasts point to moderate growth for the U.S. economy in 2010 something along the lines of between 1.5 percent and 2.7 percent in the most recent forecast by Blue Chip Economic Indicators. Th is moderate economic growth will contain inflation and keep interest rates low. Unemployment is expected to remain at 10 percent in 2010. Historically, GDP growth rates of 3.5 percent or higher are necessary for the unemployment rate to decrease. Unemployment is not expected to decrease appreciably until 2011, when current forecasts project GDP growth of 3.5 percent and unemployment of 9.1 percent.

With U.S., Euro Zone and U.K. economies still purging the results of their financial excesses in 2010, economic growth for the world economy will come from China (9.0 percent growth), India (6.4 percent), Brazil (3.5 percent) and Mexico (3.3 percent). Given current U.S. dollar valuation, companies with exports or revenues from those nations should fare well in 2010. The increase of foreign revenues could enhance earnings for many public U.S. multinationals and provide a boost to stock markets in 2010.

With the potential of a financial collapse left behind, the return to a subdued "new normal" should dominate the economic activity in 2010. The difference between brisk or sluggish economic growth will depend on the following factors and policy choices:

U.S. Public And Private Debt

The high levels of both public and private debt will impact bank lending and consumption levels. Public debt is drawing available funds from banks, which adversely impacts business lending. Continuance of this situation will constrain economic growth via limited funding to business. The high levels of private debt, together with declining real estate prices and increasing job uncertainties, will continue to depress private consumption (about 70 percent of the economy), thus restraining the growth of retail sales economy wide.

Healthcare Reform

The single most important issue impacting competitiveness, profits and job creation is the large spending by businesses and individuals on healthcare costs. Health spending tied up $2.3 trillion dollars, equal to $7,681 per person per year or 16.2 percent of the GDP. This is almost double the Organization for Economic Co-Operation and Development countries' average of 8.9 percent. Despite such level of spending there's been no substantial performance improvement on life expectancy in the U.S. "Life expectancy in the United States stands at 78.1 years, almost one year below the OECD average of 79.0 years," according to the OECD

A more competitive healthcare market can free up consumer dollars, which can then be spent on and benefit all U.S. industries. Essentially, this could amount to a free stimulus package by itself. Moreover, healthcare costs undermine the competitiveness of U.S. companies in global markets and bias economic opportunities toward large companies which can negotiate better healthcare plans versus small businesses. In addition to determining the amount of consumer dollars that can be reallocated to other sectors, the outcome of current healthcare bills in the U.S. Congress will determine the potential growth the U.S. economy can experience in 2010 through the reduction of business costs.

Toxic Assets 2.0

The extent to which toxic assets still remain on some banks' books is still unknown. According to industry sources, only 20 percent of the troubled assets have been fully recognized. In addition to existing troubled assets, new loan classes are getting into trouble, especially consumer credit and commercial real state loans. Also, the leveraged private equity segment of the private equity market may be at risk, due to the lack of effective exits for M&A activity taking place from 2005-2008.

Small Business Credit

Critical to economic growth is financing for small businesses, which accounted for 64 percent of net new job creation over the past 15 years. Despite the SBA's efforts to cut lending fees and increase guarantees for several of its lending programs, credit for small businesses is difficult to obtain due to divergent objectives by lenders. Once large banks have rebuilt their capital structures, their next priority is to return TARP funds back to the government, rather than lending to small businesses that, as a result of the impact of the financial collapse on the economy, now are perceived as high-risk investments.

In addition, current Fed policies of lending to banks at an almost zero rate and paying interest on excess bank reserves makes banks cautious of taking any lending risk. With the money borrowed from the Fed, banks invest in Treasuries and profit from the interest spread at no risk. Similarly, with the Fed paying on excess bank reserves, they have an incentive in accumulating capital in their vaults rather than facing a risky borrower. As a result, according to reports by the Federal Reserve on Dec. 10, net bank lending contracted by $1.5 trillion since early 2009, with about $854 million of that contraction taking place in the third quarter of 2009. Although regional banks have been a source of financing for small businesses, they are now facing the collapse of the commercial property market, to which they are highly exposed. As their losses in the commercial property segment grow, they will have to allocate more funds to cover those losses, at the expense of releasing lending to small businesses.

The Job Market

The still-depressed labor market has been reducing its losses since the first quarter of 2009. While employment losses in the quarter averaged 691,000 per month, the job market averaged a loss of 69,000 jobs per month in the fourth quarter, and in November recorded the first gain (4,000 jobs) in the past two years. The unemployment rate, at 10% in December 2009 according to the most recent data released in January 2010, shows an increase in long-term unemployed workers and does not fully reflect the rising number of discouraged job seekers.

While job losses continued in construction, manufacturing, and wholesale trade, temporary help services and healthcare industries continue to add jobs. For example, the healthcare industry has added 631,000 jobs since the recession began two years ago.

The U.S. occupational market will experience substantial changes in the years ahead. Recommended reading is the recently published "Occupational Outlook Handbook, 2010-11 Edition. Overview of the 2008-18 Projections." The importance of Hispanics to the U.S. labor force is expected to continue increasing, from a 14.3 percent share to 17.6 percent, reflecting 33.1 percent growth, according to the report. From now through 2018, total U.S. employment is expected to increase by 10 percent, or 15.3 million jobs. The top four industries with the largest job growth will be healthcare and social assistance (4 million jobs); professional, scientific and technical services (2.7 million jobs); educational services (1.7 million jobs) and Administrative support (1.4 million jobs).

In Closing

While the U.S. and global economies seem to have weathered the worst, the possibility that remaining threats will either reduce growth or return the U.S. economy to a recession is considerable. Active policies from Congress and the Administration are a must until consumer and business reach a confidence level indicating the economy is stabilized.

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