Tuesday, January 3, 2012

A Modest Case for Guarded Optimism in 2012

I think that there is reason to think that economic performance in the US and many portions of the world will do better in 2012 than has been forecast by many recently. Basically, recently many trends seem to be doing better than what has been forecast, coming out of a long period of fear of various catastrophes (and many very real problems), which have been deeply embedded into the forecasts and the markets as well. A way of looking at this is to consider the analysis in the Sunday Washington Post New Year's article by Neil Irwin, "Could 2012 be better?'

Irwin lists five factors that will determine how things go.
1) US political system behavior
2) Can European leaders balance every country's demands?
3) Performance of US housing market
4) X-factor
5) Can China manage a soft landing?

Irwin thinks that things are pretty shakey still on many of these, but is mildly optimistic that things will be better than in 2011. I think they might even be better than does Irwin.

1) This may be the one that I am least optimistic about, particularly given that this is an election year. However, it may be that the worst is past on this front, and that was manifested in the debt ceiling conflict last summer when the tea party pushed things right to the edge of a default for the first time since the US became the first and only country ever to impose a nominal debt ceiling back in 1917. The sign may well be the collapse of the House Republicans at the end of this past year over the payroll tax issue. Now, I am not sure that I agree with the payroll tax cut, given my old position that the whole social security system should have been left alone. But, in terms of politics, it seems that the tea partiers are now aware of the impact of the OWS and the fact that they were blamed substantially for the bad economic performance after the debt ceiling fiasco. Indeed, ironically, the fact that this is an election year may keep their noses to the grindstone a bit more and increase their caution regarding engaging in really outrageous actions with regard to the economy. Too many people are watching very closely.

2) I think the situation in Europe may be better than many think. I have been off and on arguing here and elsewhere that the freakouts over Italian deficits were ridiculously overblown, and now the markets seem to have figured this out, with interest rates on their borrowings having declined even further even yesterday. Despite all the recessionary trends, Germany has reported increased manufacturing. No, Europe is not going to be booming, but I think the threat of a full-blown euro collapse is largely past. The carrying on about the end of the euro by many US commentators is looking increasingly likely to be a big embarrassment, once again (some of these folks have been at this since before it was adopted, snore). Curiously, I think the biggest drag on Europe will be the effort to meet the Basel III capital requirements for banks, which is definitely restricting lending in the EU, not just in the eurozone. Europe will have a bad first half of the year, but once this Basel adjustment is in place, things may improve, if gradually.

3) Housing prices continue to decline in the US, and foreclosures continue at a high rate in much of the country, with something like a quarter of mortgages still under water. I do not see much change in any of those. However, we have seen an uptick in construction of multiple unit housing in many areas of the country, fairly steadily since the middle of last year actually. With very little construction for basically the last half a decade, there is good reason to believe that there is pentup demand and that this increase in construction can continue, even if it is limited to certain regions. Construction was the first part of the aggregate US economy to go down. Having it rising again steadily is important and may provide one of the more important foundations for keeping the US economy growing this coming year, even if not enough to really noticeably dent the unemployment rate.

4) The X-factor is the unknown shock, you know, those Minnesota real business cycle folks with their technology shocks and so on. Whatever. Well, yes, maybe the Mayan calendar people are right and the world will end on Dec. 21. But at least maybe we'll luck out before then and not have too many more natural disasters as bad as the last couple of years. Even if we do have some, it looks to me that there is more of a foundation for continuing growth now than previously, although heck, maybe the Mayan doom will hit even earlier in the year (and no, I am not being pollyanna here about some longer term problems such as global warming, although in the near term global warming actually helps the US economy on net as the reduced heating bills outweigh rising costs in other parts of the economy).

5) China does have a property bubble, with housing prices having more than tripled since 2005 along with sharp rises in price to rent and price to income ratios. For a pathetic story about what is going on, with prices now falling hard in some parts of China, see http://www.chinalawblog.com/2011/12/the_impacts_of_chinas_real_estate_crash_a_hard_rain_is_gonna_fall.htm . So, there is reason to believe that China is facing some slowdown in its growth rate. However, besides the fact that manufacturing rose in December above forecasts, there are other reasons to think this may have less impact there than has the housing crash in the US. Housing is a smaller part of the economy for one thing. Another is that China has had several quite sharp crashes of its stock markets in recent years with little impact on economic growth. China is planning for some growth slowdown, which would probably be a good thing and inevitable, but China is in much better shape to use macro policy tools including fiscal policy to offset a decline coming out of a property crash to some extent at least. This could be a problem, but for now much of East Asia seems to be performing above predicted levels.

So, all in all, folks, I think there is reason to think that 2012 may do better than many have been forecasting, although this may in the end prove to be wishful thinking on my part, even as I have a history of often forecasting doom and gloom.

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