Considering the gloom, doom and uncertainty facing the U.S. economy at the beginning of 2009, one has to conclude that things turned out reasonably well.
The recession appears to have ended in the third quarter (as we suggested a year ago), corporate profits turned out better than analysts expected and the stock market confounded most forecasters with 20% plus gains. As we were expecting, the unemployment rate rose to 10% even as the economy began to pick up.
In short, the economy followed the traditional downside leg of a business cycle - with above-average amplitude in the swings of production and employment. We should be thankful that 2009's 2.5% drop in gross domestic product is modest compared to countries like the U.K. and Japan with drops of 4.5% and 5.4% respectively.
To Whose Credit? Should we give credit to anyone for turning the corner toward renewed growth? Probably not. Outside of thanking the Treasury Department and the Federal Reserve for stopping the run on the banking system, and averting an even deeper "bottom" to the cycle, we should be very cautious in handing out any kudos.
While the income tax rebate checks of 2008 may have had a slight "bottom cushioning" effect, survey studies suggest only about one-third of the rebate money was spent, the rest being saved. With only a little over one-quarter of the Obama Administration's $787 billion spent as of November, its impact to date has similarly been modest. Programs such as the "cash for clunkers" simply change the timing of consumer expenditures for the most part; by one estimate only 18% of the 690,000 cars sold under the program were truly "stimulated" purchases. "Clunkers" also had the perverse effect of destroying substantial wealth. (It mandated the destruction of seven hundred thousand automobile engines, many of which would normally have been recovered by scrap dealers for spare parts, refurbishing or export.)
Business cycles have their own self-correcting features - inventories run down and eventually have to be replaced, returns to investing in new technology appear increasingly attractive, profits recover under the impact of cost-cutting, and lenders' appetites grow to make new loans instead of investing in Treasury bills with minimal returns. These have been the driving forces in the economy in the closing months of 2009, supplemented by some modest Federal stimulus spending.
Looking Ahead. The biggest threats to a continuation of the recovery are the higher taxes, deficits, and rules/regulations likely to flow from Obama Administration legislation dealing with healthcare, energy/climate change, and a major expansion of the financial regulatory regime. To this list should be added the Administration's continued very public bad mouthing of bankers' compensation and lending practices. (We thought the primary lesson of the financial crisis was too much lending, not too little.)
Such factors are of more than usual importance in sustaining a decent recovery. Thanks to past excesses, home building is likely to be of little help, in contrast to its traditional leading role in an economic upturn. Similarly, debt-financed consumer spending is unlikely to be a recovery leader. Clearly, consumers have learned their lesson from the financial crisis of the past two years: "We borrowed too much." Savings rates have rebounded dramatically; credit card balances are shrinking and prepaid or debit cards are very much in fashion. According to the Federal Reserve, consumer credit has declined by $100 billion since the third quarter of 2008.
Exports have been and should continue to be a solid plus for the economy. Even if the U.S. dollar were to strengthen somewhat, U.S. manufacturers, service providers, and agricultural and raw material producers should continue enjoy reasonably strong demand from abroad. Business investment in inventories should remain strong for the near-term, and capital spending shows signs of strengthening.
However, it is business investment outlays that is most vulnerable to ill-conceived actions by Congress and the Administration. Such actions run the risk of dampening business confidence, increasing uncertainty and sabotaging the recovery. They will be coming in the middle of Federal Reserve efforts to withdraw substantial amounts of the credit it has extended the financial system over the past year and heightened concern about financing massive deficits.
Beware the Law. In short, the Law of Unintended Consequences could be very much in evidence over the next 12 months - with unpleasant results. Politicians and pundits: be careful what you wish for.