Forecast is Bright for 2010, but Stormy in 2011–12, London Panelists Say

Published on December 04, 2009

Now that GDP is climbing again worldwide, U.S. employment should return to its pre-recession level within a year, said John Huizinga, Walter David "Bud" Fackler Distinguished Service Professor of Economics. “I’m unconvinced this recovery will be slower than average for other recessions,” Huizinga said during the 2010 Business Forecast at the London Campus on December 4.

Nonetheless, Huizinga hedged his bet with the possible effects of outlying factors. “There certainly are examples where, because of a severe financial crisis, economic recovery has been slow,” he said. “But it’s also possible for an economy to recover quickly after a financial crisis. There is economic uncertainty, but no more than after other recessions and certainly less than the recession of 1948-49, in which there was a fear of returning to the Great Depression.”

Despite his confidence in recovery for 2010, Huizinga said two “storm clouds” loom for 2011–12. The first cloud is the impending banking recovery, which will force central banks to shrink their balance sheets before inflation ignites but also to maintain reserves long enough to prevent another economic collapse, he said. “That is the biggest issue in the U.S. and worldwide,” Huizinga said.

Secondly, governments must address the fiscal imbalances they have created with expansionary policies like tax cuts and spending increases, he said. “They’re going to have to raise taxes or cut spending. When they do that, it’s quite possible we’ll head back into another recession.”

U.S. inflation will surprise the Federal Reserve by increasing during 2010–11, said Brendan Brown, ’75, director of research at Mitsubishi (UFJ) Securities International Plc. “Real interest rates on short-maturity government bonds will fall to much more negative levels in the first half of 2010 than they already are,” Brown said. “The credit bubble and burst destroyed a considerable section of the capital stock in the U.S. economy. The combination of essentially a capital shortage and profit margins rising with the inflation momentum coming from a super weak dollar will all contribute to this surprising upside in inflation.”

The strong cyclical recovery of the U.S. economy in 2010–11 will come to an early end, he said. “The bursting of the Chinese monetary bubble together with the belated tightening of policy in the U.S. will bring this early end,” Brown said. “That view is based on the inevitability of a bipolar monetary disorder ending badly.”

That disorder is reflected in a symbiotic relationship between the United States and China, he said. “The first facet of that relationship involves Hong Kong, where 0-rate dollars meets endless opportunities to speculate on Chinese assets in the yuan,” Brown said. “Second is the People’s Bank of China, which is operating as a puppet of the Federal Reserve by buying massive amounts of dollars and Treasury bonds and buying Euros to diversify its foreign exchange reserves. They — the PBC — are becoming agents of the dollar devaluation policy we all know [Fed Chairman Ben] Bernanke is following.”

The European Central Bank does not anticipate inflationary pressures in the euro area in 2010-11, but plans to monitor risks very carefully, said Lorenzo Bini Smaghi, PhD ’88, executive board member of the bank. “Commodity prices are one of these risks,” he said. “The second risk may come from the public sector, as the adjustment in public finance may lead to some extent to increases in indirect taxation, as in the past this has traditionally put upward pressure on inflation. Although these are one-off measures, one has to be careful they do not enter into the dynamics of wages and so forth.”

All indicators are pointing to recovery in the real side of the euro area economy, but consumption and domestic demand are likely to be quite moderate in 2010, he said. In 2011, parts of the fiscal supporting measures used to stimulate the economy must be withdrawn, Bini Smaghi said. “The withdrawal of some of these measures is welcome,” he said. “Sound fiscal positions rely much on a credible path regarding the consolidation of public finances. Against this background, our projections remain relatively cautious.”

                                                                                                                            Phil Rockrohr