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Posted: December 20, 2010

Economic forecast: weak, with a chance of growth

Inflation is low, but so is everything else

Jeff Thredgold

While the American economy has now registered growth for five consecutive quarters, the pace of that growth has been meager, averaging a 2.9 percent real (after inflation) annual rate...and just a 2.1 percent rate during the past two quarters. Such growth trails the average 3.6 percent real annual growth pace of the past 30 years.

What we now call the Great Recession enters the history books at 18 months in duration, officially running from December 2007 to June 2009. Never since the Great Depression has a recession wiped out all net job gains of the prior economic expansion. Never since the Great Depression has a painful and lengthy recession been followed by such a limited growth pace.

Growth in 2011? Most forecasting economists see real growth during 2011 at a 2.5 percent-3.0 percent annual rate, with the Federal Reserve's forecast a bit more cheery. As before, major economic headwinds of weak residential and commercial real estate construction, soft housing values and near double-digit unemployment impair the economy. In addition, fragile consumer confidence tied to anxiety about massive government spending and unprecedented budget deficits also constrains growth opportunities.

Budget Deficits
Effective steps to reduce future growth rates of U.S. government spending are mandatory to getting this nation's financial house in order. You cannot tax your way to balanced budgets, nor can you tax your way to economic prosperity.

Greater media focus and rising consumer awareness of painful but vital steps necessary to deficit reduction are critical first steps in the process. Both the political left and the political right have been critical of proposals by various deficit reduction groups, while the middle seems more willing to have a healthy debate. Isn't that the basis of effective government...give and take on both sides?

Record budget deficits of the past three years, combined with projected $1 trillion annual budget shortfalls for as far as the eye can see have, to this point, found domestic and global bond markets willing to provide massive deficit funding. However, financial market uncertainty about ongoing budget deficits and huge national (sovereign) debt levels across southern Europe must be "a wakeup call" for the U.S. We will simply not be immune in coming years to financial market distaste and resistance to boatloads of additional U.S. Treasury debt issued to fund irresponsible levels of government spending.

U.S. Employment
American job creation is expected to improve somewhat during 2011. However, a modest improvement in net monthly job creation will do little to trim the nation's unemployment rate, which has been at or above 9.5 percent for 15 months, the longest such period since the Great Depression.

Greater clarity from Washington DC in regard to income tax rates, combined with progress toward more affordable government spending, would go a long way toward boosting business sector confidence. In a nutshell, rising confidence levels would enhance employment creation.

Inflation
Sluggish U.S. economic performance, soft home values, and major slack in labor markets have led inflation to extremely modest levels in recent months. One measure of consumer inflation recorded its lowest 12-month rise in 53 years!

While inflation is expected to remain mute during 2011, longer-term views remain split between sharply higher inflation and the perils of deflation. The former camp is buying gold and commodities. The latter camp is buying longer-term fixed-rate U.S. Treasury and high-quality corporate debt securities.

The Federal Reserve
This nation's central bank has drawn extensive criticism in recent weeks for its current program to boost the economy with another $600 billion of newly created money. Such funds are being used to purchase U.S. Treasury notes and bonds, with the intent of pushing longer-term interest rates lower.

Despite such massive bond buying, bond yields (returns) have actually risen in recent weeks, reflecting concern about the Fed's latest venture and expectations in some camps of stronger economic growth than the consensus view. The Fed's most important monetary tool, the federal funds rate, has been at a historic low target range of 0.00 percent-0.25 percent for nearly 24 months, with little expectation of change any time before the latter part of 2011.

Housing & Home Finance
Most forecasters see average U.S. home prices stabilizing around mid-2011, with only modest gains in home values in subsequent years. Millions of homes in, or potentially to enter, foreclosure remain the fly in the ointment.

Average conventional mortgage interest rates have risen roughly 0.25 percent during the past few weeks, after plunging to their lowest levels in 50 years. For those interested in refinancing a mortgage, or financing a new home or foreclosed property, the timing remains outstanding.


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The Tea Leaf is a weekly economic and financial update by Jeff Thredgold, economist for Vectra Bank Colorado. He has been writing an economic update every week for the past 31 years and is the only economist in the world to have received the designation of CSP, or Certified Speaking Professional. Republished with permission from the Tea Leaf by Jeff Thredgold, whose site address is www.thredgold.com/html/leaf.html.
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