Outlook for 2010

This past week we have seen the economic forecasts from a multitude of business economists . In addition, a few academic economists gathered at the national convention in Atlanta have ventured some opinions. The general consensus seems to be that 2010 will be a continuation of a slow recovery. I do not agree with this consensus for the following reasons.

1. Most of the recovery has been temporary blips due to government programs such as cash for clunkers. It will not be sustained.

2. None of the recovery is leading to job growth.

3. The monetary base is incredibly high which means that either we will experience a bout of rapid inflation or higher interest rates which slows down investment, housing purchases, etc.

4. Extreme regime uncertainty. Increases in taxes, the health care debacle, the cap and trade debacle, the second or third or whatever stimulus, the pay czar, the control of the financial sector -- dare we call it nationalization -- All this leads to an environment in which businesses are questioning whether it makes sense to put money on the line right now. (Emphasizing this uncertainty note the picture: it is an ornament on the White House Christmas tree -- supposedly a Warhol of Chairman Mao, murderer of 50 to 75 million people).

5. The malinvestments made during the last decade due to the Greenspan and Bernanke puts have yet to be reversed or corrected.

The correction that has to take place in markets that were driven out of line by the Fed's easy policies requires that the so-called toxic assets be liquidated. There remain a slew of mortgages that will be dafulted on as interest rate adjustments occur. In addition, commercial real estate is likely to decline this year. In other words there are many financial institutions that will not survive the next couple of years or will require constant subsidies. Similarly, those businesses propped up by the federal government are misallocations of resources. How much morewill be used to prop up Fannie and Freddie? How much will be thrown into GM (government motors). How much will be used to protect and subsidize unions, especially the public sector unions? All these mal-investments must be corrected and resources allowed to flow where they have the highest value before the economy can return to its historical growth rates. More likely the US will struggle in a manner not dissimilar from what the Japanese have been experiencing for the past two decades. The US will struggle along, at best. At worst, another serious recession will take place either before an inflationary problem arises or following an inflationary problem.

In addition to the mistakes made during the past decade by the Federal Reserve, the Federal Government is creating a huge pit with a $13 trillion debt along with a $2.5 trillion deficit next year. Who will purchase all this debt?

What about the dollar? If it weren't for the fact that the U.S. remains more trusted than most other national financial systems, the dollar would have fallen considerably more than it has. Sovereign and other assets are being put into the US markets because of fear that other markets will be much worse. However, with the huge debts created by the federal government, the pressure on the dollar will rise. The dollar will fall while commodities will rise.

The stock market has risen about 43% from its March low. Yet what is the basis for this appreciation? Earnings have not shot up. Since stock prices are based on the present value of future expected economic profits, can we count on a continued stock market rise? I think not. I do not expect much of a change in stock prices over the next year.