January 31, 2012
Dr. Lacy H. Hunt is executive vice president of Texas-based Hoisington Investment Management. He is an internationally-known economist and author of two books and numerous articles in leading magazines, periodicals and scholarly journals. For nearly 14 years he was chief U.S. economist for the HSBC group, one of the world’s largest banks. He was also executive vice president and chief economist at Fidelity Bank.
I spoke with Hunt on January 26.
I would like to begin with your overall assessment of the state of the economy. You've written that the US will enter a recession in 2012. Has anything changed to alter that view?
I don't have any change in our view. We're still expecting a mild recession in the one-half to 1% range. Actually, that is a very significant development. It doesn't seem like one, but when you are operating at such a low levels of capacity – personal income less transfer payments is a half a trillion dollars below its cyclical peak and industrial production is substantially below its old high – a small decline is an extremely unwelcome development.
The main problem for us in this downturn is our export sector. Exports accounted for about 45% of the cumulative gain in GDP. Since the end of the recession in mid-2009, exports were growing at about 10% per annum. Consumer spending was only growing at 2% per annum. So it was a miserable recovery, but what recovery we had was due to exports.
The principal determinant of export growth is foreign income, or the level of economic activity overseas. The price considerations are another factor, but they are only one fourth or one fifth as powerful as the income effects.
By price considerations, do you mean the relative value of the currencies?
Yes, and that suggests our exports will erode this year. That process has already started, and there are a number of indicators that support that view.
Another problem is that last year we had a gain in GDP, but we didn't have an increase in prosperity. GDP measures spending. Prosperity is determined by income. Disposable income declined for 11 months in 2011, and in per capita terms there was an even larger decline. In addition, when you have an uptick in inflation, such as we did over the first three quarters of 2011, the typical response of the American household is to maintain their standard of living, and hope that inflation goes away.
So what families did is they hit the credit cards particularly hard in the second half of the year. Over the course of the year they drew the saving rate down from close to 6% to 3.5%, which took us back to where we were when the recession started – a very un-salutary development. In addition, real consumer net worth, which is derived from the flow-of-funds account, was negative year-over-year. Every time that that's happened it's been consistent with a recession.
Another problematic area is capital spending. I know there is a lot of optimism, because capital spending had a very good year in 2011. But a lot of that strength was probably related to the 100% accelerated depreciation. This gimmick has been tried many times over the years. What firms do when there is a transitory tax cut like this, and what individuals do in response to any type of transitory stimulus is they look ahead and try to anticipate their future needs. They pull them forward, and then when the stimulus goes away, the spending drops. We've seen this happen with capital spending, cash for clunkers, and incentives for first-time homebuyers.
We will see a decline in capital spending this year, because this year you only get 50% accelerated depreciation.
If you were to focus on the goal of full employment, how long will that take given our current policy direction?
I don't really think that is achievable given the current policy mix.
Are we in an equilibrium that is going to keep us in the 8.5% range, or is it going to get worse?
It will deteriorate to some extent, but mainly we will have an extended period of severe unemployment. We just don't have the right types of policies. The country is extremely over-indebted. That is our main underlying problem. We are not going to cure our indebtedness problem by taking on more debt.
I don't see the right mix of fiscal policies. I don't see that monetary policy is constructive either. So there isn’t any material way to achieve full employment with the current mix of policies.
The US faces an important choice with respect to fiscal policy: Whether to prioritize deficit reduction or to prioritize investment in initiatives such as new infrastructure which would entail increasing the deficit. Let's put entitlement reform aside for now and agree that there is significant reform that is necessary to correct those programs. If we look at the non-entitlement portion of the budget, what is the proper way to frame the debate?
One of the reasons that we are in this difficulty is that we have always put aside entitlements. We knew it was a high-speed freight train. Now we are in the situation where 10,000 people a day for the next 10 years will reach full-eligibility age for Social Security and Medicare, and then it is going to go up. Of course the theory in the past was that we could always postpone confronting entitlements, because the situation had to get better. Something would come along and ameliorate the situation in with regard to the fiscal strains in the country.
We took the postponement route. We now have a situation where Federal outlays, which include expenditures for goods and services, and entitlements are 25% of GDP. The last three years have been the highest for any three-year period since 1943-1945 when we were in a world war.
There are calculations, including one done by the very esteemed economist Barry Eichengreen, a Yale PhD at the University of California, Berkeley, showing that in 25 years federal outlays are going to jump to 40% of GDP. Well, we are not going to be able to transfer another 15% of the economy into entitlements.
We have always lacked the political will to deal with entitlements, because promises have been made that cannot be kept. We shouldn't put it off.
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