Happy New Year from Rosie

by Roy C. Smith

Yes, it has been an ugly year.

We’ve had Syria, terrorism, the refugees, a collapse in oil prices, a European sovereign debt crisis, trouble with China and Russia, and world economic growth slumping towards a pathetic 3%. And we have had Trump and the Republican wannabes that make Hillary look good, and a lot of other stuff that has taken the winds of confidence out of our sails.

Unemployment is down to the 5% level, but only 63% of the workforce has jobs, the lowest percentage since 1978.

US stocks are likely to end the year in the red for the first time since 2008, but investors are nervous about rising interest rates without seeing much to look forward to in the general economy.

So, I asked my old friend Rosie Scenario out for a holiday drink, to see if she could cheer me up.

“You’re too gloomy,” she said.

It is true that the US economy has had a rough fifteen years, with two financial crises, a Great Recession and a war in the Middle East that has cost $4-$6 trillion and still isn’t over.

But, she added, after a prolonged period of slow economic growth that has averaged barely 2% per year, things are settling down for a long-term recovery.

The Fed has decided that after eight years the economy is strong enough to leave to its own devices, so it has ceased its price-distorting QE interventions, and allowed rates to rise a little, at least symbolically. Both regulators and litigators have hammered the banks, but corporations have been able to get what they needed from a record level of new bond issues, and consumers and small business are getting a boost from “peer-to-peer” lending, “fintech” and from private equity funds.

The traditional economic “factors of production” – wages, resources, capital and enterprise – still at low costs, are ready for another round of expansion. Real estate activity is up about 10%, consumers have cleaned up their balance sheets and are active again. US GDP for 2016 is expected to be about 2.5%; not great but better than it has been, and building up momentum for a push in the right direction.

Rosie also sees the international situation also looks better than it did.

It has been bleak, she said, but the worst is over. The EU and the euro looked like it might be shaken apart by its sovereign debt crisis, but Angela Merkel and the ECB showed they had the clear head and courage to commit the resources needed to settle things down. The hodge-podge economic union of 28 states, with a common currency used by 19 of them, has survived its first serious existential crisis and is stronger for the experience.

A bigger set of problems now exists in the BRIC countries that are also facing existential issues. Brazil has been affected by collapsing commodity prices and high inflation, but its main problem, like Argentina’s, is political, and can be turned around by a new government.

Russia’s GDP will be down 3.6% this year, mainly due to oil prices, but Putin’s machismo behavior that drew sanctions over his Ukrainian actions has added to his difficulties, and sent him a message – his fifteen years of domination of Russian politics has been enabled by a robust growth in per capital GDP, but because of the recession and the collapse of the ruble, GDP per capita (in terms of current prices) will be 40% less in 2015 than in 2013.

Putin knows that strong, authoritarian leaders in Kiev, Cairo and Tripoli have been brought down by public protests, and seems to realize now that further confrontations with the US and the EU will only make his economic problems worse. After all Europe is Russia’s biggest customer for its oil and gas, and increasingly there are alternative sources of supply available to it. All in all, Putin is likely to end up more helpful than we expected in Syria and Iran, and start to make nice again to get back into the good graces of the EU. Maybe the UN’s agreement to secure a cease-fire in Syria, in which Russia played an important part, is an example. 

China, too, faces big issues in the next few years – it has to be able to deliver economic growth sufficient to satisfy the billion or so Chinese who are not yet among the middle class but aspire to be there. Growth has fallen from 12% in 2010 to 7% in 2015, with government expectations of 6.5% in 2016 (and others looking for less). Efforts to confront falling growth rates resulted in a stock market bubble that burst last summer. Serious government efforts to stabilize markets were not very successful, showing the limits to its power.

Indeed, China’s growing influence in the world has been a result of its extraordinary growth over the last thirty years. A slowdown in growth rates to a more normal level brings many challenges to the Chinese government -- domestically to avoid pressures for the level of political freedom that rival Taiwan has achieved; in South East Asia, where Chinese bellicosity has been fueled by its rising economic power; and in the broader world where China has been accepted as a superpower, but without showing it has the capacity to remain one.  It is hard to see how China’s Communist Party can remain in power without a transition to a more open and democratic state in the future. Slowing growth rates may accelerate this process, which would be good for China, its neighbors and trading partners.

Terrorism is still a big issue, Rosie says, but nowhere near as big as we (and our political candidates) make it out to be. Radical Islam has been most dangerous to other Muslims in the Middle East. It has been less dangerous in Europe, but of course its profile there now is very high (and likely to get the attention it needs). In the US since 9-11, terrorism has been less dangerous than school shootings; so far consisting only of radicalized individuals or small groups operating on their own.

In the US and the EU, terrorism is largely a police issue and the more incidents there are, the more cooperative police become with each other in developing their abilities to prevent attacks. In the Middle East, military force will be needed to contend with ISIS, but it will have to be supplied by Middle Easterners.

Finally, Rosie thinks our wild and awkward political process is likely to produce the best of all possible results.

The drama of primary elections is necessary in a country of 330 million people, who have different things to say about issues and want to vent about them. Sure, candidates say and do whatever they can to attract votes, but in the end, it winnows down to two (or possibly three) viable candidates, who stimulate the economy with billions of dollars of spending on advertising and other expenses. After the election, we either have a “divided government,” i.e., one in which the Presidency and the Congress are not controlled by the same party, or we don’t. If we don’t, then the party in control can enact whatever platform it can get by a 60-vote hurdle in the Senate. That condition doesn't occur very often, and is unlikely this time.

If it doesn't happen, the country will muddle along somehow, with minimal changes in major political or economic positions. When no one gets what he or she wants, not much actually happens. We can live with that, especially if it keeps stuff we really don’t like from being enacted.

The President, of course, can start wars or other military engagements that are hard to get out of.  After a year or more of listening to the candidates, we will know which are more warlike than others. Whatever it thinks of any candidate at any particular time, however, the American electorate has very little enthusiasm for wars in the Middle East or anywhere else.

Meanwhile, after a tumultuous year, the new Speaker, Paul Ryan, managed to get the House Republicans (and the others) to pass a $1 trillion government-spending bill, rather than shut down the government.

So, all in all, Rosie says, things are also messy, but the US will continue to be the strongest economy in the free world, positioning itself through market actions for a return to higher growth rates. The rest of the world is sorting itself out for the best, and our politics aren’t as bad as they look.   

Well, Rosie has always been able to cheer me up (at least for a few weeks), and maybe she will cheer you up too.

Happy New Year from us both.