There was wide agreement that the recession dragging on the U.S. economy is over. But as a group of economists and other analysts made clear to credit unions here, there is also wide disagreement over how long that recovery will last, and what it will mean to the movement of interest rates.
The consensus opinion among those addressing WesCorp's Economic Forum here was that the recession is over and the recovery appears to be sustainable for the short term. When asked to look deeper into the future, however, the experts expressed uncertainty. Concerns included job growth, the federal deficit, inflation and of particular interest to credit unions, the direction of interest rates.
Several speakers offered their views of the short-term and long-term economic picture, including Robert Reich, the Hexter professor of social and economic policy at Brandeis University, James Copeland, retired CEO of Deloitte, Touche and Tohmatsu, Dwight Johnston, WesCorp's vice president of economic and market research, and Ron Araujo, WesCorp's vice president of asset management and capital markets.
Reich, who served as Secretary of Labor for the Clinton administration, said he believes interest rates will rise. But in his opening keynote of the conference, he described recent reports of rising inflation as not as "scary" as they seem, and suggested rates might not jump as soon or as sharply as some pundits have theorized.
"If you take away volatile items such as food, energy and lodging, inflation was small," said Reich. "What inflation there was was commodity driven."
Another recent news item that sparked inflation fears on Wall Street was the March employment report that showed the economy created more than 300,000 jobs during the month. Reich said 150,000 new jobs are needed each month simply to meet population growth. "So 300,000 jobs is not something that will alarm the Fed."
According to Reich, long-term interest rates are moving upward because the capital markets are "rightfully nervous" about the federal deficit. He predicted "big challenges" for the U.S. economy in the next six to 10 years.
Copeland said U.S. gross domestic product (GDP) grew at a robust 4.3% in 2003, higher than the average annual rate the economy produced during the lengthy expansion in the 1990s. He said the U.S. Chamber of Commerce expects GDP of more than 4% in 2004, and projects continued growth in personal wealth, personal consumption, and an increase in consumer confidence.
One Concern: Consumer Debt Service
But there are negatives, Copeland acknowledged, including the fact consumer installment debt is near record levels. Because of low interest rates the past two years, this debt has been manageable. As rates rise, though, debt service costs will soak up discretionary income.
"The final piece of the recovery in 2004 is inventories," said Copeland. "Demand for goods has increased and inventories are at record lows, which should lead to a pick-up in manufacturing."
Job growth will be critical to the sustainability of the economy, Copeland continued. He said stronger employment growth should follow the recent improvement. However, the unemployment rate might not improve much due to formerly "discouraged" workers re-entering the work force.
"The Federal Funds rate is expected to remain at 1% until early 2005, unless there is a significant decline in unemployment," said Copeland. "To avoid the appearance of playing politics, the Fed is not likely to change rates just before or after the election, unless they feel compelled to. Credit unions can expect a stable interest rate environment, with a gradual upward trend."
Due to the volatility in the world today, any of several factors could make this or any forecast irrelevant, he cautioned. Extraordinary success could make it hopelessly conservative, or a series of terrorist strikes in the United States could paralyze the economy.
When asked about interest rate jitters on Wall Street, Copeland said: "The paranoia about interest rates is silly. Of course rates are going to go up as the economy improves, unless the economy and the deficit lead to excessive interest rates. In the long term, increasing deficits are a potential problem."
WesCorp's Johnston outlined two possible scenarios for interest rates. If the economy reacts badly to interest rate increases, he predicts the 10-year rate will go to 6% by 2006, then decline. In scenario two, he foresees a steady increase in rates as the global economy expands. In the latter, the 10-year rate will be 6% by March 2005, then rise to 8% by March 2007.
"For credit unions, both cases offer an opportunity to build portfolio yield, and both bring asset quality concerns," said Johnston. "In scenario No. 1, the economy slides again and the asset bubble bursts. In No. 2, the economy is strong, but sluggish wage growth strains consumer budgets."
Johnston's advice to credit unions: Closely monitor pricing, selling and hedging of mortgages, and know that the liquidity outlook is mixed but strategies need to be in place.
What About The Deficit?
Johnston and Araujo devoted much of their breakout session on "market review and outlook" to the federal deficit. In January 2001, the U.S. had a federal budget surplus of $397 billion. In March 2004, that surplus had turned into a deficit of $477 billion. The Bush tax cut accounted for a significant portion of the difference, discretionary spending approved by Congress added $100 billion, and the response to the Sept. 11 terrorist attacks led to approximately $140 billion in additional military spending.
Araujo said the White House has submitted a plan to halve the deficit to $250 billion by 2009. Presumptive Democratic presidential nominee John Kerry has announced a similar plan.
"There is no way to pick a path right now, because the deficit is difficult to project," said Araujo. "There are many ways to bring the deficit down."
Temporary deficits are used to provide short-term stimulus to a lagging economy, but chronic deficits can lead to less capital creation and less investment, he said. Possible solutions include tax cuts based only on economic performance, or reinstitution of a "pay as you go" spending policy-which, Araujo noted, Fed Chairman Alan Greenspan had discussed before a Congressional committee earlier that day.
Outsourcing and Protectionism
Both Reich and Copeland addressed one of the early hot-button topics of the 2004 presidential election: the loss of jobs in the U.S. due to "outsourcing" to lower-wage countries such as Mexico, China, India and Pakistan. Both said attempts at halting this process through protectionist legislation would not work.
According to Reich, there is a popular misconception that "American" companies are in competition with "foreign" companies, and the American companies hire American workers while the foreign companies hire workers in their own countries.
"This is a cartoon," Reich declared. "It is hard to buy anything completely 'American.' More Americans work for Toyota than Chrysler. Components for products come from all over. We have a global, integrated economy. Our standard of living increasingly depends on the value we add to this increasingly integrated economy. The more we add, the more we will earn, and the less we will have to worry about outsourcing."
Another popular myth, he continued, is that Chinese, Mexican and other non-U.S. workers are "taking away" American manufacturing jobs. In reality, technological advancements in factories are reducing the number of manufacturing workers needed, he suggested, adding that he recently visited a large factory that employed just four technicians-whose job was to service the robots that made the products.
The Key To Understanding
"Even China is losing manufacturing jobs," said Reich. "Just like the thousands of telephone operators that had their jobs replaced by automatic switching equipment, and all the tellers by ATMs, the economy is continuously losing jobs to technology."
The key, he said, is to understand the critical asset for any business is its employees. The best companies do not treat employees as costs to be cut, but assets to be developed. Reich said credit unions should concentrate on this human capital, because he foresees a growing disparity in the future between people who have a college degree and those who have a high school diploma.
"Don't focus on the short term, focus on the long term," he advised. "Many things are ignored but very important. A two-tiered workforce, a two-tiered society is not sustainable."
Copeland put the issue in Darwinian terms: "In business, like the jungle, there are two kinds of companies-the quick and the dead. Protectionism to stop outsourcing of jobs will not work. If the U.S. tries to legislate away natural market forces, it will lead to a stagnation and possible decline of the U.S. standard of living. Because you can be certain our competition will use outsourcing."
Instead of grasping for laws to try to stop outsourcing, Copeland said Americans would be better served by a reduction in lawsuits and regulations, which, he asserted, have hampered growth for years. "From 1950 to present, regulations and lawsuits have led to staggering hidden costs of operating in the United States," he said. "Lawsuits have made CEOs risk averse, and a new series of suits could paralyze an entire industry. Another binge of regulatory fervor could cause economic slowdown."
