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Sunday, March 18, 2012

Optimism edges up at the Fed

Tony Paradiso

Stocks were up seven straight days, Apple hit $600, and everything is one in the economic universe. Even the Fed expressed optimism, albeit of the guarded variety. In its latest post-meeting statement, the FOMC cited a “notable” decline in unemployment and continued advances in household and business spending that they believe will translate into “moderate” economic growth.

That’s about right.

Proving nothing gets by the central bank, they also acknowledged increased gas prices. An obvious observation, you say? Yes, but sometimes stating the obvious can be challenging. Look at Mitt Ronmey. Despite obviously being a wealthy, northern moderate, completely out of touch with the common man, he insists he’s an ultra conservative, honorary Southerner who feels our pain.

As for gas prices, take heart. The Fed considers them – you guessed it – temporary. Can’t argue with that. Gas prices will either go higher or lower, so technically, today’s prices are temporary. The most curious change in the Fed statement was the omission of the reference to slowing global growth. The omission is a bit premature, given growth in Europe and China is slowing.

With the Greek drama shoved under the rug, Europe has turned its attention to Spain. For Spain to adhere to the new fiscal rules, it must shave almost 6 percent of GDP from its deficit. That would be a piece of cake if Spain wasn’t in recession and didn’t have Europe’s highest unemployment rate of 23 percent.

Spain’s 2011 deficit far exceeded forecast, and they have acknowledged this year’s agreed-to target won’t be met. And Spain’s new prime minister, Mariano Rajoy, recently flexed his newfound political muscle by unilaterally setting a new 2012 debt target. The 5.8 percent of GDP that he arrived upon is a smidgen higher than the 4.4 percent EU officials had expected. Not to worry, after some friendly behind-closed-doors discussions, the target was changed to 5.3 percent.

But Spain is a mere sideshow compared to China. Last week, I mentioned that for the first time in seven years, China lowered its official growth target from 8 to 7.5 percent. One week later, China announced its largest trade deficit in 12 years. Trade deficits in China are rare but not unprecedented. They have recorded three such deficits over the last three years, all largely related to the weeklong Lunar New Year holiday. But at $31.5 billion, February’s trade deficit was more than three times larger than the previous two deficits.

There are other signs that China’s domestic economy is weakening. Auto sales fell 6 percent in the first two months of the year. And official agencies have also acknowledged that industrial output and retail sales are off their December pace. Industrial output came in a full percentage point lower than economic forecasts.

The good news is that inflation has subsided and China has ample resources to bolster short-term economic growth. A hard landing is highly unlikely, but pay close attention to the data coming out of China, because it won’t take a hard landing to materially impact our recovery.

That’s because we’re still waiting to achieve what Fed Chair Ben Bernanke dubbed “escape velocity” – private-sector growth strong enough to sustain itself without artificial stimulus. And although recent data has been predominantly positive, it remains somewhat inconclusive.

On the positive side of the ledger, employment has consistently improved, industrial production is on the upswing, and commercial bank lending has begun to ramp up nicely. These are strong signs of a return to economic normalcy. And of course, the stock market is on fire. Higher stock prices boost wealth and confidence but are no indication of our economic future.

On the negative side of the ledger are stagnant incomes and lackluster consumer spending, It’s expected that GDP growth in the first quarter will register a lukewarm 2 percent, well off the 3 percent pace set in Q4 of 2011. And there are those pesky gas prices. Some estimates indicate that even at current levels, gas prices will shave 0.2 percentage points from Q1 GDP and 0.5 percentage points from Q2 growth.

And headwinds persist. In addition to the lingering risks from Europe and Iran, our own modest version of austerity – continued cuts in federal, state, and local spending – will remain an economic drag.

The state-level numbers illustrate the challenge. Projections are that in the fiscal year starting in July, states face a combined budget deficit of $47 billion. That’s a big number by historical standards but a far cry from the $191 billion combined deficit the states faced three years ago.

With the improved economic conditions, tax receipts are rising, and previous budget cuts have lowered expenses. But despite Obama-care, healthcare costs continue to rise, funding pensions remains problematic, and federal stimulus money is drying up. That adds up to more cuts and more headwinds.

And there is one more factor: the absence of presidential election year economic candy. The Republicans – being the good little self-serving politicians that we have come to love – have a vested interest in making sure things are not artificially juiced, and I expect they’ll do their best to accomplish that goal.

Author, professor, entrepreneur, radio and TV commentator Tony Paradiso can be reached at tparadiso@tds.net.