AS THE ECONOMY TURNS

STUBBORN

Dr. William Shingleton

January 9, 2006

 

One would have to be more than a bit stubborn to do as poorly as we did last year on forecasting the state of the economy and come back for more punishment just because the calendar has turned another page.  However, the one part we did get right last year was when we said that “…January is the time economists like to make fools of ourselves, even more than we usually do. It is really quite simple; every January we try to predict the future.”  Here it is January again, and just like last year, we’ll try to look into our translucent ball.  As long as you are willing to recognize that these forecasts are worth about what you pay for them, you are welcome to read on and see what we think the economy will be like in 2006.  Please note that we have not used any fancy statistical models in our forecasting so the conclusions are more logical and intuitive than they are quantitative.

 

Just to review (We have some new readers with us.), to FORECAST is to try to predict the health and direction of the economy.  Forecasting is important in business because a strong, growing economy like we have here in the United States will generate more demand for more products than one that is lagging along like they have in most of the nations of Europe.  In addition, if we can confidently predict growth in the economy then businesses can plan to increase output and hire more workers.  If we can’t predict with much confidence then any business expansion becomes more of a risky operation and risk is a drag on business investment.  As a result, many large corporations hire economists and statisticians to forecast the numbers that are important for their individual sales and costs.  [NOTE: The measure of a being a successful forecaster is not whether you are right or wrong (you are almost always wrong) but (1) whether you can keep your errors small and (2) whether or not you can avoid consistently over-estimating or under-estimating your variables.]

 

For 2006, the general health of the economy will be influenced by a number of factors that will be different from what we experienced in 2005.  The market is already also excited about the prospect of some stability in short-term interest rates by March, although we are betting on June for that one.  The grind of the ever-higher short-term rates in 2005 was a policy decision by the FEDERAL RESERVE.  With a new man in charge in 2006, there is no question that they will continue the current policy of increasing rates 25 basis points on January 31 and probably on March 28th as well.  The question about a shift in policy will come at the May 10th meeting.  We are guessing that will be the last increase in this pattern, so the rates will be higher by about ¾ of a percent for the year when they call off the dogs at the June 28-29 meeting.  That’s much better than last year, when they raised short-term rates a full 2.0 percent. Unfortunately, monetary policy works with a LAG, there is a delay between the time the FEDERAL RESERVE acts and the time the full effect is felt in the economy.  While some of the effects will show up this year, the full benefit of the new monetary policy will have to wait until 2007.

 

The other policy issue is that there is no hope for any budget discipline out of Washington, but we did not have any last year either, so that doesn’t change things very much.  Whether they pass any tax cuts or not probably won’t matter very much either, unless they make them retroactive, which would be even more lame-brained than usual.  It’s hard to underestimate Washington in an election year.

 

Fortunately for the United States, our economy is remarkably stubborn, even in the face of idiotic economic policy.  That’s because, as usual, most of the push will be from the private sector, which looks like it is in pretty good shape.  Consider that last year’s headliners were Katrina and energy, and even the two of them did not knock the economy off of its feet.  In 2005, we had to deal with the rocketing price of oil.  [NOTE: At least there we had a good record, calling the over 60 dollar price earlier in the year. We have to get something right once in a while, it’s known as the Law of Large Numbers.] While 70 dollar oil would not be a complete surprise in 2006, both 80 (or 40) certainly would.  The good sign is that we are starting off with a mild winter, which is building our inventories.  The bad sign, at least on energy, is that Japan’s recovery will add to the growing demand from India and China, so we doubt we are going to even see 50 dollars again.  However this plays out though, it won’t be the shock it was last year.  Still a bit of a drag but not a shock is good news, at least in the odd way that economists look at the world.

 

So what will the numbers look like?  We’ll start with the December EMPLOYMENT report that came out on Friday <http://www.bls.gov/news.release/empsit.nr0.htm>.  While it is easy to read too much into one month’s numbers, the employment reports of the next couple of months may very well set the economic table for the year.  Let’s deal with that qualifier first, the one about not reading too much into one month’s numbers.  The December report only estimated that 108,000 new jobs were created in that month.  By itself, that’s pitiful, since the economy needs to create about 200,000 jobs each month just to keep labor market conditions steady over the long term.  However, the November estimate was increased by 90,000 to 305,000, so if we combine the two months the average was about where we wanted it.  (Although the October new jobs estimate was reduced from the 44,000 previously reported to an even weaker increase of only 25,000, some of that had to be attributed to the Katrina disaster.)  Two points should be made here.  First, an individual month’s data, especially when it is first released, is not completely reliable, they get “revised” all the time.  Unfortunately, by the time the data have been polished and put on a permanent shelf they are too old for anyone to really care about them.  Secondly, sometimes the data in individual months can be distorted by specific one-time events, like Katrina or plant closings.  Then they don’t show any kind of trend, they are just aberrations, sort of like the White Sox winning the World Series.

 

A better measure of how we are doing in the labor market is the comparison between December 2004, when we had 133 million workers and December 2005, when we had almost exactly two million more [SOURCE: ESTABLISHMENT DATA, Table B-1 <http://www.bls.gov/webapps/legacy/cesbtab1.htm>. That 12-month pattern has improved just a little since June.]  Combined with other factors, it’s been enough to bring the UNEMPLOYMENT RATE down from 5.4 percent last December to 4.9 in the past year.  Even economists have to smile about that one, don’t they?

 

Where will the UNEMPLOYMENT RATE go from here?  It doesn’t have much room to wiggle on the downside.  In the last ten years, the lowest monthly rate we have had was one touch with 3.6 in October 2000 and the lowest annual rate was 4.0 in 2000.  On the high side, we have hit 6.5 in a couple of months in 2003, which was also the worst year in the last ten because we had the annual rate of 6.0.  Since we have no reason to expect high or low records, reasonable guesses fall in the 4.0 to 6.0 range. Our guess is about 4.7, figuring that the downward trend of the last few months should carry over to the early spring. 

 

But if we continue to add jobs, and if we do not get burned by another spike in energy prices, we have to be optimistic about the economy.  Our record on total production, something economists call REAL GDP was good in 2005,   with the economy growing 3.6 percent over the last 12 months [SOURCE: < http://www.bea.gov/bea/newsrel/gdpnewsrelease.htm>] Just for perspective, the average rate of growth over the last 20 years has been about 3.3 percent, so we have done pretty well lately.   Even better than that, we have had more or less the same growth report for each quarter since Spring of 2003.  Without some of the problems we ran into last year with storms and oil, we should see about 4.0 or even 4.2 growth in GDP.  Those would be good, solid number and would be consistent with the job growth we talked about above.

 

This brings us to prices, as measured by the CONSUMER PRICE INDEX.  The important influence of higher energy prices is still working its way through on the price side of the economy.  Another factor to consider is the job market.  We said earlier that almost everyone had to be happy with a declining unemployment rate.  A big exception would be people who are worried about prices.  We already have a number of individual labor markets where we do not have the people to fill the positions at any price, particularly in skills that require extensive training and experience, such as highly skilled machinists.  A firm facing a gap in its labor supply is facing a bottleneck and will react by raising its prices because it is unable to increase its output. Last year prices increased 3.5 percent [SOURCE :< http://www.bls.gov/news.release/cpi.nr0.htm>] but a good deal of the upswing occurred in the second half of the year.  One of the major purposes of the higher interest rates by the FEDERAL RESERVE we discussed earlier has been to stifle the price increases.  So far, they have been moderately successful.  For 2006, we are expecting a range of between 3.5 and 3.8 percent, although inflation should cool off in the later months.

 

So there you have it, higher prices rising faster and three more interest increases; but a growing economy; and an improvement in the unemployment rate.  Just don’t expect as much from the White Sox.

 

Final notes:  If you would like to be removed from the distribution list just send a reply on email.  Back issues are available on my website <http://www.oocities.org/wsirius30/2cents.html>. The opinions expressed in these newsletters are those of the author.  Comments, including suggestions for future newsletters, are always welcome.