In the 20 years since I started writing the economic view column, I have devoted each year’s first article to making some non-consensus predictions, always preceded by an assessment of what I had said 12 months before.
Usually, this retrospective audit is a humbling experience, but in 2009, most of my predictions turned out to be roughly right. This, however, is no cause for self-congratulation, since it merely reverses the dismal record of the previous year, when almost everything I said turned out to be wrong. These two outcomes were closely related for reasons that may shed some light on the year ahead.
Since the beginning of the credit crunch, most of my analysis had been based on a core assumption that appeared ridiculous in the months just after Lehman but which now looks as if it may have been right after all. I believed that the credit crunch was just an ordinary financial boom-bust cycle that happened to be blown out of all proportion by an astonishingly incompetent policy response in the United States.
Had it not been for the inexplicable policy blunders of Henry Paulson, the US Treasury Secretary, in mid-2008, above all the decisions to wipe out shareholders in Fannie Mae and to bankrupt Lehman Brothers, but also his refusal to counteract the speculation that drove the oil price to $150 in mid-2008, the world economy would probably have suffered nothing more serious than a mild recession. Once Lehman went bankrupt, a deep recession was inevitable, but I still believed that some simple, albeit radical, policy changes would be sufficient to turn the situation around.
Thus my key predictions in January last year all related to America. I argued that US prospects would be instantly improved once Mr Paulson and President Bush were hustled out of office. “Instantly”, in the macroeconomic context, means within one or two quarters, which was why I suggested that after a few more months of severe contraction, signs of recovery would appear in the property and financial markets by early summer, with the real economy rebounding shortly after, led by inventories and exports. Consumer spending would be slower to recover, but would gradually respond to the combination of zero interest rates, unconventional monetary policy and a $1,000 billion fiscal stimulus.
As a result, I suggested that the US would “surprise most observers by staging a roaring recovery, just as it did in 1983 and 1984”. I also argued that the dollar, far from being reduced to a “toilet-paper currency” by budget deficits and monetary expansion, would actually strengthen as a result of the new Administration’s hyperactive policy approach.
These views about the US recovery turned out to be roughly right and lead to my predictions for 2010. With interest rates near zero and almost all assets still much cheaper than they were two years ago, I expect property and share prices to go on rising, at least until the fourth quarter of 2010, when the US bull markets may be temporarily interrupted by a very cautious increase in interest rates.
The claim about a “roaring” US recovery may seem like an overstatement, but recall that 2009 is not yet over in a statistical sense. Most recent indicators suggest that US growth in the fourth quarter will be very strong, notwithstanding the mildly disappointing employment December figures last Friday.
According to Ian Shepherdson, of High Frequency Economics, who has done better at anticipating the twists and turns of US economic statistics than any other analyst I follow, GDP growth in 2009’s fourth quarter was probably above 4 per cent — and other respected analysts are coming out with figures of 5 per cent plus.
So I stick to my guns in believing that a “roaring” US recovery is already under way. Unlike most other analysts, who believe that the strong fourth quarter will prove just a temporary aberration to be followed by a long period of sub-trend growth, I expect US growth to remain around 4 per cent throughout 2010, making this the strongest year for the US economy since the 1990s.
The reason for this growth surge will be quite simple. The Federal Reserve Board is determined to maximise growth and employment in an environment where consumers, financial institutions and government all need to improve their finances. To facilitate this process, the Fed will keep interest rates near zero at least until next autumn and when it does start to tighten, it will do so only very slowly, raising interest rates by no more than a quarter-point or half a point before the end of the year.
This low-interest outlook may seem to contradict the bullish view I expressed last year about the dollar — and, indeed, the dollar weakened slightly in 2009, instead of rising.
But in comparison with the dire conventional wisdom about the dollar (and the pound) after the Fed and the Bank of England started freely printing money, my error last year was more a matter of timing than direction. While the dollar is 3 per cent lower than a year ago in its trade-weighted index, it has totally defied widespread predictions of a freefall and its prospects look increasingly favourable with every passing week.
The strong dollar, therefore, is another prediction that I will repeat for the year ahead — and I will stick my neck out further by suggesting that the dollar will go up against every other leading currency in 2010, with the possible exception of the Chinese yuan.
The world’s weakest currency is likely to be the euro as US exporters increase their global market share mainly at the expense of European rivals, while Chinese and Japanese manufacturers divert to Europe many of the goods that they can no longer sell in the US.
Again, this is really an extension of a somewhat premature suggestion I made last year, when I said that the focus of global economic troubles would shift from America to Europe. This did not quite happen in 2009, although the falls in output and industrial production were much steeper in Europe than the US. But German government labour subsidies will soon expire and the financial pressures on Greece, Ireland, Portugal, Spain and Central Europe can only intensify.
I therefore repeat a point I made last year: before this crisis is completely finished, the cohesion of the eurozone will be tested to near-destruction.
Finally, Britain. Last year’s expectations all pointed in the right direction, but again were somewhat early. Foreseeing that the Bank of England would respond to the dire state of the economy and the pound’s unwelcome strengthening with aggressive and unconventional monetary expansion was relatively easy.
A less obvious prediction was that the British economy and the housing market would improve significantly in the second half of the year. This should be confirmed in fourth-quarter GDP data due next month. In contrast to America, however, economic recovery in Britain is likely to be weak. The year ahead will be disappointing in Britain for several reasons: political uncertainty before an election; an exodus of financial business from London; tax increases already legislated, with more to come in a post-election mini-Budget; and excessive strengthening of sterling.
The main good news is that the Bank, like the Fed, will do its utmost to counteract all these deflationary forces. The Bank may also surprise the markets by expanding its quantitative easing and will try to prevent any significant appreciation of sterling.
This leads to my last and perhaps most controversial prediction: despite the supposed bankruptcy of the British Government, interest rates will stay near zero throughout this year and will still be below 2 per cent by the time this column reaches its 25th anniversary in 2015.
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