Demand Side Forecast

Our forecast is not secret, which likely affects neither its relative accuracy nor the incidence of its usage.

The March 2008 update to the Demand Side Forecast is for continued ineptness at the Fed. We suspect that interest rates will drop further and commodities will strengthen further. Borrowing at three percent to buy commodities which are inflating n themselves and are hedges against dollar weakness must be very attractive to speculators. Unfortunately it hardens inflationary pressures and sets up a potentially catastrophic collapse in the dollar or commodities.

GDP

Real GDP growth in the presence of ongoing massive deficits has lost its meaning as an indicator of the productive capacity of the economy. Growth is being borrowed from future taxpayers. This is the reason we have introduced the measure "Net Real GDP," which simply subtracts federal borrowing and presents a number premised on paying our current bills.

In addition, as we have argued elsewhere and particularly in times of was, GDP is not a measure of economic well-being or health, but simply a measure of monetized activity. Additional significant unfunded borrowing from the future is not acknowledged when we ignore the environmental liabilities we are building nor the long-term costs to people and systems from the Iraq War. The liabilities associated with entitlements (Social Security and Medicare funding) are not included in their full form, but borrowing from these entitlements' trust funds by the operating budget is deducted along with other federal borrowing to create the Net GDP number.

We were among the most gloomy in November, predicting declines in real GDP throughout 2008, dipping briefly below minus two percent late in the year before rebounding sharply in the first quarter of 2009. But as a result of the dysfunction of credit across the board, we are revising our call downward. There will be no sharp rebound. Real GDP will remain in the minus one range into the third quarter of 2009.

The Net GDP number is becoming very problematic. Deficits will grow from inadequate and declining tax revenues, the need for additional stimulus and soon from the rise in debt service. We see a Net Real GDP adjusted for federal deficits of negative five percent for most of the next three years. (Our forecast presumes the Fed and its chair Ben Bernanke will sooner or later realize the cheap money is doing nothing for credit markets and is only generating inflation. The reversal of policy cold be dramatic. Such a reversal would generate sharply higher interest rates, increase inflation, and expose the debt service that is now hidden by the so-called flight to quality in Treasuries.

Inflation

One of the darkest downside risks to the economic future is a Fed which overreacts to inflation. Inflation is inevitable with the fall of the dollar. Dollar decline has arrived in a long-delayed response to economic fundamentals, particularly the decades of enormous trade deficits. The decline will be resisted by those invested in the greenback as a reserve currency, by those who depend on American markets for their own production, and by the Fed, which views inflation as a stand-alone phenomenon which is determined by monetary policy.

The fall of the dollar means rising prices because of globalization. Prices for imported manufactures will rise from nations who do not manipulate their currencies. Prices for imported commodities will rise in direct proportion to the dollars fall plus a premium for speculation. Manufactures and commodities that are domestically produced will also rise in price to the extent they are bid up by overseas consumers.

Inflation may not vary much from our November prediction, since one pressure is simply replaced by a more constricting pressure. We suspect headline inflation will reach above six percent in the fourth quarter of 2008, stay at five percent through 2009 and not drop below four percent again until the fourth quarter of 2010. That is the headline -- food and fuel -- the brutal inflation.

Core inflation which includes wages will not get so high, as downward pressure on wages and incomes increases. We suspect core inflation will not get above four percent.

 
 
 
 

Employment

The official unemployment rate has lost about one full point since 2001 because of a mysterious decline in labor force participation which keeps the rate artificially low. We suspect that the actual rate, if calculated with pre-2001 methodology, would be a percentage point higher.

Nevertheless, we include it in our forecast at its official level along with employment growth. That rate will climb above six percent, possibility touching seven percent before it declines in late 2009. Both of these numbers are susceptible to Fed tightening and presume at least a modest effort to address the housing collapse and credit market seizure.

The inability of the Administration or the Federal Reserve to effectively deal with the financial turmoil and credit market dysfunction is adding real stress to the job markets far above those which arose from the original decline in construction employment and drop in consumer demand caused by the drop in home values. Employment will take a hit. We call for net employment declines of nearly one percent throughout 2008 and recovery only when the federal government turns from stimulating banks to direct employment. Such a policy will likely require a Democrat in the White House.