Demand Side Forecast

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

November's forecast addresses three elements in graphic detail: GDP, inflation, and employment. All of these indicators are projected to break out of their recent patterns and evidence more volatility. As we've mentioned, the recession we call for has already begun and will extend through the middle of next year. Important underlying assumptions are a hawkish Fed and a Democratic president in office in 2009.

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.

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.

Given these rise in relative prices, a healthy economic program would be to allow wages to adjust upward as well. This the Fed will not do. Panicked by rising prices, the Fed will attempt to suppress inflation as it has done over the past three decades, by suppressing wages. Its "core inflation" indicator is a proxy for compensation to workers. It is quite likely the Fed will actually raise rates even in the context of economic downturn.

Resisting Fed tightening will be the financial sector and markets who need a seemingly unending supply of cheap money to dissolve the obstacles that arise in the absence of rational regulation. Financial markets will pause, however,when they see the value of the dollar deteriorating here at home, because the perceived value of the long-term bonds they are holding for security will decline. It is likely the Fed will be able to enlist many of these bond-holders with its alarm and the claim that tighter money will preserve the value of these long-term dollar-denominated securities.

This portion of the forecast is in large part not analysis of economics, but psychoanalysis of economic actors, including the Fed and the herd actors of the markets. We have assumed only a slight rise in the federal funds rate, but no action approaching the great Volcker Monetarist debacle of the late 1970s and early 1980s.

 
 
 
 

Employment

The official unemployment rate has lost much of its meaning 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. Both of these numbers are susceptible to Fed tightening in ways that cannot be anticipated. While lower interest rates may do little to stimulate the economy, higher rates can stall it within 12-18 months. This was the experience of the Greenspan rate hikes in the late 1990s and into 2000. It would be best if the Fed simply put down its gun and walked away before anybody got hurt.

Higher prices from the dollar's fall will negatively affect real compensation for workers. This slowing of demand will itself depress thing further. Fed action to increase the pressure could create a downward spiral.

The return of a Democratic president ought to return economic policy to a more pro-employment stance.