Out of Control Policy Blog

What is Wrong With an Optimistic View of Recovery

Brian S. Wesbury, author of It's Not As Bad As You Think: Why Capitalism Trumps Fear and the Economy Will Thrive, and his colleague Robert Stein write in Forbes today their reasons why the economy has a good chance of making a V-shaped recovery in 2010. One can only hope they are correct, though I'm not seeing the world through their optimistic eyes.

They argue that the forth quarter inventory led GDP growth is not only sustainable, but just the beginning.

Relative to the size of the economy, last year's (inflation-adjusted) inventory decline of $112 billion was more than twice as large as any other inventory reduction since 1950. In the fourth quarter inventories still declined--that's right, they declined. But because they declined by less than they had in the third quarter, they added to GDP growth. In other words, the inventory cycle necessary to replenish store shelves has just begun.

It is true that inventory rebuilding certainly isn't complete. But I question the sustainability of this for two reasons: first, as long as unemployment remains problematic consumer confidence won't see a solid rebound, meaning there will be no consumer follow-through in buying the inventoried products. Second, as long as the credit lines remain in frigid state, businesses may not be able to continue inventory building.

Wesbury and Stien counter that consumer spending will continue to grow in 2010. They believe that the cash-for-clunkers spending wasn't the chief driver of third quarter growth, but point to the fact that the real consumption rate beyond automobiles being 2.3% in the third quarter and overall consumer spending growth of 2.4% in the last two quarters of 2009 as positive signs.

However, while third quarter growth wasn't completely autos, it was pretty much all government supported. Overall, government spending and supports accounted for roughly 77 percent of economic growth in the third quarter of 2009, meaning that non-Washington GDP growth was only about 0.34 percent.

My outlook for 2010 sees debt continuing to weigh down banks and perpetuated problems with the housing industry. I also believe political pressure will eventually push the FOMC to begin a tepid increase of interest rates, which will put some brake on the recovery—although it will probably be necessary to drive a real correction and avoid a fauxcovery. Wesbury and Stein however say "One key reason for our optimism is the outlook for monetary policy. Fed policy is clearly loose and will get even looser as the economy picks up... As a result, with the normal lag, the economy will continue to be boosted by easy money well into 2011."

I'd love to be wrong here and do believe capitalism has the power to lift us out of the current mess. But I don't see the same scenario as the optimists. The fiscal threats of increased taxation, punitive attacks on Wall Street, and a government support recovery all point towards a U-shaped or L-shaped recovery.

Anthony Randazzo is Director of Economic Research


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