Tuesday, January 12, 2010

The 2010 Economy: A Glass Three-Quarters Full

Just a couple weeks into 2010, the year looks like a glass that`s three-quarters full. That is, nine of the next twelve months augur economic and market strength in North America. But when the leaves start to turn, so may our fortunes, unless the right moves are made.

First, the good news. As Lawrence Kudlow and others have happily reported, the US Yield Curve, which measures interest rates by maturity from 91-day Treasury Bills to 30-year bonds, is not only positive – showing short-term rates lower than long-term – but steep. This upward slope indicates good economic times ahead. Manufacturing and production indices in both Canada and the US have risen above their magical 50 percent thresholds, suggesting economic expansion. For those who need quantitative assurance that better days are at hand, the numbers are there.

And on a personal level, the opportunity is palpable. People are tired of being pessimistic. There continues to be cash on the sidelines, held by individuals and institutions that have waited to invest until the turbulence of the previous year subsides. As Canadian and American equity markets inch upward, and bits of good news – nascent economic growth, improved retail numbers, solid corporate earnings, etc. – seep into the public consciousness, more and more money will be coaxed into the game.

But when the autumn comes, it will bring new challenges. For one thing, September and October have historically been tricky months for equity markets – the years 1929, 1987 and 2008 come to mind. Moreover, for American investors, there will be incentive to dump stocks before the end of the year to avoid higher capital gains taxes in 2011 (more on that in a moment).

One area in which even the most sanguine among us should not expect improvement by this fall is unemployment rates. This is invariably a lagging indicator, so an expanding economy with a lousy jobs market is not so inconsistent as it may seem. Even so, there are moves government can make to get folks back to work.

In the United States, the 2001 and 2003 tax cuts on personal income and capital gains are set to expire at the end of 2010, meaning rates will rise. Small businesses create three-quarters of the jobs in the US, and many of these companies pay taxes at individual rates. There has been scant commentary on the impact of America’s imminent tax increases on the employment picture. But entrepreneurs and small business owners, who must keep an eye on such things as a matter of economic survival, are keenly aware that government will be hiking their overhead in the form of higher tax rates (and, quite possibly, new health care and energy fees) in a matter of months. This will hamper the jobs market unless and until American employers get a better idea of what costs will look like in 2011 and beyond. Freezing US tax rates at 2010 levels – or cutting them, better yet – would go a long way toward reducing unemployment.

Bear in mind that government doesn’t create jobs; private enterprise does. Using so-called “stimulus” money to keep states and cities from having to trim their payrolls, while hiring folks for one-off projects like cleaning up after parades and counting birds at the airport, is not a sustainable way to grow an economy. Heaping fees and heavier taxes on an already groaning private sector is no help. So the shorthand message to America’s lawmakers and president for 2010 is: Stop borrowing and spending, freeze or cut tax rates, and give the economy room to grow.

In Canada, the federal government and central bank have two key jobs apiece, in order to make the most of the next nine months. Prime Minister Stephen Harper and Finance Minister Jim Flaherty must continue to focus on reducing and eliminating the nation’s budget deficit. Every other pro-growth ambition – including meaningful tax cuts – depends on keeping government from making overspending a habit. Second, these fellows must use every political and moral means at their disposal to convince our American trading partners to get their own budget deficit under control. A spendthrift government in Washington leads to a weak US dollar, which means America buys fewer Canadian exports.

As to that, Bank of Canada Governor Mark Carney must continue to keep interest rates low for as long as he can. Hiking rates begets a rising loonie and, for Canadian manufacturers and exporters, the dollar is already too high. Carney has indicated he will avoid raising rates before the end of the summer, unless inflation forces his hand. In the meantime, Carney should continue to talk down the loonie, reminding currency traders that the central bank will not allow our dollar to be speculated into the stratosphere. Canada is an exporter nation and, as such, needs a competitively priced currency for its products. If Carney can manage this, the country should thank him.

Barring some extraordinary incident, the first nine months of 2010 look good for the economy and markets. With the right moves, North America’s leaders can give that three-quarters-full glass a top-up.


Theo Caldwell is the author of Finn the half-Great.