2015 Economic Forecast by Joel Stern
Last year my economic forecast for 2014 called for a rate of real economic growth of 4% for the U.S., much higher than the prevailing forecast at the time as well as the prevailing rate of economic growth that had existed in the years 2010-2013. Economic growth had only been sputtering along at between 1.8% and 2.2% during that period. As I pointed out last year, the general rule in macroeconomics is that the faster you decline, the faster you rebound, and that has been the case in virtually all business cycles over the past century. The Obama Administration changed all that. Its reregulation of the U.S. economy in general, and the more specific Dodd-Frank banking law, more or less stopped the banks from participating and encouraging a robust recovery. There is no reason why the economy should not have rebounded at 5 to 6% in real terms when the financial meltdown ended in 2009. The reregulation caused the tepid recovery, principally because it lowered the expected rate of return on new investments in the private sector.
What happened in 2014? Virtually everybody was shocked by the 12 snowstorms we suffered in the first quarter causing that quarter’s real growth to actually be negative. We had to think back to 1947 when a similar occurrence took place.
However, it did not take long for the economy to match the forecast I had suggested: An annual rate of economic growth of 4% in the second quarter and 3.9% in the third quarter. We have a good chance that the growth rate in the fourth quarter will be in the 4%+ range as well. The question is, what is happening? Why is this taking place now?
The answer is that foolish government policies can only impede economic growth for a while. Eventually markets find ways around the new regulations, or firms simply will invest outside the U.S. where they are not subject to the same restrictions. Notice, too, that the rapid growth rate after the first quarter of 2014 occurred despite an extremely weak economic condition in Europe and a weakening rate of growth in Asia as well.
We are going to have a robust 2015. One of the reasons why this is so is because the financial markets have been forecasting this for all of 2014. Wall Street-types have been baffled by the remarkable returns earned in the equity markets this year considering that the economic growth rate until the beginning of the second quarter had been so tepid. These people failed to understand that share prices represent the present value of the expected future performance of the firm, and since share prices are time adjusted for the value of money, which means that short term results are much more important than more distant results, it is clear to me at least that the markets are signaling an extremely strong year for 2015. My range is a forecast for economic growth of between 3.8% and perhaps as high as 4.5%. I confess that I am leaning much more toward the latter. This is going to worry our central bank, the Federal Reserve, and it is likely to start raising interest rates much sooner than people currently expect.
Employment growth is going to explode. It would not surprise me if 4 million new jobs are created in 2015, which means a rate of more than 300,000 a month. Until very recently job growth has been running at between 200,000-250,000 a month. Why the change? The answer is that businesses suddenly have recognized the enormous turnabout in the economy, and they are going to have a hiring binge to make up for the delay from past years.
The unemployment rate is going to continue to come down, but at a much slower pace. The reason is that the unemployment rate is based not only on those people who are seeking employment, but also for those who dropped out of the workforce, because they became discouraged since they were unable to find work for a very long time. These discouraged workers are going to reenter the workforce and that will increase the supply of employment. The job growth of 4 million will be supplemented by at least 2 million more who will be entering the workforce for the first time. Still, I believe the unemployment rate could drop to 5% or less by the end of 2015. Incidentally, you can be sure the Democrats will be claiming that this was the result of their brilliant policies all along. Nonsense! As mentioned, this is simply markets finally recovering at long last from truly silly policies that have been highly counterproductive.
I also expect corporate profits to grow at least 12% in 2015, and that interest rates will begin to rise dramatically. Last year I had forecasted that 30-year government bonds would hit 4%, and they came very close, hitting 3.9% in the first half of the year. I should also point out that having high real U.S. interest rates is an excellent signal to the rest of the world, because it indicates that the rates of return on capital employed in the private sector will be high. We should recognize that the 30-year government bond rate has sunk to below 3%, so that at this writing it is running at only 2.95%. I see the 30-year government bond rate rising to at least 4.5% in 2015. Also, I believe the strong dollar will continue, because of our brilliant private sector economic performance, but I fear that the Eurozone is in for big trouble.
We must keep in mind that there are several self-correcting mechanisms in world economies when they go into recession. Four things happen to extricate countries from recession. The first is that interest rates fall due to a shrinking demand for credit. Second, inflationary expectations fall driving interest rates down even more, and if the Central Bank increases bank reserves and thus the money supply, that further causes interest rates to fall, at least in the short to intermediate term. The fourth factor is a decline in the value of the currency.
So, given all of this, let us look at Europe. Interest rates there are lower than they are in the U.S. The currency has literally collapsed over the last 6 months. The Euro had been as high as $1.39 in the first half of the year, within just a penny of my own forecast for the Euro. But continued weakening of the economies, especially compared to the U.S., has caused the Euro to drop to $1.22 at the time of this forecast (December 9, 2014). I do not believe it is over. It wouldn’t surprise me if the Euro falls to about $1.18. This will be good for Europe. It will encourage exports from the Eurozone. Even more interesting is the situation in Germany. Almost half of its GDP is exports, and half of the exports are outside the Euro area. Again, I would not be surprised if Germany leads the economic recovery. France is a different story unfortunately. It lives and breathes socialism. France doesn’t call it that, but its policies for a very, very long time, for more than 15 years now, have discouraged investment and encouraged capital flight. Even Italy is doing poorly, a real surprise to me. However, at long last Spain and Greece will see signs of real economic recovery, mostly because of the collapse in the Euro. It will encourage tourism big time in the spring and summer, and it is possible that Greece will actually experience real growth for the first time in 7 years.
Turning to Asia, I remain encouraged by the policies followed by the Modi Administration in India. Given the large number of government enterprises there and the inefficiencies that it causes, along with a very large percentage of the population that needs to complete a high school education and more, and develop math and reading skills, India will continue to grow well below its potential, in the range of 5 to 7%. The important thing is that the Modi Administration appears to believe that free markets are a good thing, and with Raghuram Rajan, a brilliant financial economics professor from the University of Chicago Booth School as the Reserve Bank Chairman, his presence alone will encourage the kinds of policies that will be good for India over both the intermediate and longer term. In short, I am very bullish on India for the short term, the intermediate term and even the long term.
I have said on many occasions that China is not going to be able to continue performing at anything near the levels it reached 3 and 4 years ago when its growth rate was 10 to 11% a year in real terms. In many instances the government was following the unworkable policies that Japan implemented in the 1980s, when the government encouraged capital spending on projects that caused excess capacity in almost all areas of the economy for many, many years to come. By 1989 it was clear that although Japan had been growing at about 8% a year, at least three-quarters of it was caused by make-believe investments, investments made with no rate of return to be earned. China has been encouraging such investments in plants and in office buildings that have nobody occupying them. It even has cities with nobody living in them. Such policies are bound to catch up, and it has already begun. China will not grow even at 7% in 2015 unless it is caused by a recovery in Europe and a faster growth rate in the U.S. than my forecast. Although it appears free enterprise is alive and well in China, the facts are actually quite the opposite. Almost all large enterprises there are government owned or controlled, and instead of having a price system to tell suppliers where monies need to be invested on behalf of consumers, no such mechanism exists in China. The reason China had been very, very successful is because it has been the low cost producer in manufacturing. But inflation and an increase in the value of the Yuan has caused China to be much less competitive. The low cost producer in Asia now is Vietnam, what an amazing surprise.
Finally, the sad news is that Japan appears to be entering a recession once again. It has been almost 25 years with sub-optimal growth. Japan’s amazing experiment with government choosing to replace a market system for allocating resources has been the results that we have seen. There is no escaping economic reality. As mentioned, China is about to experience something similar. The only advantage China has now is that it is still a relatively low cost producer and it has developed significant manufacturing skills. However, for enough of its population although incomes are rising rapidly, and the middle class has grown dramatically, it means that so-called luxury items will do well in China, but for the vast population, days of sadness are ahead.
Lastly, because of my very strong interest in South Africa, where I have been on the faculty of two of the major universities for the past 37 years, let me say a word about the situation there. Given outstanding universities, an excellent climate for agriculture, a very strong manufacturing sector in chemicals, cement, other building materials, and steel, and a fully developed economic system where distribution, both wholesale and retail, works brilliantly, it is shocking to have to report that South Africa has reverted to a growth rate of only about 1 to 1.5% a year. In the early 1990s I gave a talk at the university in Stellenbosch in which I showed my forecast potential for South Africa at 8% real growth during really good years, 3 to 4% real growth in bad years, and an average annual growth rate of about 6% a year. That was the potential. All the numbers pointed in this direction. If the African National Congress had followed more of a free market policy, there is no way that South Africa would have been able to escape a 6% growth rate. Unfortunately, all kinds of impediments have been put in place that have caused the economic growth rate to fall far, far short. We all recognize that the majority of South Africans were treated very badly by the white minority, and this was so for decades. It was a disgraceful exhibition of ethical behavior and morality, and it had saddened me. I still remember on my first visit in 1976, that when I needed to use the lavatory next to the queue upon entering the country, I decided to forego the lavatory because it had a sign saying “Whites Only.” I just could not get myself to walk into such a room. What South Africa should have done when it became truly free in 1994 was to follow the wisdom of Nelson Mandela: “Let’s let bygones be bygones.” The government has been following policies instead that discourage foreign direct investment. It is as simple as that.
This investment takes two forms. The first are cash investments from foreign investors as well as from foreign companies. However, Black Economic Empowerment (BEE) and affirmative action have given blacks, who are already the overwhelming majority, preferences over whites in almost all of the important business decisions that are made in the private sector. This is the penalty they have exacted for past injustices. However, if blacks want to overcome such injustices, in my view the only way they should do it, is by using government expenditures to improve the quality of education. Once an investment in human capital has been made, it can never be taken away from the beneficiaries. Instead the government restricts immigration of qualified engineers and the like, saving those jobs for their black citizens. To me this makes no sense at all. Eastern Europe abandoned communism and is filled in many countries with highly qualified white chemists, engineers, medical doctors, school teachers, and the like. Imagine how wonderful it would be if these people could emigrate to South Africa where they could bring their skills to bear and raise incomes not only for themselves, but for all of the people who would work with them and acquire many of their skills on the job. We also must not forget that the spending of these European immigrants would increase job opportunities for the local black population. That is what is needed. It is that view that is needed. Unfortunately, my forecast for South Africa is for economic growth of only about 1.5%, if even that can be achieved. I even fear that sooner or later Black Nationalism is going to become a part of government policy, and the danger then will be capital flight. I hope I do not live long enough to see it.
In summary, the U.S. is about to experience very high and robust economic growth across the board, with an enormous increase in employment, and even a decline in the unemployment rate despite the fact that a very large number of discouraged workers will reenter the workforce. It is going to be a year of true amazement, especially for my fellow economic forecasters who will have forecast too low a growth rate. In my view, Europe is going nowhere in 2015, at least in the first half. It will take at least through the first half for the decline in the Euro to stimulate economic activity there. India remains strong, China much weaker than its potential, and Japan will be in recession. South Africa will continue with its self-inflicted wounds.
Another year has passed and so our economic expansion is extremely long in the tooth. The recovery began in June 2009, so it is now 5½ years old, and the typical economic expansion, only with rare exceptions, does not last even this long. In other words, a recession can come upon us due to unexpected aberrations elsewhere in the world, or heaven forbid, on our own soil. Another way to look at this, however, is that because of the impediments imposed by the Obama Administration, the economic recovery is now after all these years only getting underway with real gusto. Thus, it is possible that the normal 5-6 years of economic expansion will be lengthened by 2 or 3 years while we experience the really good times ahead. Let us hope so.