It was just about a year ago that Mohamed El-Erian and his colleagues at Pacific Investment Management Co. coined the phrase "the new normal" to describe their vision of America's economic future. The chief executive of the world's largest bond fund argued that retrenchment by debt-laden consumers and tougher regulation of the financial-services industry would leave the U.S. with tepid annual growth of around 2% for years.
Now, economists of a more optimistic bent have come up with a phrase of their own to describe the outlook: "the new mix." Originated by Joseph Carson, an economist with AllianceBernstein (AB) in New York, this model posits an economy powered more by exports and business investment than by the traditional drivers of consumption and housing. This shifting mix of demand will boost the economy by 3.7% this year and pave the way for average annual growth exceeding 3% thereafter, predicts Carson.
It matters a lot which group ends up being right. El-Erian warns that stock prices may already have risen too far based on his economic forecast and predicts that the Federal Reserve will keep interest rates near zero through 2010. Carson, however, sees the central bank raising rates to 2% by yearend as the economy strengthens. His former colleague at Deutsche Bank (DB) Securities, Joseph LaVorgna, predicts that the Standard & Poor's 500-stock index will climb to 1,325 by Dec. 31, from 1140 on Mar. 9, as the new mix gooses the economy and corporate earnings.
Advocates of both camps agree consumption will be held back as households struggle with a 9.7% unemployment rate and the $12.6 trillion plunge in their net worth during the Great Recession. They also agree that emerging markets, not the U.S., will lead the world economy in the recovery. Where they differ is on the extent that U.S. companies can tap into the expansion overseas, boosting American growth in the process.
Carson believes the U.S. is well positioned to take advantage of the recovery abroad because, in recent years, U.S. manufacturers have significantly boosted their productivity, enhancing their competitiveness in world markets. Output per hour worked in manufacturing rose at an annualized rate of 6.6% in the fourth quarter after climbing 14.8% in the third, the most on record. That's because factories cut workers even as demand rebounded. The weaker dollar also helps the U.S. fight for global market share. The greenback is down about 12% against six major currencies since 2006, despite its recent rise vs. the euro due to Greece's budget woes.
Declaring that the U.S. can no longer depend on the bubble-driven expansions of the past, President Barack Obama is doing his part to promote the new-mix paradigm. He wants to increase government-backed export financing for small businesses by 50%, to $6 billion a year, and he devoted more than $90 billion of last year's stimulus package toward promoting investment in alternative energy.
The performance of the economy since hitting bottom in the middle of last year buttresses the arguments of the optimists. Growth in 2009's second half was stronger than the new-normal camp had expected, with the economy expanding at an annual clip of 5.9% in the fourth quarter, its fastest pace since 2003.
More important, exports and business spending on equipment and software are providing more oomph in this upturn than in past recoveries, while consumption and housing are contributing less. Manufacturers are even doing some hiring. Factory payrolls rose 1,000 last month after increasing by 20,000 in January, the first back-to-back gain since 2006.
The new-normal proponents aren't yielding ground. They argue that much of the economy's late-2009 vigor came from temporary factors such as fiscal stimulus and inventory rebuilding, and that growth will slow to an annual rate of around 2% by yearend. That may well be. But Round One in the battle of outlooks goes to the new mix-ers.