Economists' forecasts suggest the U.S. will see a European-style recovery—growth accompanied by high joblessness—rather than Japanese-style stagnation
By Rich Miller and Michael McKee
(Bloomberg) — The U.S. may have avoided the Japanese disease of prolonged stagnation only to end up with a dose of eurosclerosis: chronically high unemployment in a growing economy.
Economists are starting to extend their forecasts through 2011 and the results don't look pretty. Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc. in New York, forecasts that the jobless rate will rise to 10.75 percent by the middle of 2011 from 10 percent now.
Even optimists such as Bruce Kasman, chief economist at JPMorgan Chase & Co. in New York, see unemployment remaining well above the 20-year average of 5.6 percent. Kasman, whose forecast of 3.4 percent growth next year is higher than the 2.6 percent median of 83 economists surveyed by Bloomberg News, projects the unemployment rate will average 9.9 percent in 2010 and 9.3 percent in 2011.
"We had been worried about turning into Japan," says David Wyss, chief economist at Standard & Poor's Corp. in New York. "But it may be more likely that we end up with sclerosis."
Persistent European-style unemployment means that the Federal Reserve, which holds its last policy meeting of the year Tuesday and Wednesday, won't raise its benchmark interest rate from near zero through 2010, according to Curtis Arledge, co- head of U.S. fixed income in New York at BlackRock Inc., the world's largest asset manager.
'Wouldn't Surprise Me'
"I don't think they're even going to be thinking about it until the third or fourth quarter of 2010," says Arledge, who helps oversee more than $500 billion. "It wouldn't surprise me if it was into 2011."
Bond investors should expect large supplies of Treasury securities as the budget deficit stays near last year's record $1.4 trillion, according to Kasman. Unemployment will help keep the deficit at an historic level by robbing the government of income-tax revenue while forcing it to spend more on jobless benefits.
Because it will help the Fed stay on hold, a high jobless rate also may mean the government can finance that deficit at low cost. The Treasury sold $44 billion of two-year notes on Nov. 23 at a yield of 0.802 percent, the lowest on record.
Stock prices will continue to rise as companies boost profits by concentrating on cutting costs and getting more out of their workers, says Allen Sinai, president of Decision Economics in New York. Employee output per hour rose at an 8.1 percent annual rate in the third quarter, according to the Labor Department, the fastest pace in six years.
Rising Corporate Profits
Sinai sees profits for the companies making up the Standard & Poor's 500 Index climbing by more than 20 percent next year. Third-quarter corporate profits increased 11 percent, the biggest gain since the first three months of 2004, the Commerce Department reported Nov. 24. The S&P 500 has rallied 64 percent to 1,106.41 from a 12-year low in March.
Annual economic growth in 2011 will be 2.8 percent, according to the median forecast in the Bloomberg News survey—slower than the average annual rate of 3 percent in the decade before the recession began in December 2007.
The pace is still faster than Japan's. The country's central bank lowered its benchmark target interest rate to near zero in February 1999, trying to boost an economy suffering through a "lost decade" of expansion that averaged 1.9 percent a year. Growth since then has averaged 0.7 percent annually as Japan sank into a liquidity trap, where additions to the money supply failed to stimulate the economy.
The median U.S. forecast for this year and next masks big differences among economists about the outlook. Mohamed El- Erian, chief executive officer of Newport Beach, California- based Pacific Investment Management Co., manager of the world's largest bond fund, argues that the U.S. has entered a "new normal" period with annual growth of 2 percent. He sees growth fading in the second half of next year after an initial burst.
"I'm more bearish than the consensus," says El-Erian, who sees the dollar experiencing "periods of downward pressure" during the year. "We start the year at 3 percent and then end up at 2."
Larry Kantor, head of research for Barclays Capital Inc. in New York, is more upbeat.
"What we think is going on right now is that the U.S. economy is growing at a 4 to 5 percent rate," he says. "When you go down hard, you tend to have a bounce because of pent-up demand, policy stimulus and the like."
Former Federal Reserve Chairman Alan Greenspan said on NBC's Meet the Press program Dec. 13 that businesses cut payrolls so deeply in the recession that they will have to begin hiring soon. The unemployment rate may continue to rise because the economic expansion will draw workers who gave up looking for jobs back into the labor force, he said.
No matter what their growth estimates, the economists surveyed by Bloomberg agree that unemployment during the next two years will remain above the 4.9 percent average of the decade before the start of the recession. The jobless rate will average 10 percent next year and 9 percent in 2011, according to the median forecast of those surveyed.
Herbert Giersch, former president of the Kiel Institute for the World Economy in Kiel, Germany, coined the term eurosclerosis in 1985 to describe European economies beset with high unemployment at a time of overall growth. Joblessness that year averaged 9 percent in France, 11.4 percent in Britain and 8.2 percent in what was then West Germany.
Economists say Europe's malaise, which extended into the mid-1990s, was caused by monetary policy biased toward fighting inflation and maintaining currency stability, generous unemployment and social benefits that encouraged the jobless to stay on the dole, and penalties such as government-imposed employee-severance packages that discouraged companies from hiring.
Fed Chairman Ben S. Bernanke can't reduce the federal funds rate—the rate for overnight loans between banks—because at Friday's close of 0.14 percent it is already essentially at what economists call the zero bound. That leaves the U.S. stuck with a higher rate than is appropriate given 10 percent unemployment and the outlook for the economy, says Laurence Ball, professor of economics at Johns Hopkins University in Baltimore.
Bernanke has tried to compensate with a variety of programs aimed at spurring credit more directly, including the purchase of $1.75 trillion in Treasuries, agency bonds and mortgage-backed securities. Fed officials themselves disagree over what impact the measures have had.
Ball says some of the European policy makers in the 1980s and 1990s, including former British Prime Minister Margaret Thatcher, were "anti-inflation zealots" who kept interest rates high even after price pressures had eased. For them, "inflation is like a vampire," he says. "You can't just kill it once."
European central banks were also constrained from reducing interest rates by a need to keep their currencies stable within the European Exchange Rate Mechanism, the predecessor of the European Monetary Union and the euro, Ball added.
The high unemployment rates Europe suffered in the 1980s and early 1990s stemmed from limited labor mobility, according to a 2009 paper by economics professors Tito Boeri at Bocconi University in Milan and Pietro Garibaldi at the University of Turin in Italy. They found that mobility increased and joblessness declined starting in the mid-1990s after European countries reduced unemployment benefits and made it easier for companies to fire workers.
Labor mobility in the U.S. dropped last year to its lowest level since records began in 1948, according to the Census Bureau. The so-called national mover rate fell to 11.9 percent of the population in 2008 from 13.2 percent in 2007 as 35.2 million Americans one year or older changed residence.
One reason is a 27.8 percent decline in housing prices nationwide between the peak in June 2006 and September 2009, the last month for which data are available, according to the S&P/Case-Shiller home-price index. Millions of owners owe more on their mortgages than their homes are worth, making it hard for them to pull up stakes and look for work elsewhere without suffering big losses when they sell.
The number of U.S. homes worth less than the debt owed on them reached almost 10.7 million, or 23 percent of all mortgaged properties, at the end of the third quarter, according to a report from First American CoreLogic, a Santa Ana, California- based real-estate research firm.
An additional 2.3 million mortgages are approaching "negative equity" as loan defaults rise nationwide, the company said Nov. 24.
"The weak housing market will contribute to high unemployment," Nobel Prize-winning economist and Columbia University professor Joseph Stiglitz said in testimony to the Joint Economic Committee of Congress on Dec. 10.
"A distinguishing feature of America's labor market is its high mobility," he added. "But if individuals' mortgages are underwater, or if home equity is significantly eroded, they will be unable to move, reinvest in a new home." He urged U.S. lawmakers to use "overwhelming force" to reduce joblessness. The U.S. is also starting to mimic Europe by increasing the role of the central government in the economy, says Nobel Prize- winning economist Edward Prescott.
"There's been a regime change," he says. Taxes are likely to rise and that will weigh on the U.S. economy by reducing incentives to work, just as is the case in Europe, adds Prescott, who is a senior monetary adviser to the Federal Reserve Bank of Minneapolis and a professor at Arizona State University in Tempe.
The U.S. shares another characteristic of the eurosclerosis era: high levels of long-term unemployment. Some 5.8 million Americans have been looking for work for more than 26 weeks, representing 38 percent of the unemployed, the most since records began in 1948.
The so-called underemployment rate—which includes part-time workers who'd prefer a full-time position and people who want work but have given up looking—stood at 17.2 percent in November.
"There's reason to think we could suffer a U.S. sclerosis," Ball says. "That would be horrible. We'd have a big pool of people being left behind."