While looking into each new year, I recite the mantra of this blog’s patron saint, Peter Drucker: "Nobody can predict the future. The idea is to keep a firm grasp of the present."
The present today is more slippery to evaluate than usual for an odd reason: It is so similar to the turn of last year. Hardly anything has changed.
Interest rates are the same, near 5 percent for mortgages, near 3.5 percent for 10-year Treasurys, both expected to rise last year as now.
The lack of employment is the same, and so the dearth of tax revenue. The economy was then expected to accelerate in a recovery assumed to be under way, making the Fed’s QE1 and home-purchase tax credits unnecessary, both to expire in spring 2010.
Those expectations were wrong, of course, but are no impediment to forecasters today, who see the same acceleration under way. The economy is doing a little better now than in summer, but there is no new fuel for the domestic economy.
In fact, compared to one year ago, headwinds are a bit stronger: the big stimulus of 2009 has washed out, leaving state and local budgets exposed; and housing is clearly in worse shape, and without any prospect for helpful policy intervention.
The only two specific economic surprises in 2010: Europe fell into currency crisis, and left-wing Democrats suffered an epic rout.
This peculiar stability begs a different kind of forecast. Sometimes an absence of visible change properly reflects an absence of underlying tension (1950s, mid-1980s to late 1990s …), and other times unsustainable trends are accumulating tension at, near or past their breaking points but not yet broken. This forecast must also depart from the normal U.S.-centric approach; economic globalization is happening at a pace beyond comprehension.
There are three large-scale unsustainables in play today, and all three will rupture; however, they are so very large that each could continue to build tension for years ahead. Stephen Hawking: "Time is what keeps everything from happening all at once."
Nevertheless, we have felt foreshocks from all three, and all are linked: Europe’s currency failure, U.S. fiscal irresolution, and China’s trade manipulation and hyperbolic growth.
Europe’s currency dilemma
You can get in a nasty fight and be called a racist for saying that culture matters; for denying Jared Diamond’s insistence that we are all the same people, that only geography, resources and power matter; and for noting the durability of national and regional cultures over centuries.
We mediate the relative economics of cultures via currencies. The dreamy, one-world pretense of gold has never worked for more than a few decades, and then only among the rich, and then ended badly.
The currencies of the most productive cultures inevitably rise in value. They sell more things to others, and receive payment; as they receive payment, those who buy are less able to pay. They either buy less, or pay with currency debased in one way or another, worth less, and by that means buy less. That devaluation allows the weak to sell their own exports. Millennia-old truths.
The euro was an attempt at cultural unity where none existed. In one short decade the euro has become deutsche gelt, a continental prison that will not allow economic adjustment.
The hyperproductive Germans run export surpluses inside Europe and out, euro-gelt pouring in, to be recycled as loans to the buyers of those exports. Payments on those loans must be made in euro-gelt, which the weak have no way to earn; their exports are locked into euro-gelt prices. To be competitive, the cost of their labor must deflate, and with it their domestic assets (homes, stocks), and their ability to make payments on loans foreign and domestic.
Europe has two ways out: true union or breakup. Germany could switch to a consumer economy and a net importer from the rest of the euro-zone, and all 16 nations could surrender sovereignty and form one treasury, one tax code and one welfare system.
Ain’t gonna happen. Culture is durable.
Meanwhile, tension is building. Club Med (Portugal, Italy, Greece, Spain) cannot conceivably make payments on current debts, and must reduce the balances owed by some form of default. Their IOUs are held by the banks of the rich, who are deep into pretense that these loans will be good. Everywhere in Europe a silent calculus is measuring the cost of continuing pretense versus breakup.
The moment of breakup will be painful, but will be mightily cleansing — just as all shifts from the fantastic to the rational. The longer that Europe waits, the more expensive and disruptive breakup will be.
The U.S. deficit
Our last two presidents have been the only ones in modern times to campaign to the center and attempt to govern from a wing. Both parties have focused on their extreme "bases" in a malignant Roveism. Very odd. This country has had only one durable base: the center.
In the two months since the wing-wipeout, both parties have come to their senses, competing for the center. The left wing lost the seats this time, but the right heard the warning.
Our government has gotten more done in two lame-duck months than the rest of the Obama administration and a lot of the prior put together: tax-bracket extension, partial FICA suspension, sustained long-term unemployment benefits, ratified START, and repealed "don’t-ask-don’t-tell."
Congress-wise Joe Biden was sent up to the Hill to cut the deals, and in brutal signal told his party’s left after it was over. We have not enjoyed competence of that kind — both parties — since Bill Clinton cut the budget-balancing deal in ’93, trading pay-go spending discipline for tax increases.
Save the Clinton moment, the U.S. budget has been out of control since 1963. The entire country is worried about deficits to the point of economic paralysis, terrified for ourselves and our children. Nobody outside the Palin and Pelosi camps thinks that either wing will decide the terms, or be happy about them.
When the people are moving, politicians elbow each other to follow.
China’s hyperbolic growth
China. The all-time black box. Churchill called Soviet Russia "a riddle wrapped in a mystery inside an enigma," and China is so big, growing so fast that China itself cannot know what is happening to it.
Back to principles of trade and currencies. If you run a big trade surplus, sooner or later your currency will rise in value. You may deny, distort, contort and delay, but sooner or later, upward revaluation is going to happen.
Next, your avoidance maneuvers will have domestic consequences: You must put your wealth somewhere that it will not affect your currency, which makes you bubble-prone (see Japan … speaking of unsustainable, its 2011 budget proposes spending $1.1 trillion versus $492 billion in tax revenue, borrowing 96 percent of the rest from itself).
Then, if you peg your currency to another, you will import the other’s monetary policy: In this case, super-easy Fed policy brings to China overheating and inflation (note the reverse in Europe, in which German-driven monetary policy crushes Club Med).
Your certain-to-fail peg begets speculation, everyone trying to buy yuan-denominated assets to hold for the day that the yuan soars. That anticipatory scramble reinforces the bubble and inflation pressures. Reports from China all through 2010 describe a wage-price spiral underway.
Two laws and lessons: First, we have nothing to fear from inflation here because our wages are suppressed by foreign labor competition. China has nothing to suppress its wages.
Second, once a capitalist economy enters a wage-price spiral, nothing will stop it except a recession. The longer you let it run without the pain, the worse the ultimate discomfort; but you can run it for a long time (see U.S., 1968-1980). China’s growth has been compounding at annual rates in excess of 10 percent for 20 years, the curve steepening beyond capacity some unknowable time ago.
I have no idea which of these three unsustainables will burst in 2011, if any, or all three. Each does have so much momentum behind it that when one does break, the whole globe will feel the consequence, which will be to slow the world economy and suppress inflation.
Beyond that suppression, resolution to these three over-stressed trends will be very good news indeed. Past them, we can look forward to the next stage of global commerce, and nothing in economic history has held so much promise for the standard of living and well-being of mankind.
