Headwinds for the Economy

Despite signs of recovery in the broader economy, I remain concerned about a double dip recession. First, the evidence that the economy is recovering:

Economists have steadily grown more upbeat about growth in recent months and boosted their estimates for the fourth quarter of 2010 in this survey. On average, respondents now estimate the U.S. grew 3.3% at a seasonally adjusted annual rate in the fourth quarter—up from an estimate last month of 2.6% growth. The economy grew 2.6% in the third quarter.

However, the headwinds moving against the economy appear powerful. First, the housing market has never been allowed to adequately deflate. I repeat a previous graphic on the subject:


Just as the original recession was triggered by the fall in housing prices, I believe that a double dip could be similarly triggered.

State finances are going to get worse before they get better. First, their borrowing costs are rising.

Yields on 30-year triple-A rated general obligation bonds shot higher to 5.01% on Thursday, reflecting a spike in perceived risk, according to Thomson Reuters Municipal Market Data. The last time those bonds yielded 5% was Jan. 30, 2009, during the financial crisis.

Second, attempts to raise taxes are going to be met with business flight. Illinois' massive personal and corporate income tax increases will only encourage the loss of wealth producers. The news from Illinois:

In a deal hammered out by the state's Democratic leadership, the lame-duck legislature pushed through a 67% increase in the state income tax and a 45% increase in the corporate tax.
. . . "We're saying to the people of Illinois, 'For eight years we've overspent, now we're going to make it your problem,'" said Rep. Roger Eddy. "We're making up for our mistakes on your back."

Gov. Mitch Daniels of Indiana and Gov. Scott Walker are ready to welcome Illinois' businesses to their states.


Pension problems are hitting as the Baby Boomers are hitting retirement age. State, local, school district and union pensions are all underfunded. I have blogged and tweeted about a number of these problems already. To some extent demography is the key challenge here, look at the bulge in the U.S. demographic trend. (Note that this is 2000 data, so to make sense of it, add ten years to the age.) Note that we have the peak of the boomer bulge currently in the 50-54 age group, but there are significant numbers of people retiring.


The only hope is a quick deflation of the housing bubble, followed by more spending as the properties get bought up and corporations open up their bank accounts to invest in new growth.