W-Shaped Recovery - Nobel prize-wining economist Paul Krugman said there is a 30-40% chance the economy will dip into recession the second half of 2010. The Fed's exit plan and wind-down of stimulus money removes what propped up the economy in the second half of 2009. Retail will have another lackluster year, thanks to shoppers cutting up their credit cards. This puts additional downward pressure on the economy, since consumer spending drives 70% of GDP growth.
Bank Lending Won't Come Back in 2010 - Banks are hoarding cash to write down more toxic assets coming down the track. First, commercial real estate defaults are looming. There is $3.4 trillion in loans for shopping centers, office buildings and hotel that will roll over this year. Estimates are that 45% could default due to high vacancy rates. Losses will especially pummel smaller, community banks who avoided the subprime mortgage mess.The meltdown in small banks could be similar to the Savings and Loan Crisis 20 years ago.Second, there is 15 months worth of "shadow inventory." This means, there are enough homeowners that are in danger of defaulting on their mortgages to create foreclosures for the next 15 months. Add that to the nine month inventory of unsold homes, and you end up with a depressed housing market. Home prices aren't rising. Banks aren't lending. Small businesses aren't able to get loans, so they can't grow. Small business growth creates most new jobs. The result? Unemployment stagnates at the 10% level, possibly throughout 2010.
Dollar Decline - The dollar weakened 20% against the euro between March 3 - December 1, 2009. This trend will continue, thanks to the $13 trillion U.S. debt. Other governments, like China and Japan, buy this debt. They are lending to the U.S. to keep us buying their products. But their loans are losing value because we borrowed so much money to save the global financial system. This high debt level makes them concerned that the U.S. will let the dollar decline so the relative value of its debt is less. As a result, they are diversifying their portfolios with more non-dollar denominated assets, especially the euro. Result? Higher import prices, contributing to inflation.
The good news is a low dollar keeps the Dow above 10,000. The stock market could plummet if investors get spooked. However, as long as the dollar loses value, the stock market will regain any lost ground. The other good news with a declining dollar is lower export prices. This will spur economic growth.
Inflation Will Be Controlled - You'll hear a lot of talk in 2010 about runaway inflation. It won't happen. Federal Reserve is withdrawing stimulus spending. Fed Chairman Ben Bernanke has already started winding down many of the programs. He also outlined a plan to absorb money the Fed has pumped into banks since August 2007. As a result, he can keep the Fed Funds rate at or near zero throughout 2010. This means if you have an adjustable-rate mortgage whose interest rates resets this year, you'll probably be OK.
Bernanke said the most important role of the Fed is maintaining public expectations of moderate pricing. He said the 1970's showed us that high inflation leads to more economic volatility, as the public expects and plans for greater changes. The best prevention against inflation is to reassure the public the Fed is committed to preventing it. Once the public expects inflation, it becomes a self-fulfilling prophecy. The Fed can maintain confidence in the economy by demonstrating moderation, resulting in less extreme changes in public economic behavior. Result? Core inflation will remain under 2%.
Uncertainty Will Create Volatility - Increased economic uncertainty, like the Dubai default, makes over half of senior finance officials think the economy still runs a risk of a W-shaped recession. An October 2009 poll of more than 140 financial executives showed they are experiencing a shift in the whole way they do business. Nearly 60% say they face high or very high uncertainty now. They are buffeted by an onslaught of unexpected changes to their business, such as bankruptcies of key customers or suppliers, loss of bank loans, and decreasing demand. As a result, they are not confident of their ability to predict the future, making 60% of them reforecast their entire business every month.
This uncertainty will cause increased volatility. Gold and oil prices will rise and fall, depending on investors' moods. What it means to you - prepare for spikes in gas prices, which could translate to food prices.
