Diane Swonk is a senior managing director and chief economist for Chicago-based Mesirow Financial. She is also a professor at DePaul University's MBA program, a past president of the National Association for Business Economics, and is on advisory committees to the Federal Reserve Board, its regional banks, and the White House Council of Economic Advisers.
Harlan Levy: How do you rate the U.S. economy in light of the latest reports on jobs, jobless claims, housing, manufacturing, consumer confidence, and retail?
Diane Swonk: The U.S. economy is still on an uneven recovery path. It would be nice if we were running on all cylinders, but we're still a long way from home. I was recently watching The Wizard of Oz, and I feel like we're not in Kansas anymore. I think we'd like to get back to Kansas, and it's still not the case.
The good news is that some things have fundamentally changed this year from last year, and the most notable one is that home prices are rising and continue to rise, mostly because we have a shortage of housing today, and demand has come back. Put the two together, and you get a pretty accelerated rise in home prices, just nowhere near the previous peaks, but the fact that they're rising is the No. 1 issue that's a game-changer for the overwhelming majority of U.S. households.
H.L.: What's the biggest drag on the U.S. economy?
D.S.: The biggest drag on the U.S. economy is the U.S. government and state and local governments. We had a major contraction in government spending in the first quarter, which helped us fall shy of what we expected in terms of overall Gross Domestic Product growth in the first quarter.
Many of us don't realize that the deficit is falling so rapidly that the debt ceiling debate has been pushed back to the fall from the summer. That's because the government spending is not only contracting, particularly on the federal level - and many people don't realize that spending is falling both in nominal and inflation-adjusted terms - but also we're seeing a sharp increase in revenues because we have tax increases. Put these together and you do get deficit reduction with a contracting federal government. In fact, the deficit has fallen much more rapidly than anyone thought this year. We are on track to have the lowest share of GDP on the deficit since the peak of the Bush years. And we've now seen enough revenues to keep us out of hitting that threshold on the debt ceiling until much later in the year than anyone once thought.
The problem is that does put a drag on the U.S. economy at a critical time when you'd like to see a lift-off and sort of an escape velocity for the U.S. economy.
H.L.: So it sounds like you think Congress needs to increase spending on job-creating measures like infrastructure rather than embrace austerity.
D.S.: The bottom line is that in an ideal world we would backload the pain and frontload the stimulus, and the stimulus we had wasn't perfect by any means and wasn't enough. So that said, at this stage of the game I think the best we can hope for realistically is to do no harm.
There are certainly some bipartisan projects underway to deal with the sequester in a more thoughtful way. The sequester is not the most thoughtful way of cutting spending in the U.S. economy. Coming up with an actual budget this year would be something new, something we haven't done in quite a while, even if we get to a place where we know certainty in terms of tax reform, corporate taxes, and we saw some
momentum there, where we saw even incremental changes.
The incremental changes we've seen in the deficit so far add up to $2 trillion of the over $4 trillion we were looking for, so we're almost halfway there, even doing it the incremental and messy way we've gotten there. But we need to deal with some fundamental problems in the U.S. economy. If we had some certainty, that alone, and that in and of itself, even if we didn't see an increase in spending, would help to mitigate the fallout from some of what we're going to have to deal with in terms of the deficit going forward.
H.L.: What kind of growth do you expect this year and next year in the overall economy with regard to housing, and jobs.?
D.S.: We're looking at an economy that has crosscurrents in it, but at least there are crosscurrents, and it isn't all negative any more, an economy that hopefully will cross the 2.5 percent threshold in 2013 and set the stage for a much better 2014.
I'd prefer much more to see an economy growing closer to 3 percent, but I think that's going to be very difficult this year, given that it looks like growth is going to slow to the 1 percent range in the present quarter in the face of the sequester. I'm hoping that we deal with the sequester in some way to stem some of the pain in the second half so that the good things about the economy can have more impact, like the auto sector where the demand is tremendous and replacement demand has surged and the housing market where rising home prices have allowed people who refinanced to redeploy those debt savings on their housing into home remodeling and vehicle purchases.
The housing and vehicle sectors are two of the bright spots in the U.S. economy and could help to propel more strength in the second half of the year. We also have some "onshoring" going on as opposed to offshoring. Every major auto maker and major appliance producer announced plans to expand North American production in the last months of 2012. For all our faults, we are now winning the battle on manufacturing, and that is something to be joyful about, and that could see a reacceleration in growth. The question is how fast can it happen.
We need to see much more robust investment in the U.S. economy to have a foundation to grow upon. So I'm looking for a little above the natural rate of growth. It's still sub-par economic growth. It's better than we've had in several years. But if we get to 2.5 percent next year -- although it could be closer to 2 ¼ percent -- it would feel more like we're running in place or running on a treadmill rather than running on a track.
H.L.: Some financial institutions appear to be repeating risky behaviors again with their issuance of large amounts of various kinds of complex, hard-to-value bundled securities. Are you worried?
D.S.: It's something the Federal Reserve is very concerned about, and
well they should be.
The fear of the collateral damage of running systemically low interest rates for a long period of time is that you get this "reaching for yield." You get financial institutions and systemically important institutions starting to do things, particularly off-balance-sheet actions of an opaque nature that could cause big problems down the road.
So far the evidence of bubbles out there is actually pretty limited, but we're uncertain about these things.
I think it's extremely important that, for instance, the Federal Reserve is looking at bank balance sheets and testing them to see what would happen if interest rates rise, how susceptible they are to some kind of massive unwinding that could hurt us once they start to raise interest rates. These are critical things that need to be done.
The other issue the Fed is exploring and looking at is how can they use regulation to mitigate the damage of running systemically low interest rates for a long period of time where people get complacent about risks. I find reassuring the recent [poor] Sallie Mae sales on their bond issuance. That's the student loan issue out there. We now have student loan defaults of 17 percent, up from the low single digits just a little over a year ago, and that's a major upswing. We know that we have over $1 trillion in student loans, and, frankly, that understates the delinquencies, because many people are trying to extend out those student loans. The fact that the market wouldn't take that risk, to me, is one reassuring sign that we're not crazy. We don't always know bad debt when we see it, but we know one category of bad debt. That's student loans.
H.L.: Is the stock market acting reasonably now, and do you expect some kind of correction soon?
D.S: We have had more of a lumpy stock market since the U.S. economy has shown some signs of weakness, and I think that's a little welcome. With the run-up in the stock market you had to start wondering if it was sustainable.
My own view for the year was that the Dow Jones would hit 14,500. We've crossed that mark already, and I didn't like crossing it that early. Whether or not that means we will end the year a little higher than that, I think we could. That means I'm pretty comfortable where we're at right now, but not with a lot more upward momentum. But I wouldn't fight the Fed though. The Fed is a powerful momentum out there, and let's face it: One of their targets is asset prices. If people want to question the efficacy of monetary policy and the Fed's large balance sheet, all they need to do is look at housing prices and asset prices in general, which is one of the things that low interest rates impact, and clearly they're up. It has reversed some of those declines. And picked them up with momentum. You just don't want to have too much upward momentum, so I like some moderation at this stage of the game.
H.L.: Are you worried about what's happening in Europe?
D.S.: I'm extremely worried about Europe. Europe is finally coming to terms with the fact that you can go too far with austerity, that there's a vicious cycle that can be created. We've seen many of the peripheral countries actually enter full-fledged depressions. Greece has had a 25 percent contraction in their economy, and they picked up their revenue collection by finally collecting on taxes that weren't collected in the past, which was one of their problems.
It's important to understand that there is no alternative to the euro. The crisis has gone from being acute to being chronic, but it's going to be chronic for several years. It's going to take many years to fix. The reality is setting in that going too far on austerity too soon doesn't get you there, because then you get political backlash. You risk unraveling the euro, and what that means with no alternative is not acceptable.
Buying time is the best we can do right now in Europe, and trying to set policies that ultimately deal with the euro. I'd like to see the euro succeed. My fear is that it could take 20 or 30 years to fall apart. We're going to see some chronic situations for a while, but I am somewhat relieved that there's some recognition that too much austerity is the wrong answer if it creates a backlash and unravels the euro too soon.
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