Interview With Economist Lynn Reaser: No Recession Ahead And No Need For Stimulus

Includes: AGG, DIA, QQQ, SPY
by: Harlan Levy

Lynn Reaser is chief economist at Point Loma Nazarene University in San Diego and is immediate past president of the National Association for Business Economics. Previously she was managing director and chief economist for the Investment Strategies Group at Bank of America.

Harlan Levy: With the dismal third quarter now behind us, are we for all practical purposes at the start of another recession?

L.R.: No. The economy will be somewhat better in the second half of the year, but it won’t be robust growth. It will be slightly over 2 percent growth. The economy still has a lot of headwinds in terms of the European debt crisis, the budget deficit, and the housing overhang. However, interest rates are at rock-bottom levels. and there remains considerable pent up consumer demand.

H.L.: How long do you think the economy will stay in the doldrums?

L.R.: it should be fairly sluggish through at least 2012 as we continue to work down the leverage positions of households and work through the overhang of distressed housing,

H.L.: What should the U.S. do to extricate us from the lack of jobs, adopt the Obama plan or is that not enough?

L.R.: Short-term fixes to the economy will not likely be effective. The aftermath of the financial crisis requires some healing time, and it is necessary to address our long-term deficit situation and improve our underlying tax structure. Long-term strategies are probably going to be more effective than to try to quickly ramp up job activity.

Businesses need some certainty about the long-term path of our federal budget situation and also some certainty about what their tax liabilities will be going forward. This economy today is facing a crisis of confidence which means that efforts to emphasize the strength of our nation could be helpful.

H.L.: Some economy-watchers say that it’s not uncertainty and high taxes – fake reasons, one pundit says – but a simple lack of demand, and that more jobs is the answer. What do you say?

L.R.: Some of that is true, but a lot of the reasons we have a lack of demand is that consumers lack confidence, and businesses are uncertain about the course of policies in this country and therefore are reluctant to undertake key job and investment decisions. Also, the critically charged environment in Washington has exacerbated the uncertainty.

H.L.: What do you expect will actually be done about jobs, if anything?

L.R.: We probably will see Congress at least enact an extension of the payroll tax cut that will affect this year and maybe some additional relatively modest incentives to additional hiring. But the resistance to significant tax increases will prevent a major stimulus program, especially as Congress is charged with developing a major deficit reduction program in just the next three months.

But the U.S. economy has a natural tendency to grow. We do not need an ongoing program of various stimulus packages.

One element that would be helpful in the short term would be to adopt the free trade agreements with Panama, South Korea, and Colombia. Exports are a major trump card for the U.S. economy.

H.L.: What has to be restructured in the U.S. economy?

L.R.: First in priority, education must be restructured. Second, our process of budget decision-making needs to be restructured in Washington. We need rules so that Congress is forced to pass budgets and move to a more sustainable fiscal situation. And third, we need a total revamping of our tax system with a much flatter tax rate without various distorting tax incentives and deductions.

H.L.: Third-quarter earnings may be robust, but what are the chances that they will lead to more hiring in the absence of demand?

L.R.: Profits in part are being generated by higher demand. The economy is not growing rapidly, but consumer spending is climbing, and consumption is at an all-time high.

H.L.: Isn’t it inevitable that the growing debt problems in Greece, Ireland, Portugal, and maybe Italy as well will spread and infect the global economy with many years of recession?

L.R.: No. Each country has its own fiscal situation. That of Greece is the most serious, with a debt-to-gross domestic product ratio of 150 percent. But the Europeans are committed to preserving the eurozone and to preserving the major banks in the region. They will not let major banks fail in Europe. I think that there will be restructuring of Greece’s debt, which will bring more losses to creditors, including the banks; but the Europeans will act to shore up the stability of the European banking system.

H.L.: Who are the parties behind all the volatility in the stock market? Are they the hedge funds and other big players just bidding prices up then selling en masse then repeating the cycle?

L.R.: Hedge funds are certainly a major player. Mutual funds probably also have played a significant role, and they continues to be a very significant herd mentality on Wall Street. In addition, there have been many cases of extreme volatility due to short covering or covering other positions.

The most important driver of the volatility has been Greece. The European decision-making process is very long and very convoluted. One day we get some positive signs, and the next we get some concerns about the debt. Superimposed on that have been scattered economic reports, political events in Washington involving the deficit debate, and changes in monetary policy. Those four major sources of global economic concern have fueled the uncertainty and volatility in the equity markets.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.