Harlan Levy: Are we - the U.S. and Europe -- headed for a bad recession in the next four or five months?
Andres Carbacho-Burgos: We don't believe the world is headed for significantly slower growth compared to the previous two years.
Regarding Greece, we're more optimistic than some, but we still have a roughly even probability for Greece exiting the euro. The timetable of a Greek exit has been set back by the Greek elections, particularly if there's no change in the existing bailout agreement. But for the next couple of months you're likely to see Greece getting just enough money to keep the government and its banks running. By running I mean keeping them open. You're still going to see substantial job and wage cuts for the Greek government, and you're not going to see the Greek banks doing any significant lending. At least for the next several quarters the unemployment rate in Greece is going to edge up. A lot depends on how high the unemployment rate peaks. If it's high enough, you may see a change in government like in Argentina.
Our baseline forecast is that Greece muddles along for the next year or two in a deep recession.
H.L.: What are the chances that the euro zone leaders can fix the zone's toxic sovereign debt problems and keep the euro zone alive?
A.C.-B.: Technically they have the tools available. They just need to change the European framework so they start issuing euro bonds and have a greater fiscal union of the different countries. Yes, that would include putting some of the basket cases like Greece on permanent life support. The real question is whether the core countries have the political will to bring about this change and whether they do so rapidly enough to prevent Spain from exiting. If Spain exits, that's the earthquake right there.
Basically, I think they will continue to bail out Greece and Spain, but they won't do enough to improve the job situation in either country, so the real question is how long can the electorate in both countries accept things as they are now and whether or not Germany and France can put together a better fiscal arrangement for the euro zone before the political situation in Greece or Spain becomes untenable. At this point we think they will be able to do it, but the clock is starting to tick away. The deadline is probably by the end of this year when they need to have made significant progress to get a semi-permanent fiscal arrangement that does not involve emergency bailouts.
H.L.: Will they do it?
H.L.: How do you rate the U.S. economy?
A.C.-B.: Our assumption is that Europe muddles through and does not experience a major financial earthquake. So for the euro zone as a whole you get a moderate recession that will pull down U.S. exports but will not generate a financial crisis in the U.S. Overall, that translates into slower U.S. growth, particularly since the emerging markets countries, particularly China and Brazil are also experiencing slower growth at this time.
We had to push down our U.S. forecast over the last six months. But we're still predicting a rate of 2.2 percent for this year and around 2.5 percent for 2013. It's only in 2014 that we expect growth in the U.S. to accelerate as Europe starts to climb out of recession.
H.L.: Will the stock market continue to be so volatile?
A.C.-B.: The stock market will be volatile, because it's defined by short-term news, but we're not predicting that there's going to be any major stock market collapse. We would be surprised if the S&P 500 went below 1,300 for any extended period of time.
H.L. What's ahead for housing?
A.C.-B.: We believe that the overall U.S. housing market has reached a bottom. There have been enough distressed sales now, and the remaining distressed sales over the next year or two will not put pressure on U.S. home prices as a whole.
H.L.: What areas of the U.S. economy do you like
A.C.-B.: Particular sectors of the U.S. economy that have been recession-proof because demand has been steady include the healthcare industry and higher education. There are exceptions, but private universities on the whole, and a significant share of state universities are doing fairly well.
H.L.: What's unhealthy in the U.S. economy?
A.C.-B.: Manufacturing started to recover but is facing a year or two of slower growth because of recession in Europe and slower growth in emerging markets.
Second is state and local governments. Local governments face much lower property values. State governments face lower tax revenues than they did before the recession, around 2008, and both have had to cut spending and staff substantially. That's one of the main drags on the U.S. economy right now.
The third drag, which is more regionally concentrated, is financial services. Some financial centers like New York City are still doing very well. Fairfield County and Hartford in Connecticut are doing badly because of uncertainty over Europe and also because there is still a trend toward relocation away from the Northeast. That's part of the reason why insurance carriers in the Northeast have been downsizing, relocation, notjust recession.
H.L.: What do you think of the jobs trend?
A.C.-B: In the U.S. it's been growing at a fairly steady but unspectacular rate, and of course it slowed somewhat in the past three months, so, in part because of the slowing we don't think the U.S. will return to its pre-recession peak until 2014.
H.L.: What has surprised you?
A.C.-B.: I'm concerned about how unstable the federal budget process is, in particular because we have the Bush tax cuts, whether or not they'll be extended, the trillion-dollar year-end automatic budget cuts, especially to defense, and the debt ceiling. All three of those potentially huge traffic accidents we must be very careful to avoid over the next 12 months.
H.L.: Do you think we will?
A.C.-B.: Our baseline assumption right now is that the Bush tax cuts will be phased out for the upper 1 percent and that Congress will avoid any bump into the debt ceiling and allow it to rise by the February deadline. Also, by the end of this year, Congress will put together at least a legislative package that will avoid the automatic cuts for at least the next six months or a year. In other words once again they kick the can down the road.