Forecast 2008: Outlook for the US Economy

Includes: DIA, QQQ, SPY
by: J. Christoph Amberger

I'll be the first to admit that I was wrong. Based on the fall surge in the markets, I had pegged the Dow Jones Industrials to finish 2007 at a new record, near 15,000.

So I was off by a few hundred points…

Am I ready to commit myself to a fresh new forecast? Not quite. Not necessarily for lack of venturing spirit, mind you. But mainly because I consider 2008 to be a transitional year. Let me explain:

The way I see it, the economic momentum built up by the Bush tax cuts after 2001 will continue to last for at least another two of three quarters, the sub-prime crisis notwithstanding. Economic growth will indeed slow from the record-setting levels we saw in Q3 2007. Gradually so.

But from what I can see, we are still far removed from posting two successive quarters of negative growth. And without wanting to be a stickler for definitions, two back-to-back quarters of negative growth still are necessary to meet the official definition of "recession".

This being a year with an epoch-changing presidential election, there is the distinct potential for a strong November rally elevating the US indexes near existing or even past new record highs.
But while The Daily Reckoning's Bill Bonner may have already given you a slice of life in the year 2008, there are a few predictions that I'd like to add myself.

Dollar lows and export highs

The next couple of months will be ambiguous in regard to the dollar: Europe and Japan are highly interested in keeping the greenback from declining further — current levels have already resulted in reduced growth forecasts.

A low dollar buys less imports while making US goods more competitive internationally. In today's globalized economy, an undervalued currency and cheap labor (relative to your closest competitor in regard to quality and productivity) are money in the bank.

The loud laments about the twin deficits have subsided over the past 18 months as the US budget deficit has contracted far below historic averages based on the new-debt-to-GDP ratio. As such, we may actually see a decline in the US current account deficit thanks to the low dollar. The greenback may or may not hit rock bottom at around $1.60 vs. the euro before the European Central Banks intervenes.

Of course, a current account deficit is also an indicator of healthy domestic demand — a statement that the Germans or Chinese may wholeheartedly agree with. Due to the size of the US consumer market, and the lack of similar aggregate demand anywhere in the world, foreign manufacturers will have to face sacrificing margins for market share, so as not to lose business in the States altogether.

The low dollar will attract cross-border business to US retailers along the Canadian border, and draw millions of European tourists to the States hoping to buy goods (including European-made luxury goods) at bargain-basement discounts over what they'd have to shell out in Europe.

Inflation, Made in USA

Meanwhile, the US will have to deal with increased inflation. This is partly due to increases in resource prices due to the dollar weakness. But inflationary pressures will come to bear as Democrat state governments are giving a taste of what the entire United States will be experiencing come 2009.

Already, one-party states like Maryland have begun squeezing the American consumer by hiking consumption and income taxes. State governments all across the States will use real estate boom high water marks as the baseline for property-tax assessments to make up for predicted budget shortfalls.

This will make for a curious paradox: While dropping real estate valuations will eventually be making property more affordable to new buyers (reducing the nominal cost of living), ham-fisted and short-sighted politicos will not hesitate to make owning real estate as expensive as possible for the middle class. While nominally inflation-neutral, existing home owners (the majority) will find themselves squeezed tightly by increases on the cost of living thanks to their state governments.

Meanwhile, trouble is brewing on the Federal tax front. Notwithstanding record tax revenues, thanks to the Bush tax reform (deceptively propagandized by collectivists as "tax cuts for the rich"), the Democrat political platform is built on unheard-of increases in public spending — to be financed by a small minority of Americans.

Some analysts expect the bill for programs like the nationalization of the healthcare industry and subsidies for overpriced college tuition to translate into marginal tax rates of 50% and more for individuals. Add in increases in state income taxes, sales, and property taxes, and Americans can look forward to again spend up to two thirds of the year working for the government… just like in the good old Jimmy Carter days.

(I'll never get over the irony while that the European left — arguably the most backward intellectual force in modern history — has slowly come around to acknowledge that lower taxes translate into strong economic growth and individual prosperity, American liberals (now calling themselves "progressive" out of all things) are now advocating a return to the bad old days and failed socialist experiments of the 1970's…)

Capital Flight

The actual implementation of this suicidal tax policy will, of course, not take place in 2008. But when it does, in late 2009 and 2010, it could not hit at a worse time. Tax hikes will suffocate economic growth and domestic demand, resulting in a widespread relocation of US economic bellwether companies offshore.

(Think Haliburton (NYSE:HAL) is the only company that can say goodbye to the good ole USA? Imagine CITI (NYSE:C) moving headquarters to Abu Dhabi or General Electric (NYSE:GE) moving out to Shanghai, and you get a whiff of how history is made in the Global Economy.) Like in the Clinton Era I, there will be a revival of the necessity for individuals to apply asset protection strategies abroad.

Which will eventually deprive US markets of new capital inflows, and increase the pressure of an economy hit by the double whammy of demographic shifts and cyclical economic downward trends…