It's a 'Murphy's Law' economy

The Baltimore Sun

NEW YORK - It's all too clear that the economy is in a rough patch. The dollar's weak, energy and food costs are high, the stock market is down, oil is at record levels and housing values have lost years of gains. What's next?

Marshall Loeb, MarketWatch senior columnist, recently interviewed Irwin Kellner, chief economist for MarketWatch and distinguished scholar of economics at Dowling College in Oakdale, N.Y.

In a few words, Irwin, please describe our current economy. For example, a few years ago, when everything was going well, experts dubbed it the "Goldilocks Economy" - not too hot, not too cold, but just right.

Well, you can call it the "Murphy's Law Economy" - if anything can go wrong, it will.

Are we near a bottom?

We are bumping along a bottom. But it is really amazing that bumping along a bottom is all that's happened, given the one-two punch that was doled out to us. I am talking, of course, about the bursting of the housing bubble, and the resulting credit crisis from the securitization of the housing market - packaging mortgages so they could be resold to investors.

But I don't think the housing market has bottomed. Housing prices have farther to fall. For example, South Florida can go down another 10 percent to 15 percent, as can Las Vegas, Arizona and the whole state of California.

What other consequences will the continuing housing decline have on the broader economy?

All this is affecting the consumer. Falling housing prices dissuade builders from building, and they affect individual perceptions. People are feeling less rich than before because their homes are worth less.

This will take another one year or more to unwind.

Meanwhile, what other forces may give some strength to the economy?

What is offsetting the housing slump is spending by business on technology to make its operations more efficient and lower costs. But the resiliency of the U.S. economy in the face of the housing bubble is amazing. It is a testament to the Federal Reserve for doing such a good job at dealing with a difficult situation.

But for every action, there is a reaction. The Fed has flooded the economy with money, and this has depressed the value of the U.S. dollar. This boosts inflation.

Inflation is no longer well-anchored, to use [Federal Reserve Chairman Ben S.] Bernanke's term. This is going to be felt much more today than it was in the 1970s, partly because of how companies interact with their employees. In the 1970s, companies were willing to pay their employees a few percentage points more to beat inflation. But today in the era of downsizing and outsourcing, this has not happened.

What is your forecast for U.S. economic growth? On Christmas Day, will the economy be higher or lower than it is today?

My prediction is the economy will be growing at the same rate as today, about 1 percent. I don't see what will push the economy higher. We will still be under pressure from similar forces that won't be completely worked out yet. We have to take into account rising energy prices, which act like another tax.

What should our energy policy be?

We need a policy that takes our reliance off oil. Clean coal plants are one suggestion. There is also a slew of other alternatives: geothermal, solar, nuclear, and even a hydrogen car is being made.

Government should give incentives to entrepreneurs who are experimenting with new, clean technologies. ...We have moved to too much dependence on oil and too many geopolitical problems.

How do you think the stock market will perform in the next six to 12 months?

The market hasn't fully discounted the hit to corporate profits that the one-two punch has dealt. ... But, at worst, I believe the Dow can sink another 5 percent to 10 percent or so from current levels. At best, it will stay flat, always looking over its shoulder for bad news. We will continue to have plenty of days when the Dow is down 1 percent to 2 percent, and then up the same amount.

How about individual asset allocation? How should the intelligent investor allocate his assets?

I've always believed that a person should have the same amount as his or her age invested in fixed-income securities. And by fixed income I mean government bonds. If you are aged 70, you should have 70 percent of your wealth invested in bonds.

What effects do you expect the national elections will have on the economy?

I believe the differences between the candidates in this election are as great as the differences between conservative Ronald Reagan and liberal Jimmy Carter in 1980.

Historically, the economy performs better when a Democrat is in the White House than when a Republican is president.

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