Rain? Shine? Expect a Little of Both

As a nation, we’re long past our first offense with respect to the rule of holes: For each of the past four years, Washington has addressed our national debt with an even bigger shovel than the one used to rack up $10 trillion in debt by 2009. While many factors will shape the potential for economic growth in 2013, none seems to loom as large as the federal debt issue.

"Wealthier Americans may hardly notice" higher payroll taxes, "but millions of middle-class and low-income consumers will, and it could well rob the economy of enough spending power to send us back into recession." -Stephanie Kelton, chair, Department of Economics, University of Missouri-Kansas City

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That’s why it’s time, says Bill Greiner, chief investment officer for Mariner Wealth Advisors, to get back to economic basics: “The first rule of holes,” he says. “We need to stop digging. Gaining some degree of balance in the federal budget is the first stage, but we’re nowhere near that.”

Ingram’s invited Greiner and other economists from the Kansas City region to assess the economic landscape heading into the new year, at both federal and regional levels. What they had to say may provide some guidance for businesses trying to set strategies, but as with any forecast—for the weather or for the economy—certain variables moving at unexpected speeds can quickly alter the projections.

On balance, there is reason to be optimistic—cautiously so.

The Tax Picture

Congress just missed its December 31 deadline for resolving the fiscal-cliff considerations of tax policy, but the measures approved Jan. 2 will have the same impact, since they apply to 2013 and beyond. Stephanie Kelton, chair of the Department of Economics at the University of Missouri-Kansas City, said it was virtually assured that the cliff would be addressed—to have done otherwise, she said, would have been “the epitome of economic malpractice.”

But the issue hasn’t been fully resolved, she said: “We didn’t avoid the cliff—we just redesigned it” by ending the payroll tax holiday for 160 million Americans. “Wealthier Americans may hardly notice,” she said, “but millions of middle-class and low-income consumers will, and it could well rob the economy of enough spending power to send us back into recession.”

John Keating, an associate professor of economics at the University of Kansas, called it a “typical can-kicking, to some extent.” “Some taxes had to go up, but not much was done with regard to spending—in fact, it generated more spending, not less.” That’s not a bad thing now as the economy continues to struggle, he said, but it’s bad for the longer term. “We’ve got a two-edged sword pointed at us: On one side, we’re still not out of the grip of the recession, we’ve still got nearly 8 percent unemployment.

Historically, he noted, when there’s a bad recession, you get a stronger recovery. “Even in the Depression, where it was slow for a long time,” he said, “the fastest growth ever was in recovery coming out of the Great Depression. This is different.”

The Debt Picture

Congress, says Kent Townsend, chief financial officer for Capitol Federal Savings, missed an opportunity with its consideration of the tax rates.  “On the heels of the ‘fiscal-cliff’ is the debt-ceiling issue,” he said, “which should be addressed concurrently with the fiscal-cliff to avoid prolonged negative news out of Washington.” Congressional failure to address long-term spending and debt issues, he said, means that “the slow recovery we have had for the past two years will likely continue.”

Going forward, he said, “deep cuts on the spending side will reduce the government’s payments for many services and will reduce its contribution to the economy, possibly through reductions in staff, not unlike we have seen at the state and local levels, which will also contribute to slower growth.”

Greiner said the results of the past two elections—a Republican romp in 2010, and a status-quo election that tilted toward Democrats last fall—reflects a somewhat ambivalent electorate—it desires a government policy that is neither austere nor prolific. But, he cautioned, “People in general are done with small government, and the days of small government are behind us.” Given that, any solution to address long-term spending issues must take a balanced approach, he said, one that he expects would be crafted with a package of spending cuts that amount to 70 percent of the need, with 30 percent made up by tax increases. The chances of getting there, however, aren’t good if current trends bear out: “Keeping that ratio in mind, so far we have had literally 100 percent taxes and zero spending cuts,” Greiner said.

Kelton offered a sobering assessment for those who argue that debt-reduction is paramount: The federal government has achieved fiscal balances, even surpluses, in just seven periods since 1776, she said, and economic depressions immediately followed or were concurrent with six of those “balanced” periods. Only the 1998-2001 period avoided outright depression, for a reason: “The dot-com and housing bubbles fueled a consumption binge that delayed the harmful effects of the Clinton surpluses until the Great Recession of 2007-09,” she says.

Why does something that sounds like good economics—balancing the budget and paying down debt—end up harming the economy?  “The answer,” Kelton said, “is that a government surplus takes more money out of the economy (through taxation) that it puts back into the economy (through spending).  The result is as simple as it is devastating.”

The Regional Economy

Moving out of Washington policy and into the Midwest,  one of the biggest challenges to predicting what happens on a regional level, Kelton said, is that much of what happens at the state level depends upon federal actions. “State governments aren’t like the federal government,” she said. “As users (rather than the issuer) of the currency, they can’t afford to do what the federal government can do. So, what you typically get are beggar-thy-neighbor policies designed to pilfer existing jobs rather than create new jobs overall.  We’ve seen a lot of that over the years right here in the metropolitan area.”

Townsend said that in almost all aspects of the recovery, “the consumer has to be willing to spend and in some cases businesses have to be willing to invest.  It is somewhat of a chicken- and-egg-situation—which comes first?” If there is greater confidence in the direction of tax policy, if federal spending is reined in and if we can move into a less onerous regulatory environment, he said, that would make decision-making for consumers and business more clear.

One key factor for the Midwest economy, Greiner said, would be energy costs. A primary driver of those—oil prices—is likely to inject volatility into business calculations. GasBuddy, which tracks fuel prices at 140,000 service stations around the nation, is projecting a spike in gasoline and diesel fuel starting in March and peaking in April. The organization anticipates a national median of $3.95 per gallon at that point, as refinery output is decreased for annual maintenance and the switch to cleaner-burning summer fuel formulations. That would represent a 35 percent increase based on the $2.92 per gallon price at the pump at many Kansas City area stations early this month, before resuming the cyclical down stroke.

But how far down for the underlying oil prices? “In Kansas, specifically, I’m worried about energy prices,” Greiner said. “If we fall into an economic contraction, and we estimate a 25 percent probability of that occurring, Kansas probably stands to suffer more from energy prices than does Missouri.”

Oil rig utilization had recently rebounded to levels from the mid-1980s, he noted, “and that creates a ripple effect, an income-multiplier effect.” “And there are a lot more oil reserves in Kansas than natural gas reserves,” which themselves are considerable, so “oil prices are the key to prosperity in Kansas,” he said.

Greiner also noted that Kansas, by virtue of being better positioned than Missouri in terms of its unemployment rate, home-appreciation rates and farmland prices, has farther to fall in a downturn than does Missouri.

Reading the Tea Leaves

Given all that, what should prudent business owners and executives be doing to position their own organizations for success this year and beyond?

“Aside from the issue of confidence and having a positive outlook for future prospects,” said Townsend, “smart business owners and executives should do what they always do: Plan well and consider contingencies, look for new markets to be in and weak competitors that they can take advantage of, consider technology improvements to reduce time and costs to deliver products and focus on providing the best service they can.”

Greiner said now was the time for anyone positioned to be borrowing money to get it done. “If they’re thinking about borrowing money, they probably need to get it done fairly quickly,” he said. “If we stay out of recession the next 12 months, the fed is very—how should I say this?—tolerant of any push on upside for inflationary pressure.” So while the Fed isn’t encouraging inflation, it’s willing to accept some, along with higher interest rates, if that will generate greater economic momentum, he said.

Keating said federal health-care re-forms would continue to shape business strategy-setting. “A lot of businesses are not happy about the additional costs it brings them,” he said, “but a lot of workers probably are happy. That’s kind of small potatoes compared to the entitlement guillotine, this huge unfunded mandate.”

Depending on the business, he said, some executives should be more concerned than others, particularly in the health-care field, with so many variables yet to assert their impacts. As for inflation, he said, “I don’t expect it to be what some of the gold-bug folks were thinking. I would have gone short on gold at some point if I were an ambitious investor, but I’m not ambitious enough to roll that dice.”

Still he said, the Fed has more than doubled the supply of money that it controls, and “that hasn’t registered in the marketplace yet.” When it does? “I have some confidence that Ben Bernanke will be able to pull some of that out,” but not all of it,” Keating said. Therefore, while he doesn’t see the prospect of 10 percent inflation, there is potential, he said, for a 5 percent uptick.