Flapping butterfly wings concern economist

ACCORDING to The Chaos Theory, a tiny air disturbance from the flapping of a butterfly's wings in China ultimately can lead to a hurricane in Florida.

“There are events that seem very remote and inconsequential, but could in fact have far-reaching implications,” Scott Franklin said, “and as we look at 2004 and our global economy, there are a heckuva lot of butterflies.”

Franklin, in his presentation, “Economic Outlook: Pearls and Perils,” said that while 2005 “scares” him, he expects 2004 to be a strong rebound year.

“Business will continue to expand much more than in prior years,” he said. “It will be a good comeback. It won't be as substantial as it was in the 1990s. You're going to see profits grow. A lot of companies, as their profits have grown and they have cut expenditures, now have internal sources of cash to finance projects.”

He said three major decision-makers will drive the American economy in 2004: households, which account for 67% of all spending in the US; the government; and business, or private sector.

He said that despite an increase in unemployment to 6%, consumers continued to spend throughout the recession, which he described as “very unusual and baffling. While the recession ended in November 2001, there has not been a huge gain in employment since, he said. Some analysts are saying the villain is productivity, but he believes that's unfair.

“One out of every three jobs in the private sector could be outsourced or offshored to Asia,” he said. “That could have an incredible impact on US employment and the ability of the consumer to spend. It's not just call-center folks with American Express. It's skilled engineers, architects, accounting firms. I predict that there will be some sort of tax incentives for companies to keep jobs in the US.”

He said that government statistics are sometimes misleading. For example, although the unemployment rate has dropped to 5.6% in the past few months, “that doesn't mean that there are more Americans employed. It means that there are discouraged workers who are no longer looking for work. I pay more attention to the number of people employed. President Bush said he wanted to see two million jobs created in 2004. I think that's rather modest. I think we'll do better than that.”

The other side

So much for the pearls. On to the perils:

  • Consumer debt could be a factor. Low interest rates allowed people to buy homes who normally could not have afforded it, and he said many were taking out three-year ARM loans at between 2 and 2.5%.

    “If there is a spike in interest rates, you'll see mortgage delinquencies go up and people pressed on discretionary spending,” he said.

  • State and local taxes have risen by an average of 14%.

  • Health-care premiums have skyrocketed, and companies are passing that on to their employees.

  • There was 4% growth in the fourth quarter, but not a corresponding increase in jobs. He said in the future, higher-than-normal growth will be needed to create the same number of jobs.

  • A $521 billion deficit.

    “One thing you'll hear is that it's not the size of the deficit that counts — it's the percent of GDP of national income,” he said. “That's true. Right now, debt as a percentage of GDP is 5%. US dependence on foreign capital is a big issue.”

  • There won't be any substantial increases in short-term interest rates in 2004, mainly because “the economy is so precarious. When they do come, they might be of the 1/4% variety, rather than 1/2%.”

  • Trade policy.

    “We are running a $40 billion deficit,” he said. “One of the biggest culprits is China. But before you blame the Chinese government, that trade imbalance comes from multinational corporations that have put their manufacturing platforms overseas and are shipping back to the US. American companies are locating there to take advantage of inexpensive labor. I don't think the trade imbalance is ever going to become slimmer. It's due to the fact that exports have fallen $85 billion in the last two years.”

  • Protectionism.

“When George Bush announced in 2002 that he was putting tariffs on imported steel … it wasn't a great idea,” he said. “More American jobs were lost because of the steel tariffs than were gained, because so many large end users of steel took their fabrication operations offshore so they could escape the tariffs. I think in a global economy, you need a long-term perspective.

“One of the disadvantages is that we produce everything. Really, the only things we have to import are some agricultural products that can't be grown in the US. But at the same time, you can't panic and put on tariffs. There are countries in Asia and South America that, without their own government intervention and without doing anything illegal, can outcompete the US. They have inherent competitive advantages. It might be due to incredibly low labor costs or lax environmental regulations. We have to swallow it and realize if we want the benefits of international trade and the ability to export, we have to import also without reductions.”

Franklin said that 2005 “scares” him because he believes interest rates eventually will go up.

“I think that's going to hurt consumers,” he said. “They have a lot of debt. The deficit, in terms of being able to attract foreign currency, places us in a vulnerable situation. If the US Treasury goes out to sell 10-year bonds at 4% and ends up having to sell them at 4.75%, that's going to be reflected in the rest of the credit market and will quickly find its way into product costs and inflation. I just don't see anything at the federal level to indicate that they're going to try to harness this in. If there's some reform on tax cuts, that may help. But if not, I see that as a tremendous problem. The other thing I see is trade retaliation against the US for some of the things we've done in the past. Third World countries are not happy.”

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