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February 2011 by Nicholas S. Perna, PhD When Punxsutawney Phil did not see his shadow on February 2, the famous groundhog indicated that spring would come early (as opposed to winter lasting another six weeks). As for the economy, I think it will take another six months for conditions in Washington and elsewhere to clarify. After that, the downside risks will shrink. Towards the end of last year, the economy began looking better. As discussed in the previous issue of Perna’s Perspective, light vehicle sales are well above the recession lows. The stock market has been happy. The Bush tax cuts were extended and Congress provided an extra Christmas present by eliminating one-third of Social Security taxes paid by workers during 2011. For workers earnings less than $103,000 (the Social Security tax ceiling), this amounts to a nice two percent raise for 2011. While Santa was loading his sleigh, some economists were busy upgrading their forecasts. Then early this year, came the news that jobs only increased by about 100,000 in December -- much less than expected by the “experts.” I have raised my forecast slightly with real GDP rising a little more than 3% in 2011. This, plus the stronger finish to 2010, should be enough to get the unemployment rate down to 9% by year-end. While the Fed will hold off raising shortterm interest rates until November or December, the bond market will continue to push yields up from the unsustainably low levels reached in 2010. But back to those shadows. I am worried about several situations that could shake financial markets during the first half of the year and dampen economic activity even longer. For a number of reasons, including these issues, I disagree with those forecasters who now see four percent or more GDP growth. The new Congress has already convened. Probably the biggest near-term challenge is the need to raise the Federal debt ceiling which could come as early as March 31, according to Treasury Secretary Geithner. You might chuckle and say it could be a good thing if the federal government shut down for a while. However, running out of debt capacity also means that the Treasury cannot issue new debt, roll over existing debt and make interest payments. Chaos would surely ensue! While unlikely to get that bad, there could be some anxious moments that might make a grown man cry… The Euro Zone countries’ debt problems continue to fester. Most recently, concern has focused on Portugal. Again, I think the odds of the weaker countries going into default are quite small, but some restructurings are more likely. There could be some contagion from restructuring as fears spread to other forms of debt. In the U.S., state and local budget problems are heating up. A number of states have used all their “one time” revenue sources such as rainy days funds. The Federal Reserve has made it clear that it continued cannot intervene if the municipal bond market gets into trouble. And the Congress is in no mood to bail out cities and states. Large tax hikes and spending cuts will make widespread defaults unlikely, but at the price of keeping a lid on economic growth this year. And then there is real estate. On the residential side, plenty of foreclosures are still in the pipeline, increasing the possibility of further prices declines. For commercial real estate, there is considerable uncertainty about whether borrowers will be able to roll over the large amount of debt that comes due soon. Now that Phil has not seen his shadow, we look forward to an early spring. However, the groundhog has a less than stellar forecast track record, having been right less than 40 percent of the time over the years! Whether Phil’s record is better or worse than mine – I’m not telling. Nick Perna is Resident Economist, Members United Corporate. He specializes in economic analysis, forecasting and strategy. Dr. Perna has served as an economist for the Federal Reserve Bank of New York, General Electric and a number of major banking institutions. The Wall Street Journal and BusinessWeek have each twice cited Dr. Perna as one of the top economic forecasters in the United States. He has served as an economics professor at Williams College and New York University, and currently teaches an economics course at Yale University. In addition, he has also appeared on The NewsHour with Jim Lehrer, CNN, CNBC, the NBC Nightly News, ABC Radio and NPR’s All Things Considered.