Where do we go from here?

Ryan Herzog, Ph.D. Assistant Professor of Economics

Gonzaga University06/16/2010

Prepared for Spokane Mortgage and Lenders Association

Outline• Brief Economic Overview

– Unemployment• Long-term interest rates

– Government Deficits– Monetary Policy– China– Europe– Financial Regulation

Job Creation

• Unemployment rates are stubbornly high (9.7%).– Are will missing the root of the problem?– Workers unemployed for more than 26 weeks

continues to rise.

Structural Concerns

Construction and Manufacturing

Jobs• The recession has simply magnified and sped up

job losses in the manufacturing sectors.– The construction industry temporarily provided

alternative employment. • We need to focus on retraining 7 million

manufacturing workers.• Extending unemployment compensation does

not address the structural problems.– Workers are searching for jobs that do not exist or

will not exist in the near future.• The combination of unions and the emergence of

China have made U.S. manufacturing uncompetitive.

Fiscal Policy

• The cost of current and future government deficits could amount to annual interest payments over $1 trillion.

• Who will continue buying U.S. debt, at what rate?

Fiscal Debt - Projections

Government – Interest Payments

Foreign Investment

• Foreign inflows have been into U.S. treasury securities– China: $895 billion– Japan: $784 billion– Oil Exporters: $229 billion– United Kingdom: $279 billion (threefold increase

in one year)

Overview of Fiscal Policy

• Should we be concerned about added spending?– We need to return deficits to manageable levels.– The current path of government spending will crowd

out private investment through sharp increases in interest rates.

• Where will the money come from and at what cost?– How dependent will we be on external funding?

Monetary Policy

• How long will the Fed maintain a low interest rate policy?

• Is inflation a rising concern?• What can we learn from Bernanke’s recent

statements on government deficits?

Credit Easing

Money Supply

Inflationary Concerns?

Will the Fed Raise Rates?

Are Banks Beginning to Lend?

Is the Economy Starting to Respond?

Monetary Policy - Overview

• Will the Fed be able to unwind their balance sheet before inflation risks mount?– The Fed is paying interest on reserve holdings which

will allow them the time to take reserves out of the system.

• Will the Fed be able to withstand political pressure when they need to increase rates?

• The Fed will likely keep short-term rates low for the foreseeable future, and will slowly reverse the credit easing program.

Europe and China

• Is China starting to overheat? – What effect will this have on the U.S.?– Will China be able to maintain a pegged exchange

rate policy?

• Are the EU’s struggles over? – Will we continue to see a capital flight from

Europe to the U.S.?

Long-term Interest Rates

• Bonds are still sexy (Japan’s marketing campaign) and in demand .– Stock market could be overvalued by 40-50%

(Smithers & Co.).• Long-term interest rates will start to increase in

the near future.– As foreign economies begin to recover demand for

U.S. bonds will decline.• The Federal Reserve will start to sell off MBS.

Long-term Interest Rates

• China is facing high inflationary risks, which could force them to abandon their exchange rate peg.– They will decrease their holdings of U.S. debt.

• Increased capital requirements will slow down lending (and raise rates).

• High levels of uncertainty over the short run should outweigh risks mounting from China, Fed, and financial reform.