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Matthew Adams: Expanding on UCSB Economic Forecast Project

Global perspective adds depth in looking at future growth and expectations

The UCSB Economic Forecast Project’s annual summit was yet another wonderful success featuring presentations from Andrew Ross Sorkin, Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis, and UCSB’s own Dr. Peter Rupert.

Matthew Adams
Matthew Adams

Each speaker covered a range of topics, and the audience was offered informed opinions on the future of the financial system, the impact of ongoing regulatory reforms, economic growth forecasts, inflation expectations and much more. However, as someone who spends most of their day researching investments, I would have enjoyed learning more about their global perspectives as well. For those who were also craving some international forecasting, I’ve highlighted a few key elements below.

As the director of investments at Mission Wealth Management, I found their forecasts to be overall very close to our own in terms of national and local growth, employment and inflation. In particular, I agree with both Kocherlakota and Dr. Rupert in terms of their forecast for roughly 3 percent Gross Domestic Product growth and their forecast for elevated levels of unemployment persisting in the 8 percent range this year.

However, even though last Friday’s report brings good news showing 244,000 jobs added in the month of April, it is still not enough job growth to significantly lower the unemployment rate by year end. So long as there is an elevated unemployment level in the United States, I agree with Kocherlakota that core inflation (excluding food and energy) is likely to remain in the 1 percent range this year and next. Further, given the Federal Reserve’s dual mandate of promoting maximum employment and price stability (2 percent inflation), Fed policy is likely to remain quite accommodative, in my opinion.

Sorkin’s historical commentary on all financial meltdowns ultimately being a “debt” crisis in one way or another was especially poignant. Our research partners project that the U.S. government runs a fiscal deficit this year alone of $1.35 trillion. The cumulative federal debt is now well more than $14 trillion, and according to our sources, that cumulative debt is likely to balloon to nearly $23 trillion by the end of the decade. Given the amount of sovereign debt circulating in the financial system, Sorkin’s comments about all crises being “debt driven” resonated deeply with the audience.

Kocherlakota defended the Fed’s actions during the financial crisis of 2008-09 and spent considerable time exploring the monetary policy benefits of cutting the discount rate to nearly zero as well as the Fed’s policy of “Large Scale Asset Purchases.” Large Scale Asset Purchases is financial jargon for the strategy of buying predominantly Treasury bonds and expanding the balance sheet of the Federal Reserve via Open Market Operations — essentially, printing money.

By buying Treasury bonds, the Fed can increase the price for Treasury bonds and by extension suppress interest rates. With interest rates artificially low, economic activity will be further stimulated. Kocherlakota summarized the reduction in short-term interest rates and Large Scale Asset Purchases as having created an environment similar to a hypothetical one where a negative 2.5 percent interest rate would exist. Since a minus-2.5 percent interest rate is impossible (can’t go below zero — wouldn’t that be nice?), the Fed creates this extra stimulus by buying (mostly) Treasury bonds.

Although I am not in a position to disagree with Kocherlakota’s calculation of the hypothetical minus-2.5 percent interest rate, I am familiar with the research surrounding the Taylor rule, which suggests how much monetary stimulus is appropriate at any given time in an economy. Our research sources not only calculated where Fed policy placed us during the 2008-09 period, but also what would have been necessary via the Taylor rule to fully stimulate the economy at that time.

By our calculations, the economy was in such distress that a hypothetical short-term interest rate of minus-4 percent to minus-7 percent is/was necessary to fully invigorate the domestic economy. Believe it or not, the Fed may not have gone far enough to pull us out of the Great Recession. When asked what would have happened had the Fed not intervened aggressively in the 2008-09 meltdown, Sorkin shared an unofficial estimate from a Fed employee he interviewed that unemployment would have skyrocketed to nearly 25 percent to 30 percent, with firms such as General Electric having been merely days away from financial collapse themselves. Truly an environment reminiscent of the Great Depression, indeed.

So how does one invest in the environment that we find ourselves today? In my opinion, it starts with the realization that not all economies are faced with aging demographics, high unemployment and massive amounts of debt. The balance of power has shifted dramatically over the past decades, and we now find investment opportunities abroad in countries such as China, India and Brazil. Economic growth rates in these countries are expected to be in the 5 percent to 10 percent range this year, and on balance these emerging markets have far less debt and have far more compelling growth stories ahead of them.

Should there have been just one additional item covered by the forecast, I would have enjoyed to have heard their global economic forecast and how the United States, and Santa Barbara in particular, could leverage this phenomenal growth overseas further. Our belief is that the investment opportunities abroad may be used to leverage the growth of faster growing countries.

If you’re interested in discussing this topic further or would like a review of your investments, contact me at .(JavaScript must be enabled to view this email address).

Matthew Adams is the director of investments for Mission Wealth Management. Click here for more information.

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