March 31, 2011 Patrick Oliver-Kelley

For all the talk of recovery, Americans are growing increasingly pessimistic about the economy as soaring gas costs strain already-tight budgets. Obama will have to convince voters who are still feeling financial hardship that things are getting better. Obama’s approval ratings have held steady at around 50 percent over the past month. Just 15% of Americans said they believed the economy had improved over the past month. As we have repeatedly written, until there is a credible and convincing plan, the economy will continue its anemic recovery. The unemployment rate is easing slightly.

Housing data set another record low this month. February sales of new one-family homes ran at their lowest level (an annualized 250,000) since sales records began in 1963. Sales of existing single-family homes were also weak, plunging nearly 10% in February from January. Low borrowing costs are generating a bubble in oil prices and in inventory. A highly respected economist says that if oil prices limit US economic growth, it will be due to the repercussions on incomes and monetary policy rather than the scarcity of oil. It is no doubt that high prices at the pump are forcing changes in lifestyle.

Summary: Nothing can be taken for granted. The US economy is recovering, but slowly and a crisis on the other side of the Atlantic can derail it. Given the weakness of the recovery, adoption of a credible plan it address deficits over the next few years is the safest course of action. Global markets are creating their own bandwidth. The Middle East continues to threaten disruptions in petroleum supply, even as global demand is increasing. America’s recovery is getting stronger, but we must expect setbacks.

Oil: two things determine the price of oil: supply and demand, and naked fear. Our biggest risk is a serious supply disruption and even fear can send prices soaring. Libya is the 13th largest oil exporter. Lately production has fallen 2/3rds. The Middle East and North Africa produce more than one-third of the world’s supply. How vulnerable is the oil market and how sensitive is the world economy to oil price spikes? The market’s reaction to date has been surprisingly modest. Dearer oil prices can fuel inflation. And can policymakers cope? Demand for oil is getting stronger; China, India and Brazil now vie with the amount demanded by the US. The key question is how much delivery will be lost by the disruptions and for how long? None can say with any confidence. Our danger is that higher oil prices and more intense political uncertainty feed off of each other. All this is a dark cloud on an otherwise bright horizon for the global economy. A large enough spike in oil price can do great damage. Consumers and businesses trim spending and investment plans. Significantly higher oil prices may be only a matter to time.

America’s fiscal problem cannot be solved unless entitlements are tackled. Social Security, Medicare and Medicad take up ever larger part of the American budget. The chart below, shows the proportion of GDP spent on that ever growing part of the budget. By 2025, entitlements and interest will absorb all government spending. Where then is the appetite for cutting entitlements or for increasing taxes sharply?

Eurozone: A disappointing outcome will fuel market doubts about the fiscal sustainability of the most troubled euro area economies. Those doubts remain sky-high. A more fundamental rethink is needed. It may be better to bite the bullet of default, starting with Greece. Moody’s downgraded Spain’s sovereign debt rating by a notch, Greece’s by three notches and Portuguese government bonds are at an unsustainable level. These paint a wobbly picture.

German manufacturing orders rose by a greater-than-expected 2.9% in January, amid strong domestic demand, particularly for intermediate goods.

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