Nine Reasons The Economy Will Soar By 2020

No one can predict the future with absolute certainty but many make educated projections. 24/7 Wall St. has reviewed long-term economic forecasts issued by the government, financial analysts, and academics. While they are different and not all positive, we have identified nine critical economic measures that suggest the economy will significantly improve by 2020.

Read The Nine Reasons The Economy Will Soar By 2020

The White House and the Congressional Budget Office (CBO) issue various official projections for the state of the economy, federal spending, taxes and inflation over the next decade. The projections almost certainly have flaws, as most long-term forecasts do. For example, the outlooks for spending on the military and entitlement programs are too high. Alterations in the projections yield a picture of a U.S. economy that will be robust in 2020 in terms of employment, housing, real income, interest rates and the state of U.S. trade.

24/7 Wall St. has looked at these government projections, as well as those from several organizations that include economists and think tanks. For the most part, financial forecasts issued by independent groups are less affected by politics than those issued by the government. Their projections provide more realistic measurements of the impact of government spending on the overall economy over the next five years, and how this will affect the following five years after that. Their observations are based on a fundamental understanding that 1) entitlement programs will have to change considerably; 2) military spending will decrease out of economic necessity and a less aggressive U.S. role in foreign conflicts; 3) the longevity of many Americans will change spending habits; and 4) the federal government will most likely implement effective programs to aid the housing market. This housing aid probably will provide a primary foundation for a sharp recovery in the U.S. economy.

24/7 Wall St. looked at nine specific and critical measures of economic health and forecast how each would appear in 2020. These are housing prices, real income, inflation, military spending, entitlements, unemployment, taxes, interest rates and the state of the U.S. deficit and debt. These are our conclusions:

1. Housing

Housing prices will rise sharply. Congress and the Administration have finally joined the majority of economists who believe that if housing prices do not recover, the odds of a broader recovery are unlikely. Home prices continue to fall and experts like Robert Shiller expect another two or three years of deterioration. The Administration’s first attempt to revive prices through foreclosure prevention modified only 600,000 mortgages by lowering the interest rates on them. With an estimated 11 million mortgages underwater, this is hardly sufficient. The latest plan to help homeowners probably will be successful in one form or another. It will allow people with houses worth less than their home loans to refinance at current interest rates, which are at historic lows. The program likely will be run by the Federal Housing Finance Agency (FHFA). Home prices have dropped by 50% in many markets — and as much as 70% in the hardest hit areas of California and Florida. Research firm Zillow reports that the entire equity value lost in the housing collapse is $9 trillion. Americans can no longer tap the positive equity value of their homes for present expenses or retirement. Low interest rates, combined with low prices, will stimulate demand for homes. In addition, reduced unemployment and government programs to support underwater mortgages will improve the ability of Americans to buy homes. Home prices should regain the value they lost between 2006 and 2011 because of these factors.

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2. Real Income

Real income will rise by 10%. The Census Bureau reported recently that real income fell 2.3% in 2010, putting it 7.1%, below its 1999 peak, based on inflation-adjusted numbers. This is partly due to unemployment and partly to the size of the labor force, which increased with the baby boom generation. Fortunately for workers and potential workers, baby boomers have begun to retire and most will be out of the workforce in the next 10 years. This will open up jobs for both the lowest paid groups in the economy — minorities and people under age 24 — and the middle-class workers who now compete for jobs with those older than they are. Real wages also will be helped, at least short term, by relatively low inflation. So, even small income gains will not be substantially offset by price increases. An extension of current tax credits will help stabilize incomes as the government takes a smaller portion of gross earnings. It also appears likely that Congress and the Administration will pass a jobs bill, even if it is modest. The action will put tens of billions of dollars into job creation and benefits for employers who add new workers, especially from the rolls of the long-term unemployed. Those efforts, combined with low taxes and mild inflation, will increase American consumers’ spending power.

3. Inflation

Inflation will be moderate. Inflation rates are among the most complex parts of the economy to forecast. Inflation can be imported as the costs of goods and services brought into the U.S. rise. It is also affected by monetary policy. And, it is especially influenced by the prices that businesses must pay to create products used in the consumer sector of the economy. Energy prices have been among the most critical causes of inflation since oil moved to $140 a barrel in mid-2008. The Federal Reserve, however, has put into place policies that likely will keep inflation muted for the next several years. Atlanta Fed President Dennis Lockhart recently commented that he expects consumer caution and Fed policies to keep price increases low. Oil prices have fallen by almost half from their 2008 peak, and slack demand from the largest net importer of crude — China — will continue as that country’s PMI and GDP growth slow. Lack of demand for China’s goods from the crippled EU markets will keep the need for crude in the People’s Republic modest. The price of agricultural commodities has also fallen. The production of grains by U.S. and Canadian farmers is near historic highs. The government recently released a document that said, “The 2011 bounty for the US farmer will be based heavily on exports. The USDA says Fiscal 2011 agricultural exports are forecast at a record $135.5 billion, up $9 billion from the November forecast and $26.8 billion above 2010.” Crop shortages in Russia and China have begun to ease. And, of course, the unemployment rate is expected by the Administration, Fed, and CBO to stay above 8% until 2013, which will keep consumer demand modest.

Also Read: Business Confidence Takes Another Blow

4. Military Spending

Military spending will fall sharply. The federal government has faced huge expenditures over the past three years from the wars in Iraq and Afghanistan. The total cost of the war in Iraq, which will end as the last U.S. troops leave the country on December 31, is estimated to be above $800 billion. The Afghanistan war has cost over $450 billion. The new Senate version of the federal budget contemplates defense expenses that are $26 billion below the Administration’s. That puts the Senate figure at $513 billion for the next fiscal year. Congressional planners have mentioned huge future cuts, which could involve a reduced standing military, elimination or delays in the production of expensive programs like aircraft carriers, and cancellation of the Joint Light Tactical Vehicle program. Also involved would be cuts the Army’s Ground Combat Vehicle buy, and a reduced Joint Tactical Radio Systems program. The latest CBO Budget and Economic Outlook released in August shows that defense spending will rise very slowly from $708 billion in 2012 to $714 billion in 2014. After that, the pace of total dollars spent each year is projected to rise more rapidly to $851 billion in 2020. Two things are likely to make this 2020 number lower: One is a slow rise in inflation; another is the apparent inclination of Congress to use military expenditures as a way to close the budget deficit. The number of federal dollars spent on defense is unlikely to be above $800 billion in 2020 if either of these trends takes hold over the next several years.

5. Entitlements

Entitlements will be cut. Mandatory spending is expected to rise from $2.1 trillion in 2012 to $3.1 trillion in 2020. Outlays for Social Security will grow at an average annual rate of almost 6% over the 2012 to 2021 period, CBO projects. The agency also forecasts that between 2013 and 2021, Medicare outlays will grow at an average annual rate of 6.3%, reaching $966 billion (4.1% of GDP) in 2021. These increases will be only partially offset by a drop in payments made for unemployment insurance, which should fall along with joblessness. Social Security is not a “Ponzi scheme,” as Governor Rick Perry claims. It is one of the keys to reducing the federal deficit and eventually the size of the national debt. A majority of Americans, particularly those over 50, do not favor lower Social Security spending, according to several polls. But a recent survey of so-called Millennials — the generation born in the closing decades of the last millennium — shows they disagree. Half of Americans between the ages of 18 and 29 do not believe that Social Security will exist at all when they are 67. Only 5% believe it will resemble the program that exists today. That change in perception will allow the government to slowly decrease benefits and increase the retirement age over the next decade. Lower expectations will create an electorate likely to accept the reality of America’s need to curtail entitlements as the most critical way to balance the budget. The more costly program, at least in terms of the growth in costs, is Medicare. Federal officials calculate that the program spent an average of $11,743 on beneficiaries in 2009, according to the Centers for Medicare and Medicaid Services. New proposals would provide for payments of $8,000 to retirees who would buy health insurance from private providers. The change in the expectations of younger Americans will allow for alterations like this to be made.

6. Unemployment

Unemployment will drop to 6%. The CBO expected unemployment to drop to just above 5% by 2020, and there are several reasons that this is likely to be right. The first is that the U.S. labor force will have been reduced by baby boomer retirees by then. The next is that a recovery in housing prices will spur consumer spending, which will in turn produce jobs. Government incentives to businesses to add employees will improve hiring. Programs of this kind are already being discussed as part of the jobs bill. They make economic sense because the Treasury gets tax receipts from those who are hired, which more than offsets the cost of tax credits to create jobs. The rise in productivity has been extraordinary since the peak of the recession. This has been driven in part by advances in technology. Productivity has also been enhanced by the ability of businesses to get workers to labor harder for less compensation in a period of protracted unemployment. Productivity has its limits, however. The Bureau of Labor Statistics (BLS) reported that from the second quarter of 2010 to the second quarter of 2011, output increased 2.4% while hours rose 1.6%, yielding an increase in productivity of 0.7%. That was a slowdown from increases seen during the most quarters since 2009. The natural limits of getting more work out of each worker are likely to be reached as this decade moves toward its close. That alone will help increase the number of jobs.

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7. Taxes

Individual tax will remain modest. One of the by-products of cuts in entitlements and military spending is the ability of the government to keep taxes moderate. The effects of this are compounded by the recent consensus of both political parties to keep taxes low as a means of stimulating the economy. Even once this stimulation process becomes unnecessary, America’s corporations likely will be targets of higher taxation rates, which will relieve the burden on individuals. There is a growing belief that U.S. companies have kept their taxes low by running portions of their businesses outside American borders in order to receive favorable tax treatment abroad. There is also a deep concern that some of the biggest U.S. companies have created large cash hoards that do nothing to increase American productivity and job creation. The cash balance of the S&P 500 nonfinancial companies is now above $1 trillion. That figure continues to grow as most of the large corporations in the U.S. continue to post strong quarterly results. The ability of corporations to create a balance sheet bounty is helped by the extremely low tax rates most of them pay. Washington is likely to increase the federal government’s take of this. The final factor that will keep tax rates in check is a drop in unemployment. With 14 million Americans out of work, the difference between the current 9.1% jobless rate that reflects that number and a 6% rate in the second half of the decade will add millions to the American workforce. This turns people who take money out of the system through unemployment benefits into tax payers — increasing and broadening the tax base.

8. Interest Rates

Interest rates will stay low. The Federal Reserve has kept interest rates low as a means to stimulate the economy. Mortgage rates are consequently just above 4% — very near an all-time low. Rates will stay down for the next two years or more as the Fed works to buttress any expansion. The reasons rates will remain low after that are based primarily on a need to keep GDP growth relatively high and to allow American businesses to remain competitive in a world in which most other major nations use rates as a means of stimulus. It is worth noting that because deeply wounded economies take a long time to mend, demand for money can stay relatively low for a long period. This is certainly true recently. After the shock of 9/11 and the subsequent economic slowing, the prime rate dropped from 6% to 4% in mid-2003. The figure did not hit 6% again until mid-2005. The Great Recession was such a great wound to the U.S. economy that the growth of this interest rate is likely to be very slow. There is also every reason for the Federal Reserve to be gun-shy in the future when increased rates are a possibility. Unless inflation begins to rise very rapidly, the Fed will be reluctant to be aggressive. Chairman Ben Bernanke recently said that the Fed began raising the Fed Funds rate in the spring of 1928, and kept raising it through a recession that began in August 1929. This led to the stock market crash in October 1929. In 1936 the Fed raised reserve requirements, which is often mentioned as a reason the economy faltered again in the late 1930s. Business activity will improve enough over the next decade to push rates higher, but not substantially.

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9. AAA Rating

The U.S. will get back its AAA rating. It lost the rating from S&P because of political strife in Washington, concerns the U.S. could not control its deficit, the increase in its debt and the observation that the U.S. economy would not grow over the next two years. The CBO expects the annual deficit to fall from $1.3 trillion this year and nearly $1 trillion in 2010 to an average of $250 billion in the years from 2014 and 2020. Those numbers have been greeted with skepticism because of the projected rise in entitlements and military spending, and halting improvements in tax receipts. This skepticism is only warranted if the costs of government are not addressed in any major way in the next five years, or if the economy grows at 3% or less based on GDP. A combination of aid from the federal government and Fed is likely to encourage strong growth. Lack of commodity price increases likely will keep the cost of living in America at reasonable levels. Very moderate tax rates set to ensure growth are likely to stay low. The tax base will improve due to lower unemployment. The U.S. will have its AAA rating back long before 2020.

Douglas A. McIntyre