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The good news is that the economy is in a bottoming process right now, according to Bruce Yandle, interim dean of Clemson University's business school and professor of economics at George Mason University's Mercatus Center. Yandle is perhaps best known for having developed a theory called "Bootleggers and Baptists" to explain political behavior.
"Recessions start when the economy is at peak growth," Yandle said on a recent visit to Motley Fool Headquarters. "The peak defines the beginning of the recession. Recessions end when they can't get any worse. We're getting to the point where we're beginning to flatten out. When we're flattening out, [we're] bottoming."
Yandle pointed to a couple of economic indicators that signify the U.S. economy is bottoming: the Institute for Supply Management's services and manufacturing indices. The ISM index for manufacturing, which sharply dropped from September (at the time Lehman Brothers collapsed) to December, has begun to recover, signifying that a bottoming process is in the works. The same goes for the ISM services index. Though still erratic, the index is moving upward. A reading of 50 on either scale is neutral. A reading above 50 means the economy is expanding; below 50, the economy is contracting. While the latest readings for both indices are still below 50, they are moving back up toward that mark.
Although the economy is troughing, Yandle said it won't actually post positive gross domestic (GDP) growth until the first quarter to mid-year of 2010, which he said will be tepid at best.
The long-term trend for our economy has averaged 3.5%, and he says we could see growth below that level in the coming years. "We're not getting back on the yellow brick road," he said.
Recovery drivers: The employed and entrepreneurs will fuel recovery
Who will we rely on to fuel economic recovery? Traditionally, the consumer is the one to help our economy out of the doldrums, and Yandle says this time is no different. While unemployment is approaching 10%, and, he says, will most likely climb to that level, he points out that "employment efficiency" is still at 90%. "It's that 90% of the country that is employed that will pull us out; not monetary policy," he says.
To that end, Yandle says those that have lost their jobs will be forced to be creative, spurring innovation and fueling recovery. According to Yandle, historically following every recession, the number of entrepreneurs, or "non-employer firms" (firms that have only one employee, with the rest being contractors), increases. Currently, 75% of firms in the U.S. are non-employer firms. Yandle thinks we're poised to have the largest surge in entrepreneurs in the next three to four years as a result of government policy and people who lost their jobs.
Risks to recovery
Though the economy has gone through much of this virus, there's always the risk that another shoe will stomp on the anemic recovery. One potential pitfall is a large number of adjustable-rate mortgages (ARMs) that are subject to adjustment over the next 10 months. Depending on which direction interest rates move, those mortgages could adjust up or down.
"There's a [potentially] serious hazard out there," he said. "If those interest rates go up, then we will have another wave of foreclosure, not as serious as the last one, but serious. Along with that comes the commercial real estate part. That shoe has not dropped and is going to drop."
Yandle says there's going to be more commercial real estate-related bankruptcies than we've seen thus far, which could be triggered by rising interest rates. However, Yandle thinks that, while we'll feel some pain, it won't be of the same magnitude as the subprime collapse we've already experienced.
Financial reform and the power of the Fed
There has been a lot of finger-pointing as people seek to address the downfalls of missing the financial debacle, which has infected the rest of the economy. As a result, the Obama administration has proposed legislation to overhaul the financial regulatory framework. One part of the proposed new rules Yandle favors is that regulators will be given the authority to handle situations such as the collapse of Lehman, or wind down "too big to fail institutions" such as Citigroup (NYSE: C ) and Bank of America (NYSE: BAC ) , which would be stabilizing for the financial system.
However, what worries Yandle most about the proposed regulatory reform is ceding greater power to the Federal Reserve. "The problem here is that the Fed would become a major regulator in addition to being the central banker," he said. Should the Fed obtain these powers, Yandle worries it would no longer be independent from the political process. He worries that politicians would now be able to control the Fed and influence, or skew, monetary policy decisions according to the interests of politicians and lobbyists, not in the interest of what is best for the overall economy.
"So now we have a Fed that will be controlling wealth and the ability to produce wealth by some huge enterprises," he said. "They will become the target of huge lobbyists like never before. It's to be expected ... this is a serious problem."