Federal Reserve Bank of Chicago Economic Forecast

I covered the Federal Reserve Bank of Chicago Economic Forecast last week, where all speakers issued this refrain: “More of the same.” Key economic indicators have been stuck in neutral—the proverbial “sideways” movement—so the consensus in the room was one of faint frustration tempered by gratitude. Everyone had lived through worse.

The current “recovery” is underperforming any other in recent memory according to many measures, especially employment.

The conference was very well organized and featured expert presenters. Reading between the lines, I perceive significant opportunity that will surprise most people. After my notes of speakers’ remarks, I’ll share my thoughts on 2013’s opportunity that is evident when one regards “the economy” from a different point of view.

Everyone wonders what kind of presents we will open in 2013 (right).

Consensus Outlook/William A. Strauss (Senior Economist & Economic Advisor, Federal Reserve Bank of Chicago)

The morning started with some fun and crowdsourcing! At the 2011 Economic Forecast, as is the custom, participants, many of whom are economists, were invited to predict economic vital signs, and here is how the group’s forecast compared to 2012 (actual):

• The growth in real GDP was in-line with expectations
• The unemployment rate came in lower than predicted
• Business fixed investment started much stronger than forecast, but by the third quarter, growth had slackened
• Inventory building was initially much stronger than anticipated, but slackened as 2012 unfolded
• The industrial sector exhibited the same weakening pattern
• Consumer spending predictions were extremely accurate compared with actual expenditures
• Light vehicle sales were stronger than predicted
• ?Housing starts increased at a stronger pace than forecast
• Residential investment increased at a more robust pace than anticipated
• Ten-year treasury interest rates fell further than forecast
• The balance of trade was forecast was perfect
• ?The dollar was predicted to edge higher, but it rose even more
• Inflation came in lower than forecast
• Oil prices were higher than was expected
• The forecast for short-term interest rates was accurate
• View the slides on the Federal Reserve Bank of Chicago’s website

Federal Reserve Bank of Chicago’s 2013 Economic Outlook

A similar year to 2012:

• “Slow and steady” improvement overall
• Much slower “recovery” than normal, after “recessions”
• Continued low interest rates for “a while”
• High unemployment will continue, although it is coming down, very slowly
• Europe very worrisome; no “good news” possible, only bad or worse
• Emerging markets starting to recover, but their growth will continue lower than peak
• U.S. fiscal cliff won’t be solved, but consensus expects halfway measures

Consumer Outlook/Carl Tannenbaum (Chief Economist, Northern Trust)

Overall: moderate improvement in GDP, moderate drop unemployment, but many risks:

• Net worth stratification
• Slow consumer recovery, a long way to go
• Unemployment participation falling, yet 55+ increasing
• Consumer spending 2/3 U.S. economy, so their savings act as drag on GDP recovery/growth
• Part-time employment not converting to full-time as in past recoveries
• Employment growth, this “recovery” (1.9%) compared to “average” (8.1%)
• A lot of talk about “structural” unemployment (people who will never get employed, skills too outdated)
• Housing “affordability” never better, but many grads at home, high student loans
• Mortgage lenders very conservative, 20% downpayment the norm; people don’t have it
• Mismatch in housing stock; too much luxury/investment, need entry level
• Fiscal cliff will be dampened, halfway solution
• Tax policy uncertainty drag on capital investment
• One third Dodd Frank implemented only, uncertainty to banks
• Europe uncertainty

Automotive Outlook/Mary D’Ascoli (Economic Analyst, Toyota North America)

Auto industry much stronger than in “the boom,” when we faced significant overcapacity; see solid growth in 2013.

• Auto industry much healthier, took out excess capacity, less dependence on incentives
• In the U.S. capacity utilization 80%, 2012-2013, higher than any other geography
• Asia is very hot in demand growth, except Japan/Korea, which are flat
• U.S. fleet aging, there are few low-mileage used cars now; coupled with population growth, bodes well for robust demand
• CAFE standards: 35.5 MPG in 2016, 54.5 MPG 2025; this will pressure replacement; consumers focused on fuel economy
• Hybrid and electric vehicles
• In the U.S., we think in terms of three C’s: car, credit and confidence are key; 1st two positive, confidence not high.
• Gen Y: 46% 18-24 year olds prefer internet access to car
• 26% Gen Y no driver’s license
• There is increased competition among the top seven in the U.S.: GM, Ford, Toyota, Chrysler, Honda, Hyundai, Nissan. Market share is converging, 5%-17% (est.)

Steel Outlook/Robert DiCianni (Marketing Manager, ArcelorMittal USA)

Growth in all markets, but very tepid and unprecedented risks.

• Europe, euro breakup; it’s bad or worse
• U.S. raw steel capacity utilization recovering from 2008 trough, at 72.5%
• Manufacturing leading economy out of recession; for steel output, all sectors have recovered from the 2007-2007 troughs except nondurables; durable goods, primary metals, motor vehicles, drilling, oil & gas, machinery and fabricated metal products
• We have a theory that Q3 pessimism overdone, December upticks that go into Q1 in 2009, 2010 and 2011, so we predict a strong Q1 2013
• Mixed U.S. demand in specific sectors, slow in most
• Reshoring added 50,000 U.S. manufacturing jobs; more understanding of total cost
• China seems to have succeeded in soft landing, coming back into the market, it seems
• 1.9% GDP growth 2013, but it’s still growth

Heavy Machinery Outlook/Don Johnson (Chief Economist, Caterpillar)

Developing countries growing slowly, emerging market growth to improve over 2011-12 but not at double-digit rates.

• Machines/heavy equipment driven by economic growth and several sectors: construction, industrial production, mining
• U.S. recession unlikely for 2013; we predicted Great Recession in May 2007; using same indicators, show 2013 as being slightly positive (growth)
• U.S. construction slow recovery, not approaching last peak, but making progress
• Same for mining
• Industrial production (manufacturing/mining) 26/43 countries in our global survey below peaks, have not recovered former peak, but slow progress
• Interest rates in 15/47 countries in our survey are below lowest rates of the Great Recession; 40 countries tried to raise rates but recovery proved too weak and central banks backtracked (to more accommodative)

Energy Outlook/Loren Scott

U.S. energy industry has a new lease on life due to fracking, which has increased addressable supply of natural gas and oil.

• Shale natural gas in almost every continental state
• Very beneficial to chemical industry
• Manufacturing benefits from lower input costs
• Europeans overpaying Russia for their natural gas, but they have large shale deposits; if their governments change course (they are hostile now), it will dramatically increase supply (and price could collapse)
• Exports: converting three LNG import ports to export
• Oil: gulf and shale plays (deposits)
• [after the BP fiasco, U.S. government cracking down; very difficult to get approval to drill]
• Argentina scared off non-U.S. sources; it nationalized the Spanish exploration company
• Pipeline overview; transport of oil a problem; oil and natural gas have different regulations; natural gas easier; oil has to negotiate with every landowner
• U.S. oil production up 25% since 2008, helped tighten Iran sanctions
• U.S. stealing market share worldwide

Fracking Overview

• Each hydraulic fracking stage requires 300,000 gallons of water and 200 tons of sand, and 20-40% of fluid solids flow back to the surface as hazardous material, must be transported to disposal sites
• 60 years of fracking, no scientific cases of drinking water contamination
• John Deutch, chair of Obama’s panel on fracking: “economic benefits of natural gas production massively outweigh environmental & public health concerns”

Analysis and Conclusions

• Conventional wisdom, to say nothing of prevailing economic measurements, holds that the Midwest is dominated by manufacturing, and The Chicago Fed’s selection of speakers certainly underlined that: automotive, steel, heavy machinery and oil. Professional economists measure the economy’s productivity in terms of these “industries.”
• I’ll hazard that a big part of the “problem” is that global supply of all these industries is outpacing consumption, which pressures prices and jobs. Yes, BRIC holds the theoretical promise of growing demand for several years, but I’ll argue that China in particular will be able to drive its industrial growth to meet most of the brute demand, and its industry will accelerate past demand. Such advanced manufacturing plants as we have today require few people, are highly configurable and contribute to global oversupply and commoditization.
• G7 countries show mostly flat population levels and no growth in demand, yet supply increases consistently, from a global perspective.
• As I argue in the Social Channel, the real issue is that the Industrial Economy is waning as the engine of wealth that has improved the lives of billions of people across the world. Obviously, there are many pockets of exceptions, but our context here is macroeconomics.
• In short, I predict that things will never return to “normal.”

A New Economy

Instead, a completely new economy is developing, but most people do not see it or measure it yet. This is due to the fact that very few business or government leaders understand social technologies, how they create economic value and how they have profoundly changed the economy—so much so that it requires a new name. I call it the Knowledge Economy. It is distinct from the waning Industrial Economy.

• Having led marketing and product development at several global and entrepreneurial businesses, I have been on the front lines of trying to meet the market better than competitors. The biggest barrier for most businesses is lack of knowledge of clients’/customers’/constituents’ most profound needs, which are usually based on their specific goals. It has been a communication problem. Firms traditionally try to meet it with market research, which is expensive, slow and flawed because it doesn’t disclose individuals’ needs.
• Social technologies (Web 2.0, social networks…) encourage many-to-many sharing and drive communication costs to zero. Therefore, one of the hallmarks of the Knowledge Economy is free communication. However, it does little good until providers are flexible enough to listen and respond meaningfully.
• Consider these two symptoms of the Industrial Economy’s communication gaps:
  • It is a fact that much/most of a product’s potential utility is wasted—because users (customers, etc.) have selected the wrong product or aren’t familiar enough with its features to maximize utility.
  • It is a fact that organizations’ “innovation” track records are extremely poor (most references hold greater than 90% of innovations and product launches fail).
• Based on my direct knowledge of hightech (I include automotive and other “technology-intensive” industries here), utility can be increased manyfold through free communication, once firms learn how to use social technologies, and they transform their business processes. This will be a new S-curve and will create far more wealth than we can imagine.
• The Social Channel predicts pervasive mass customization, which will be a means to add Knowledge Economy value to users and leverage hyper-configurable, software-powered machining and delivery.
• Employment will be transformed. There is now little use for people to “screw mirrors on car doors” all day. This is painful for workers, families and leaders to accept, but I cannot imagine productivity going backward. Knowledge workers will be involved in serving people online and creating digital artifacts.
• During the 1980s, many leaders feared that computers would destroy jobs. They did eliminate many rote jobs but replaced them with even more higher paying jobs. Knowledge worker jobs will follow the same pattern. Knowledge Economy Products explores how the nature of products will evolve.
• Manufacturing and products makers will be transformed because their key value driver will shift from efficiency to continuous innovation: during the Industrial Economy, manufacturers were managed to amortize capital assets and related processes, which made innovation a dubious proposition (as it forced profound change). Knowledge enterprises can make products, but their DNA is collaborating with clients and partners to innovate continuously, and most will deliver mass customization. This will hold true for B2B and B2C businesses.
• More about how firms will create value in the Knowledge Economy is available in The Social Channel Executive Summary.