- 2009 Predictions

A few months back, I was asked to submit some testimony on what I thought the impact of the financial crisis would be on the NJ economy, for the legislature's Labor Committee. So far I think it was pretty much on the money, and the things that haven't already happened are all looking to occur this year. But more than just a statement about the financial crisis, it's a comment on the broader issues surrounding the NJ economy. This has attracted some small attention because of Bill McGurn's piece in the Wall Street Journal calling New Jersey a bad example to follow. If Obama does follow it, then I suppose we can expect something similar to this on a national scale as well.


The broader US economy is much more diverse than the economy of NJ and that will mitigate some risks while causing others. NJ has no auto industry to bail out. But while the numbers may differ slightly I think the broader effects will all apply on a national scale, so this is now my prediction for the US for 2009 as well.

Here again is that piece:


Testimony Submitted 9/22/2008 to the Labor Committee of the New Jersey Legislature:

My name is Tom ------------ and for the last 19 years I’ve been employed as a quantitative analyst and portfolio manager in the financial services industry. I started my career at JPMorgan, but for the last 11 years I’ve been working for multi-billion dollar hedge funds like ----------- and ----------. Much of my work has been dedicated to developing an understanding of market crises like the one we’ve recently witnesses, and I hoped it might help to offer the perspective of someone who makes their living dealing with circumstances like this.

As you can imagine, there are many questions about what the effect of this crisis will be, but some aspect of our economic future are already set is stone. So I’d like to take a moment to tell you about some of the more certain consequences of our current circumstance, and how they will change the economic condition of New Jersey in future weeks and months.

In a few weeks, a plan will be put in place for the federal government to take on a large portion of the devalued bonds that were the initial catalyst of this crisis. That will greatly expand our national debt. The current package approved by the government is for 800 Billion, so that can be thought of as a minimum. Further insolvencies might push it substantially higher than that before the crisis is over. This makes our national debt so large that the politically viable alternatives for either political party to deal with it begin to diminish dramatically. In the end they’ll have no choice but to embrace the “Japanese Solution” which is to dramatically inflate the currency and to hope for economic growth.

This will affect the New Jersey economy in several ways. First, to raise the 800 billion dollars they need, the federal government will issue Treasury bonds, and that will cause interest rates to rise for everyone. So it follows that the cost of borrowing money for the state government will be much higher than it has been in the past. Thanks to rising costs for government labor, a massive unfunded pension liability and other heretofore unaddressed expenses, the balance sheet of New Jersey’s state government is already in strained condition, and significantly higher interest costs will push it close to its limit.

New Jersey will also be dramatically affected by the cutbacks in the financial services industry. Even if further failures are prevented, estimates of the total number of unemployed for the greater New York area are already in the hundreds of thousands. The financial professionals who will be unemployed spent a great deal of money to support doctors, car dealers, contractors, stationary stores, restaurants and other businesses. A significant part of New Jersey’s total economy was driven by financial services and all those who provided them their services will also feel the pain. It’s not just some fictional “fat cats” who will bear this burden, but everyone.

The combination of the strained balance sheet for the state and the dramatic drop in tax revenues from high unemployment will almost certainly bring the New Jersey’s credit worthiness into question. In the past New Jersey’s made great use of the very same tools and products that have just blown up in the Mortgage market’s face. Bond insurance and Credit Default Swaps will no longer be viable tools for reducing the states interest payment’s on its debt and with the states credit worthiness in question, New Jersey’s cost of borrowing will rise even higher.

In the meantime, economic activity in New Jersey will slow to a crawl. Thanks to the high taxes and heavy handed regulation already in place, New Jersey already has a higher unemployment rate than the rest of the country. But the contraction of the financial services sector will strike New Jersey directly, and will make conditions in the state much worse than the country in general. Nationally we’re headed toward a recession. And with the present policies in place I would expect the unemployment statistic in New Jersey to reach 11% or 12% at a minimum. If any new “anti-business” regulation is added or taxes are increased, then it will likely be even higher. Either way, since current policy will cause the economic recovery to take longer here than elsewhere, the most productive members of the population will leave in large numbers as they abandon New Jersey for jobs in the low-tax, pro-business states in the west and south. In short, with the present policies in place, ours will be a deeper trough, and a slower climb back than most other states.

I referred to the unemployment “statistic” a moment ago because I would expect real unemployment to actually be much higher than that. Roughly 280,000 people in New Jersey work “off the books” either because of a lack of legal work status as immigrants, or to avoid the minimum wage laws and other obstacles to low income employment that government’s put in place. These people don’t show up on any employment statistics, but they represent such a large “underground economy” in New Jersey that the effect of their absence will certainly be felt. I would expect productivity in the construction sector in New Jersey to fall 80% at a minimum, and for a similar percentage of the foreign nationals working in New Jersey, to simply return home as rising prices and high unemployment make conditions here more closely resemble those in the countries they left behind. This loss of population will also affect the demand for housing, so the resale of existing homes will likely drop as well.

In the meantime on the national scale, all prices will begin to rise dramatically as the government allows the currency to inflate as a means of reducing its debt. In the hope of generating economic activity, the fed will push short term rates to new lows, but indecisions about the future and the threat of additional regulation from government will counter the effect and keep economic activity and confidence about the future low. Productivity will fall, and the economy will slow and eventually begin to contract. A national recession under the next administration is a foregone conclusion.

While all of this takes place, the most economically and historically ignorant in government and the media, will be demanding that government “Do Something!” They’ll be presenting this as a failure of capitalism or claim that it was caused by deregulation; neither of which is true. Operating from a position of complete ignorance of history and economics, they’ll be demanding a “New - New Deal”. They’ll call for policies with the intent of “helping people” but in reality they will be ensuring that those same people remain unemployed, and that the economy goes into freefall.

It won’t occur to them that they’re contradicting to the academic consensus that the policies enacted in the 1930’s made the depression much worse than it could have been. They’ll remember the myth that it solved things, rather than the reality that it actually made things worse. And because of that ignorance, they’ll demand new anti-business policies that make them feel better about themselves, but which really cause greater harm to the very people that they want to help. And while each political party will certainly be busy blaming the other as the “one who caused all this”, it’s already clear that it was policies endorsed by both parties which actually created the cause of this crisis.

So if a “New - New Deal” will cause more harm than help, what’s the State government left to do? Without command and control economic policies and fixing wages and prices like Roosevelt did, what options does the State have left for improving conditions of its citizens?

Well ironically New Jersey is one of the few states that actually has the power to cure locally what was caused for it nationally. And the answer is its unusually high tax rates. Every state in the country is about to see a period of rising prices, higher interest rates, and slower economic growth. The result will be a reduction in the “standard of living” across the entire country. But if the state legislature could seize this moment to adopt a pro-business, light regulation and low tax economic policy, the pain of the coming economic contraction could be kept to a minimum for everyone. With cuts to tax rates and to government spending, New Jersey will become an economic lifeboat in the sea of financial troubles. And when the trouble has past and the economy begins to grow again, New Jersey will be a clear leader in the next economic expansion. By seizing this opportunity the New Jersey legislature could create an engine of unprecedented wealth creation, and make New Jersey the envy of the nation. Or it can reduce its remaining citizens to bread lines and welfare roles, while it’s best and brightest flee.

This financial crisis will create great challenges for everyone. But we aren’t powerless. New Jersey’s future can either look like Monaco, or it can look like East Germany. Low tax pro business polices will lead to one future; high tax, strong regulation policies will lead to the other. At this point we can either learn from history, or repeat it. There is no third choice.

Thank You.