The Hedge funds and speculators that are pushing up oil prices and depressing the stock markets are in for a nasty shock when the oil price bubble bursts. Oil supply will soon outstrip demand and the resultant decrease in oil will leave many hedge funds with large losses on their speculations. It will also power forward a faster US rate of GDP growth currently at 3.5 % far in excess of what is happening in Canada or Europe.

The Wall Street Journal recently reported that the U.S. economy will perform well in 2005, according to its survey of economists' predictions, with modest but healthy growth, subdued inflation, and only slight rises in interest rates [to about 3.5 %]. Many of the forecasters surveyed were concerned about the low household-saving rate and the increasing budget and trade deficits. While a few of the economists believe these problems could create trouble in 2005, the majority sees these as long-term problems that won't derail the US expansion anytime soon. The consensus outlook of 56 economists surveyed by The Wall Street Journal was that gross domestic product—the broadest measure of economic activity—will expand at a rate of about 3.6% in 2005. If oil prices collapse GDP growth should actually be over 4 %.

This growth will be far higher than Europe’s or Canada and combined with increasing personal disposable incomes, ensures that the US economy and dollar will both increase in strength. Rising expectations in the US can be found in all areas – from jobs, to inflation control, to energy prices, to manufacturing and trade.

Jobs
U.S. businesses are expected to create 175,000 to 225,000 net jobs a month, in 2005, rising from the 186,000 average seen in 2004. Job growth will be driven by a stable economy and a slowing in productivity growth, which lets companies produce more with fewer workers. The unemployment rate should decline only slightly from the 5.4 percent registered in December 2004 or even rise, as people re-enter the job market. Non-payroll figures make job creation look even better as small start up firms, independent consultants and contractors take themselves off of payrolls to increase their net disposable incomes. It is estimated that over 2 million such jobs have been created but not counted in official payroll surveys since 2001.

Economy.com expects business to create good-paying jobs in the professional, technical and health care services, among others. Construction employment is expected to slow, along with mining and other commodity production. Average hourly earnings adjusted for inflation should rise 1.3 percent, the consulting firm says.

Oil prices will fall:
Sizable increases in supplies, coupled with consumers' desire to conserve energy in light of recent price increases, will lead to declining prices in 2005. Some analysts feel that oil prices could be in the low $30s at some point this year. Other experts such as Wachovia economist Jason Schenker expect the average oil price will be $46 a barrel this year, up from $41 in 2004. He argues that continued growth in economies around the globe will increase demand. Regardless the current level of $55 + per barrel will be reduced over the course of the year and this will help stimulate economic growth and consumption.

Inflation/interest rates
Competition should keep prices stable as rates rise as strong competition from businesses at home and abroad will prevent companies from raising prices too much. Low inflation will give the Federal Reserve room to continue to raise interest rates at a slow, steady pace, preventing a jarring rise in rates that could dramatically slow the economy. This year, economists expect the Fed's target will end the year around 3.5 percent, a level close to the neutral level. This will cause the U$ to increase in value as monies are allocated from other currencies to the higher interest rate paying US debt instruments.

Housing
Increased demand will keep higher rates from stifling sales. New and existing home sales are expected to fall slightly below 2004's record level. Home prices should rise about 5 percent to 6 percent on average, down from the double-digit gains of 2004. Housing analysts expect rates on 30-year, fixed mortgages, now about 5.8 percent, to remain under 7 percent through 2005 -- with some expecting rates below 6.5 percent. Even if rates rise faster, the market should remain solid because demand outstrips supply in many areas.

Contrary to hysteria in The Economist and elsewhere, there is no housing bubble. A market that rises 5 -7 % per year is not a bubble. Housing is a local market not a national one. Making analogies between housing and stocks is rather absurd. A variety of factors feed local housing prices and a national market has never existed for housing inventory. As well a recent study by the staff of the Federal Reserve Bank of New York discounted the idea that a national housing bubble could pop.

Dollar
The dollar has fallen 25 percent in value in relation to a basket of major foreign currencies in the last three years, according to the Federal Reserve. The decline has been larger against some currencies such as the Euro or the A$. Continued concerns about near-record U.S. trade and budget deficits and their potential effect on the U.S. economy will likely lead to more declines in the dollar this year, some economists say.

However the European and Japanese economies are weak, making the US one of the most attractive places for foreign investors to invest their money. William Hummer, chief economist at Wayne Hummer Investments in Chicago, expects the dollar will actually strengthen against the euro, in part because of the comparative strength of the U.S. economy. The expectation that the Fed will continue to raise interest rates will also lure investors who are seeking the greatest return on their money. This makes sense and combined with strong GDP and productivity growth, one should expect the $ to increase in value in 2005 improving real disposable incomes.

Manufacturing/trade
U.S. factories are enjoying increased profits and production and orders for computer software and construction machinery have surged more than 30 percent. The S&P 1000 is currently experiencing a 20 % increase in net profits year over year, comparable to what occurred in 2004. Increased profits will eventually translate into plant expansions, job hiring and more investments. As well US exports are up 30 % thanks to the weak dollar. Foreign affiliations are bringing in record profit levels for US firms and US investment in Europe is increasing at about 20 % year over year. In general manufacturing and trade are doing well and this will stimulate investment and economic growth.

Summary:
The US economy is in good shape – low unemployment, high productivity, good profit levels and GDP growth ensure higher incomes. This will be magnified when oil prices fall. If Bush can reduce the budget deficit, reform some government managed social programs such as Social Security, and collapse unneeded spending, while preserving tax cuts, then the US should be on a multi-year expansion. If the US Government and its ‘compassionate conservatives’ decide not to cut spending, raise taxes to pay for Social Security reform, and proceed with fiscal disasters such as the Medicaid ‘reform’ [$70 billion in more spending per annum], than the US economy might experience a dislocation as interest rates increase and money supply is tightened and investors worry about the escalating deficits and debts putting their money elsewhere. Tax cuts are the right answer, but you can’t cut taxes without cutting spending.

For a March 2005 TD survey with some good details on the US economy see http://www.td.com/economics/qef/usmar05.pdf
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