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2013 economic outlook shrouded in uncertainty

Lynn Reaser. Courtesy of Point Loma Nazarene University

The global, national, state and local economies are all poised for stronger growth in 2013, but that could go awry if Washington fails to find an answer to its looming budget and debt problems, economist Lynn Reaser told a packed room of business executives in the La Jolla Hyatt Regency on Tuesday morning.

Reaser, chief economist for Point Loma Nazarene University's Fermanian Business & Economic Institute, predicted that the political squabble will be resolved before it becomes too disruptive.

But there’s so much uncertainty about the potential outcome that she suggested that businesses should develop best-case, worst-case and most likely scenarios just in case.

“Local businesses just don’t know what’s going to happen in Washington, and many are using that as either a reason or an excuse to go into freeze mode with their hiring and investments,” she said.

John Maguire, president and CEO of Torrey Pines Bank, which sponsored the talk, added that “while people are generally feeling more positive about the economy, there’s still a lot of uncertainty about the national debt, the 'fiscal cliff,' the federal budget, taxes and health care expenses.”

Reaser said she has no crystal ball to resolve such questions.

“In fact, my floor is littered with the shards of broken crystal balls,” she joked.

Nevertheless, she offered a fairly upbeat economic outlook, with some major caveats.

* San Diego -- After hiring nearly 20,000 workers in 2012, local companies will add 25,000 more this year, fueled by projected growth in defense, housing, technology, health care and international trade, Reaser predicted. She forecast that the unemployment rate would drop from today’s level of around 8 percent to 7 percent or 7.5 percent by the end of the year.

"San Diego’s not booming, but we’re looking at continuing improvement in 2013,” Reaser said.

She forecast that home prices will grow by up to 6 percent; and more than 8,000 new housing units would be built -- mostly condos and apartments.

“One problem now is that there’s not enough inventory,” she said. “It’s a seller’s market.”

Reaser said that because potential homebuyers are still having problems securing mortgages, apartment housing is the hottest market for commercial real estate, followed by industrial space, offices and well-situated retail locations, although there are still some lingering problems with small retailers at strip malls.

Reaser warned that since 25 percent of the local economy is tied directly or indirectly to the military, the budget debate could have a huge impact on the local economy.

She noted that nationwide, national security spending is already being cut from $670 billion in fiscal 2012 to $640 billion in 2013, but it could be slashed to $580 billion through across-the-board cuts in a worst-case scenario in which Congress fails to produce a budget deal.

* Inflation -- So far, the Fed has managed to keep that money out of the U.S. economy, where it could cause a spike in inflation. But at some point in time, the money will likely filter back into the economy, where it could either spur inflation or create an investment bubble, such as the bubbles in real estate, dot-com stocks, Asian currencies, gold and oil that have periodically occurred over the past two decades.

“Federal Reserve economists say they can keep the inflation risks down and keep everything moving on an even keel, but we’ll see,” Reaser said. Her last words drew a skeptical murmur from the audience.

* Interest rates -- Projections from the Fed indicate that interest rates will remain at their current historic lows through at least 2015.

But Reaser predicts they may start rising much earlier, especially if the economy picks up. She suggests the benchmark federal funds rate, which is now near zero percent, could move as high as 2.5 percent by the end of the year, as 10-year Treasurys start moving from their current 4 percent to their historical average around 10 percent.

Carlos Michan, who heads the Strata Equity Group real estate investment firm, told Reaser after the event that he’s concerned about interest-related problems in the residential real estate market.

Interest rates are so low right now that the market has become crowded with speculators whose cheaply obtained money is pushing prices higher.

“Too much money is being thrown at properties,” Michan said.

He said he worries that another bubble may be forming in some segments of the market, which might pop once interest rates start climbing again.

Reaser said there’s no indication of that kind of bubble on the horizon in San Diego County, although she added that it does appear to be an increasing risk for some farming areas in the Central Valley.

* California -- Reaser said even though California’s naysayers -- especially Wall Street’s bond rating agencies -- continue to fear that “the state is ready to go bankrupt or fall into the sea,” the state’s job growth has been outperforming the national average, buoyed by growth in trade, technology and tourism.

She added there has been significant improvement in the state’s budget, thanks to the improving economy as well as new tax revenues generated by the passage of Proposition 30 last November. But she was skeptical of Sacramento’s current projections that the state will have $800 million surpluses in both 2013 and 2014.

“If you plow through the numbers, the situation’s not quite as rosy as it appears,” she said. “It involves tricks like stuffing money through accounts and delaying payments. But there clearly is an improvement. On the other hand, the real challenge in Sacramento is rising health care costs and unfunded health care and pension benefits. That’s the gorilla in the closet.”

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