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Diane Swonk: Most Clients Are Worried About Inflation

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We're looking at busy week in terms of gauging the health of the U.S. economy. Monday is Consumer spending. On Tuesday, Federal Reserve Chairman Ben Bernanke testifies before the Senate Banking Committee. Friday is the all important jobs number.

I caught up with Diane Swonk, Chief Economist at Mesirow Financial, and asked her about the economic headwinds facing the country and s her outlook on the Mid East turmoil.

LL: What is the biggest risk to the economic recovery?

DS: The greatest risk is trading near-term (immediate) budget cuts for long-term deficit reduction. We need serious deficit reduction that is PHASED in overtime.

Bond markets and foreign investors can't be fooled by one-offs and political theater instead of serious austerity measures forever. The American public needs to come to terms with the fact that entitlements were not properly funded.

LL: The jobs report is coming out this Friday. What are you expecting? What about the number of individuals out of work for two years?

DS: I am hoping to finally see a jobs report north on the 150K threshold. I think that the number unemployed more than two years will easily exceed 2 million, probably closer to 3.5 million of the 15 million or so unemployed.

LL: Last week St. Louis Fed President Jim Bullard tossed out the question if the Fed should consider the global economy when implementing its monetary decisions since many countries have a dollar reserve currency. What do you think?

DS: I think the Fed played a key role in stabilizing global financial markets when the crisis erupted. Foreign banks topped the list of those using the discount window at the height of the crisis. The Fed's mandate, however, is a US mandate. They need to take into account how their actions will play out abroad only to the extent that it affects our economy.

LL: What is the biggest question your clients are asking you right now and what are you advising them?

DS: Most clients are worried about inflation. I remind them of how uneven inflation has remained, and how oil has acted as more of a damper on demand, and forced consumer to make trade offs in their limited budgets, than fire to dry kindle for inflation. I remind them of how little pass through inflation that we have experienced in the last decade.

When I ask them how much they have passed along to consumers and you see a fairly substantial break. There are those who can pass along some of the increase in costs if their clients are other businesses. Those who deal with consumers can't pass along the increases as easily or are paying the price in volume if they do.

LL: I interviewed David Wyss, Chief economist at Standard & Poor's who said oil at $148 in 2008 was one of the factors that created the recession and if oil reached that number again he would be worried about the recession reappearing. Do you think the U.S. economy today can withstand that?

DS: No, I don't think the US or much of the developed world could withstand 148. Indeed, the economy slowed dramatically and oil prices plummeted once the 150 billion tax rebate was spent in July. (Oil prices also spiked in early July 2008). Moreover, oil is an input cost for agriculture products. I can only imagine the additional inflation and social unrest emerging economies and poorer nations would suffer.

LL: Is there a specific price to oil that you are watching for when it comes to impacting the U.S. economic recovery?

DS:I don't know of a magic tipping point. I think we have absorbed at least some of the shock of rising prices thus far because it has been gradual.

I fear much of the payroll tax cut will got to pay for gasoline, and if we cross the 100-120 range and hold it, we would be running a very high risk that the economy stalls or contracts for at least a quarter, both of which would be disastrous giving the high number of long-term unemployed.

A Senior Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."

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