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Why Unemployment Will Remain High For Years (Parts I and II)
Part I
(This is included for those who didn't read Part I on Wednesday. To skip down to Part II, click here.)
There are 15.1 million workers unemployed in America (U-1). Another 9 million are working temp for economic reasons, and another 2.5 million are marginally attached or discouraged from the work force (U-6). That is about 26.6 million people in trouble. We can argue about the "true" number of unemployed but for the purpose of this article, the fact that it is high under any measure is sufficient.
The labor participation rate, which shows what percentage of the workforce is engaged in employment, has been steadily dropping for ten years:
It hovered at about the 60th percentile for many years (1948 to 1970) and then it took off in 1970 and peaked at 67.1% from 1997 to 2001 when it started declining to its present level.
Thus, it seems that we have been going backward for the past ten years after rising rather steadily for 30 years.
What has happened during the past ten years? We have experienced two business cycles as a result of the Federal Reserve's money manipulation. The Dot com boom result in the Dot bomb bust of 2001 to 2004 and stubborn, but moderate unemployment. In our current cycle, unemployment has risen sharply since late 2007. These two unemployment cycles have lasted longer than any other Post-WWII cycle. This chart illustrates the problem:
Note the duration of the brown line (2001) and the red line (2007). Just from looking at this chart it is obvious that these recent cycles have been more difficult for the government and the Fed to "stimulate" into jobful recoveries. The depth of our current recession is unprecedented for the period following WWII.
The Big Questions: Why does unemployment persist? What is different about this cycle that makes it worse than others?
One answer is that many jobs created during these booms aren't coming back. Another answer is that a lack of "real capital" will hinder robust job growth.
The Dot com boom tricked those involved in it that they were experiencing a "New Paradigm," or a world where profitability mattered less than "concept," where buzz meant more than feasibility. Tremendous amounts of capital poured into dubious companies. The Geek Moment was at its all-time high, and they poured into Silicon Valley to make their overnight fortunes. That ended as soon as Alan Greenspan wrote "irrational exuberance" on the blackboard 100 times. What had made sense during the heat of the moment didn't look so good when the Fed's juice ran out. It was like a game of musical chairs, but in this game half of the chairs were taken away when the music stopped. Those jobs disappeared never to come back. Just look at the brown line again on the spaghetti chart: it took 47 months for employment to get back to positive job growth.
The Crash of '08 was the biggest credit bubble the world has ever seen. New Fed money flows somewhere during booms and this time it was into housing. It was so vast that the spillover poured into commercial real estate, leisure and hospitality, autos, consumer goods, and student loans. As we are finding, this boom spread to most of OECD economies (Organization for Economic Cooperation and Development, comprising 34 of the world's more prosperous economies). Fake wealth from new credit instruments spread worldwide as investors jumped lemming-like into the pool.
Credit bubbles never last. When the frenzy created by easy money starts to spin out of control the Fed regains some sanity and stops "printing money" by raising interest rates. Then things fall apart. This is the inevitable bust phase of the cycle.
This time we were hit really hard since the Fed's monetary expansion was immense. All jobs related to residential real estate have been severely impacted: workers in the construction industry, building materials jobs, developers, real estate salespeople, escrow and title workers, the real estate finance sector including home mortgage brokers, banks that financed mortgages, high-end employees in structured financing departments in very large banks, investment houses, and hedge funds. The spillover wealth effect of the boom that had pumped up the auto, retail and leisure, and hospitality industries, hit these industries hard in the bust phase.
We all understand this effect of economic busts: businesses go bankrupt or cut back, workers are laid off, and banks suffer huge losses. Then things are supposed to get better, and after some passage of time we continue growing. But that isn't happening and hasn't been happening for the past ten years if one measures employment and the labor participation rate. I don't put any faith in traditional measures of economic recovery by the NBER, the arbiter of when recessions start and end. I don't accept that there is a "recovery" when unemployment is close to 10% of the workforce.
The reason employment has been declining for the past ten years and what is significantly different from past cycles is that these boom-bust cycles have been destroying real capital on a massive scale.
The perceived prosperity of the boom was false, supported only by the Fed's creation of fiat money and credit. When the veil of fiat money was lifted we discovered the ashes of projects that were a waste of the capital invested in them. If you destroy enough capital in an economy, then fewer jobs are created because fewer businesses are able to expand and grow. It is my belief that this has happened on a massive scale in the past ten years.
Another way of saying this is that quite a bit of the perceived expansion of the economy for the past ten years was a waste of money. There is a technical term for this in economics, called "malinvestment" of capital. Let me explain this concept and how it works.
First a couple guidelines. If the Fed or any central bank could create wealth (capital) by printing money then we would all be rich. They can't. The only way capital is created is through the production of goods from which some profit is derived and saved. Government can't create wealth because it produces nothing. Only the private economy can do that.
What printing money can do is destroy capital.
How? By creating money out of thin air. Here's how it works.
Let's say you are a developer of residential housing. You've been looking at a piece of property for a 100 home project and you pencil it out to discover that it doesn't make sense. Let's say that a year later you look at the property again, but the Fed has been printing money for the past year and as a result price inflation has driven housing prices up. You think you can now sell the homes for $250,000 rather than the $220,000 you had projected last year, and now the project looks feasible to you. You think you can make 15% profit on the project. You go to your bank and borrow 70% of the money for the project, say $15,000,000. For the other 30%, or 6,250,000, you get 90% of it from a big pension fund and put up 10% of the money yourself.
The bank extends the loan and the Fed creates it out of thin air. By a few keystrokes the bank has another $15,000,000 on its books and credits your account by that amount. It is brand new money, freshly "printed" by the Fed. All the bank needed was $1,500,000 of uncommitted Tier 1 capital to make this happen. You now go out and build the project with the new money and bid away building materials from others and pay with checks that are deposited into the suppliers' bank accounts. What have you done? You have gotten something for nothing. You have bought goods for free because the money is a fiction of a keystroke.
Other builders see this new activity (assume you aren't the only one doing this) and they see prices of homes rising and do the same thing. All prices are going up as new money bids away scarce resources. As we get farther away from the bank's injection of new money, the lowly consumer earns no more money but prices are going up and he has to pay more. He's getting screwed and you've gotten something for nothing.
It takes you two years to build the project. But by then the Fed sees that prices are spiraling up and up and they raise interest rates to slow the creation of money. Mortgage rates increase, and for a while home prices also continue their rise. But now fewer folks are buying homes because they can't afford them: it only worked with cheap mortgage rates. Now buyers can't afford to buy your homes, and your sales slow down. Maybe you've sold half of them but the rest lay idle. You know that you wouldn't make any money until the sale of the last 15 homes. At this point, you haven't made enough back to pay off the bank or the pension fund, or take money home for yourself.
The economy slides into recession and more and more housing projects are going belly up. You can't sell a thing. After another year of trying to work things out with your lender, the bank forecloses, and takes back the 50 unsold homes. They sell the homes at wholesale prices and have lost about $4,000,000. The pension fund lost its entire $5,600,000, and you've lost $550,000 and the bank and the pension fund are going after you personally for repayment. You go bankrupt and they get nothing.
This is exactly what happened during The Great Recession. I speak from experience.
Your project wouldn't have happened had the Fed not created money out of thin air. Because of fiat money creation, it did happen. As a result, real capital, the $6,000,000 from you and the pension fund, was "malinvested" in a project that wasn't economically viable from the start. If you magnify this worldwide, as the bust spread throughout the residential markets, and then the banks, and then mortgage backed securities and other derivatives, and the credit default swaps, and the rest of the complex financial instruments, trillions upon trillions of dollars of real capital were lost. To this day, no one really understands how much capital was and is still being lost.
Why aren't jobs being created?
First, many of those jobs related to the housing boom have disappeared and won't return. Developers have quit or have gone bankrupt. Mortgage financing is a shadow of the former market as new home building is at historic lows. All the related services have cut back. Small business bankruptcies are historically high.
Second, it is my belief that the rate of home ownership will drop to near its historical level. From 1970 to 1995 the home ownership rates was about 64% to 65% of American families. Starting in 1995 they shot up reaching a high of more than 69% in 2004 and 2005. Now they have settled back close to 67% and are still heading south. I believe they will settle around the 66% level. Also, demographics suggest that we will not return to the heady levels of new home construction found during the boom. Assuming the economy recovers to a steady 3.0% to 3.5% GDP growth, it will not be sufficient to recreate jobs in the housing market to their boom levels.
Third, and most important, there is only one way to create jobs and that is through business formation and expansion and we don't yet have enough new capital to create such growth. New capital can be created only through production and savings. And that won't happen until the private sector has first sufficiently deleveraged (reduce debt incurred during the boom). Again, if the fix was as easy as the Fed creating more money out of thin air we wouldn't be in a recession to begin with.
Why have we been going backwards for ten years? Because the Dot com bust, although smaller in scope, was also destructive of real capital. The Fed's attempt from 2001 to 2004 to revive the economy through the creation of fiat money (M1 up almost 30% from 2001 to 2005) caused the false boom in housing and that it why we are where we are today. With each cycle, fiat money only serves to destroy more capital.
Now it is happening again with ZIRP and QE I and II. Except this time there is a difference: we've wiped out too much capital and we haven't yet generated enough new real capital to drive growth. Attempts to flog the economy with fiat money will only lead to one thing and that is stagflation. Stagflation was the curse of the '70s and early '80s when we had high inflation and stagnant economic growth.
How much real capital exists in the economy? The real answer is that we don't know and it is not possible to measure it from existing data. Instead economists look at the effects of a lack of real capital in order to determine if real capital is growing or shrinking. Austrian theory economist Frank Shostak suggests that the state of bank credit (lending) may be a reasonable proxy for measuring the effect of a lack of real capital (savings).
As long as the pool of real savings [capital] holds up, commercial banks are likely to cooperate with the Fed's monetary pumping and convert it into a stronger money-supply rate of growth.
However, if the pool of real savings is in trouble, banks are likely to ignore the pumping by the Fed. Why is that so?
A fall in the pool of real savings means that less real wealth can be generated. This in turn means that the quality of banks' assets is likely to come under pressure. Obviously, this leads to the curtailment of credit and the curtailment of the expansion of credit out of thin air.
All this puts pressure on the rate of growth of the money supply. When the damage to the pool of real savings is severe, this is likely to be mirrored by a much more severe curtailment in credit expansion by banks.
And that is where we are today. While there has been some improvement in bank lending, it has failed to significantly increase the money supply through the expansion of bank credit. As this chart shows, total commercial loans have collapsed resulting in the current s0-called "credit freeze."
What this tells us is that despite the Fed's attempt to increase money supply, banks aren't lending. Almost all of the increase in money supply (using Austrian theory definitions) is coming from quantitative easing (the Fed's direct injection of fiat money into the economy).
This suggests that the state of real capital is weak and economic growth will be hindered which in turn will not create enough new jobs to put a significant dent into the unemployment rate.
This is a terrible prospect for the millions of unemployed Americans who need jobs. Yet our government and the Fed seem oblivious to the issue and still pursue policies that exacerbate the problem. They fail to see the scope of what they have done. This is no ordinary recession. The boom phase was unprecedented in history. Easy money led to a worldwide frenzy of malinvestment that is still in the process of being unwound. The more the government and the Fed interfere with the corrective process, the longer the misery of unemployment.
Current Fed policies are doomed to failure. This time instead of fiat money induced fake growth we will have fiat money induced stagnation and inflation.
What our leaders are doing to American workers is shameful and cruel. They seem to hate workers because they are doing everything they can to prevent job formation. I cannot predict when we will see healthy job growth again because I cannot predict what the government and the Fed will do. But based on the unprecedented loss of real capital, it could be another five or six years. In the meanwhile, unemployment will remain persistently high.
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The new graduate with a degree in hand will be in luck if he finds a job. Most dont. Talk to the kids that are in the 4th or 5th year or graduated this year or last year. The military is not also full. no jobs equals---- the new LOST GENERATION
The horror of war and MASSIVE political and civil unrest is COMING TO THE UNITED STATES.
Please watch the video “Hero of War” at (http://youtu.be/z0XPqiQM92Q) and see what the MAINSTREAM MEDIA doesn’t want you to see.
-Anonymous
Wow this look like a movie but the truth is that it’s not.
More ridiculous nonsense from Econophile. Look honey, the ONLY figure that matters is employment among those with a Bachelor's degree or higher. BLS in November was 5.1%.
Don't like that figure? OK, 10.2%. SO WHAT? This is a CRISIS? No my dear, this is an OPPORTUNITY. For what? For FULL-SCALE, FULL-BORE, NON-STOP, NO-COMPROMISE MELLONESQUE LIQUIDATION.
And that is EXACTLY what is happening. These thieves are taking one look over their shoulder and saying, "As long as BLS BA+ is under 20%, KEEP SHOVELING THAT MONEY IN THE BAG."
It's too bad this hysterical hand-wringing of yours keeps you from presenting to readers the ONLY fact that counts among the ONLY people who are making decisions.
And if you're so in the know, Econophile, tell me the month and year BLS BA+ unemployment will reach, say, 8.7%. You won't come up with a month and year, you'll blather something about how it doesn't matter, or how inaccurate BLS is, and so on and so forth. And you will just refuse to answer the question.
Idiot.
Junked you for suggesting that only one education level matters. Unless you want to explain why you wish to throw a ton of people under the bus and say they don't exist.
Unlike some parts of the world, the US does not make a habit of condemning the under-degreed/non-degreed to certain poverty.
do you know?
or do you just like being really constructive by calling someone an idiot.
I think asking someone to foretell the future is kind of idiotic ...
btw, your idiology is way off. These 'thieves' could give a rats ass about numbers. All they care about is what will keep them in power and in the way of money flow. If that takes BA+ 5% or above or 20% is irrelevant.
Agreed. High unemployment, and massive underemployment, for decades:
http://www.xtranormal.com/watch/8083657/
Well, to get everyone on an even keel, we had to become a Nana Public.
Congrats to the Marxists/Socialistas..they have all but succeeded.
But,they still have to fight the war.
Love this article. Posted on facebook for all of my idiot friends to learn Austrian business cycle theory.
How to stay employed?
Simple:
Be worth more to your employer than he is paying you.
http://therookiecynic.wordpress.com/
How to stay employed?
Simple:
employ yourself!!!
That doesn't solve the problem, it just transfers all the risk and none of the benefits of scale onto you.
Or not give the employer the ability to lord over people.