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Why Washington’s Happy Talk Will Not Save The U.S. Economy

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Submitted by Eric L. Prentis

Recession Coming: Why Washington’s Happy Talk Will Not Save the U.S. Economy

Wall Street bankers, Washington politicians, economists and the media trumpet a substantial rebound in the U.S. economy, in the second half of 2013 and beyond, as a result of the Federal Reserve’s continued and open ended use of $85 billion dollars a month in quantitative easing. Learn why this is wishful thinking.  Rather than do want is necessary to solve the ongoing 2008 credit crisis, those in power stoop to public relations tricks and propaganda.

Case for the U.S. Economy Experiencing a Double-Dip Recession

The Economic Cycle Research Institute (ECRI) has an excellent professional reputation—correctly forecasting the past three U.S. recessions.  During the last week of September 2011, ECRI gives advance warning that the U.S. economy had recently reached a peak expansion high, and the U.S. economy would then begin slowing down. On the same day as ECRI’s recession announcement, Fed Chairman Bernanke reveals a new quantitative easing (QE) policy called operation twist, and in September 2012, QE3, and in December 2012, an open-ended QE4. The Fed’s actions slow the inevitable economic decline, but will not stop it, says ECRI, and may ironically, make the eventual trough of the recession even worse. For as former Bundesbank President Axel Weber says, “Central banks can buy time, but they cannot fix issues long-term.”

U.S. GDP growth is slowing. In 2010, GDP growth is +2.4%; in 2011, + 2.0%%; and for 2012, it is +1.7%. For the first half of 2013, on an annual basis, GDP growth slows further to +1.4%. Nalewaik, a Federal Reserve researcher, investigates economic growth, and discovers slowing economies reach stall speeds. Since 1947, a sub +2% GDP growth, year-over-year, as an economic expansion slows, always correctly predicts an economic recession, which normally becomes evident, 70% of the time, within the next year. Consequently, negative GDP growth is 70% probable in 2013, and if not then, almost a certainty by 2014. From this we can infer the U.S. economy is now in a recessionary slowdown, and will experience quarters of negative GDP growth, perhaps within the year.
Important real economic measures indicate the U.S. economy remains weak. The civilian labor force participation rate drops to 63.3%, during March 2013, from a high of 67.3% in 2000, matching levels last set in 1979. The unemployment rate decline over the past three and one-half years, from 10% to 7.4%, is almost solely attributed to discouraged workers leaving the labor force. About 90 million working age Americans do not have a job.

In addition, the quality of jobs in the U.S. is declining. Real wages, a good indicator of living standards, turn negative in both 2011 and 2012, falling by about 0.5% a year, even though labor productivity is increasing, according to the 2013 Economic Report of the President. This is indicative of a shift in the mix of U.S. jobs, from high wage full-time jobs, to low wage part-time jobs. The hollowing out of the U.S. economy continues. Good jobs are sent overseas, as part of U.S. corporations’ globalization strategy—even while U.S. corporate profits, as a percentage of GDP, reach an all-time high. Without real wage growth, it is difficult for Americans to pay down their high levels of debt. Consequently, the 2008 credit crisis continues.

Other real economic indicators are just as dire. Since 2008, the number of persons on the Supplemental Nutrition Assistance Program (SNAP) increases +50%, to about 48 million Americans. The Center for Retirement Research reports an increase in the number of the unemployed applying for Social Security Disability Insurance (SSDI) benefits, once their unemployment insurance ends. Social Security Research, Statistics, & Policy Analysis, as of January 2013, lists 10,895,000 Americans in the SSDI program, including their dependent spouses and children, up about +15% over the past four years. Few on disability insurance ever reenter the labor force. 

U.S. leaders hope a technological or energy discovery will help the U.S. economy recover, giving America a new growth engine. This is less likely to happen, because of massive malinvestment. Good money is being thrown after bad, going to insolvent banks and bankers, rather than to innovative engineers and productive operations managers.

How to Solve a Credit Crisis

Market economies are prone to devastating secular credit crises, leading to social catastrophe, if the state allows a credit crisis to spiral out of control. The grand art for the state is recognizing the difference between a cyclical recession and a potentially devastating credit crisis collapse, and then when to step in, and how to solve the credit crisis. Bagehot presents tried-and-true management rules that states have followed numerous times, to successfully solve credit crises. They are: “1) first and foremost,  the character of the borrower has to be judged excellent, with no taint of scandal or fraud; 2) only then lend freely; 3) at high interest rates; and 4) to solvent borrowers offering high quality collateral in return.”  
  
The state’s timing in taking action in a credit crisis is also crucial. Stepping in too early, the state saves wrongdoers. Too late, the resulting downward spiraling economy causes political upheaval and possibly, war! The art, says Kindleberger, “is after the credit crisis has occurred: 1) it is important to wait long enough for the insolvent firms to fail; then, and only then 2) not wait so long as to let the causes spread to solvent firms, needing liquidity.”  U.S. leaders, during the ongoing 2008 credit crisis, regrettably, violate all four of Bagehot’s management rules and both of Kindleberger’s timing requirements.

High Debt Levels Are the Problem

To make up for lost employment income demand, debt levels significantly increase from 1980, when President Reagan said debt doesn’t matter—to today. Total U.S. government and private debt-to-GDP was about 165% in 1980, and 33 years later, it is now at 350%. The total debt peak is 260%, in 1929, leading up to the Great Depression. Therefore, the U.S. has hit a debt ceiling.

A nation’s economic engine is circular and goes: employment income > consumption > production > employment income. Americans can no longer service their high debt levels. Therefore, there is leakage in demand from employment income to consumption, because of high consumer debt payments. In addition, since production is now moved offshore, this reduces payments from production to U.S. employment income, leaving less monetary demand to rotate through the next economic cycle.

High debt servicing levels and production outsourcing act as a break on U.S. economic growth. The ever increasing debt economic model is now exhausted. Deleveraging will have to occur. The longer the deleveraging is put off, the worse the eventual economic collapse could be.

Businesses Follow Demand

International corporations are cash rich, after championing weak trade unions, aggressive cost cutting displacing workers, slowing wage growth and reducing capital investment. However, these same companies are not hurrying to invest their large amassed cash reserves, because they do not know which products or services to invest in.

The Fed’s Zero Interest Rate Policy (ZIRP) is taking about $425 billion dollars a year of interest income out of consumers’ pockets. This is ironic, because when interest rates are high during the mid-1980s, the U.S. economy is strong. Restraint of economic growth is not because of high interest rates, but hinges on profitable productive opportunities for businesses to expand operations, based on growing consumer demand.

Because U.S. consumers have reduced disposable income to spend, businesses will not make capital investments if they observe declining demand for their goods and services. Even technology led products are risky and prone to economic failure. Rather than investing, large corporations are simply increasing stock dividend payments and buying back their shares.

The major economic problem is the U.S. is lacking final consumer demand, because of ZIRP and an over-indebted society. Increased government demand is not real demand, decided on by consumers. Businesses, rightly so, do not trust this fabricated government demand, since it can change on a politician’s whim.

Conclusion

From 2009 through 2012, the Federal Reserve’s four quantitative easing programs and deficit spending by the federal government—use over $7 trillion dollars, or 45% of a year’s GDP— trying to solve the ongoing 2008 credit crisis. It is reasoned, the U.S. economy will soon experience negative GDP growth, and a double-dip recession will become evident—which will, at that time, call the Fed’s experimental policy of quantitative easing into question. Instead, the U.S. 2008 credit crisis could have been solved in two years, and cost the U.S. government and the Federal Reserve about 5% of a year’s GDP, by following the tried-and-true credit crisis management rules of Bagehot and Kindleberger.

For the U.S. to extricate herself from the ongoing 2008 credit crisis, it is recommended that politicians: 1) allow insolvent banks to go bankrupt; 2) prosecute fraudulent behavior; 3) permit interest rates to rise, by doing away with the Fed’s ZIRP, thereby increasing consumer demand; and 4) eliminate austerity for the people, by sharing productivity gains with workers. This will help restore income equality and further grow final demand, which will direct businesses on where to make profitable investments. Thereby benefiting the common good, and strengthening the United States.

This article draws from my recently published Journal of Business, Economics & Finance paper entitled, “COMPETITIVE MARKET ECONOMIES: Self-Regulating Markets vs. Economic Stability, and the Paradox of Change.

 

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