Forecast - Continued Recession
We are still in 1931, perhaps about to enter 1`932. We regret that the bounce from the stimulus may not be high enough or linger long enough to prevent a move to the right in the fall elections, and so an even steeper decline. Although there is the Gulf oil spill and the crash in oil prices that seems to be kicking in right now.
We have characterized ourselves here at Demand Side as alone and lonely in the "we are still in recession" camp. It's time to acknowledge that the "threat of a double dip" crowd is equivocating itself back in this direction. A double dip recession is ONE recession with two bottoms, by definition. We doubt that the double-dippers will acknowledge us, but they are sidling back into the room.
Until we reconcile ourselves to two fundamental policy strategies -- writing down debt and engaging government in massive long-term reconstruction -- we will not recover economically. Politically, the ramifications could be explosive.
This is the basic Demand Side forecast. On Monday, we'll go into some of the theory supporting the idea that -- without bankrupting our governments -- we can build our way out of this mess by government investment in needed infrastructure, education, social insurance and -- perhaps above all -- redevelopment to meet the climate change crisis.
Today, we'll look at some evidence in support of our forecast and see how writing down debt in a methodical and forward-looking way is indispensable to recovery. If we do it, we recover. If we don't, we don't. This means debt everywhere from the household level to the level of national governments.
Just a few notes on the news first. Let's make them bullet points.
- Did you see that the Senate voted 94-0 to block indiscriminate IMF aid for Europe? Since the US bankrolls the IMF as well as provides its very thin intellectual capital, this is a big deal. Maybe I missed it, but I haven't seen a lot of noise about that.
- The bubble in China is getting more attention. If you thought there was corruption in the US banks, wait till you see what happens in China.
- And credit crunch in Europe: The NYT is out with a story on how credit growth is drying up in the Euro area just as it started to in the United States two years ago.
- We need to remind you again about the fall in the price of oil. Down twenty percent in less than three weeks, now at seventy dollars and a few pennies. We pegged this decline from the Gulf oil spill disaster, but one of our correspondents reminds us that in the past we have said, "Dollar up or oil down?" Indeed, the strength of the dollar against the euro is no doubt a major factor in the drop.
- Contagion and market fears and so on. When you see the term "markets" in such context, replace it with "casino players." Legitimate markets have a longer time frame. Which reminds us, some of the weakness in markets derives from the crazy drop of one thousand points in six minutes. Some investors no doubt took this as evidence that casino players were pitting their computers against each other in a game, and the fundamentals themselves are simply the pretexts for the next move. Weakness in markets could be because exchanges as places for legitimate financial transactions are weak.
Too often economists -- this one included -- get caught in the weeds, arguing about this or that worry of the week or location of crisis without tying it into the bigger picture. The bigger picture is aggregate demand. Demand produces supply. The Keynesian Revolution in economics, since ousted by the neoclassical monarchists in policy positions, but still the key to rational understanding.
We're talking effective demand, of course.
The chief problem of debt and debt service is that it reduces demand. Reduces it, that is, in the pay-back phase if no productive asset was created when the debt was incurred. The so-called recovery of the aughts under Bush and the global boom itself were -- as we can now see -- produced by an explosion of debt from the primary demander -- the household, its mortgage and those who assisted. No matter that in the US this was a tepid recovery as measured by employment.
The industrial plant of the world and the budgets of virtually all nations came to be constructed on this foundation. The trade deficit of the US was the trade surplus of the rest of the world. Meanwhile the global environment moved from pre-crisis into crisis and is now not recoverable according to many, including Bill McKibbon. McKibbon's new book Eaarth describes the planet of the new century. It is not the planet of the past ten thousand years. But let's leave that for later.
The debt constricts effective demand for productive reconstruction as well as for consumer toys.
We heard Richard Koo last week call this a "balance sheet recession," in which companies have gone from maximizing profits to minimizing debt. Koo suggested that the tens of millions of balance sheets now under repair mean a fundamentally different dynamic is in place, and that governments need to fill the gap in demand with their own spending. He saw the Japanese experience as being fundamentally successful -- not the basket case the Western economists like to paint. Japan avoided having its GDP fall off the same cliff as its real estate prices. Japan tried all the monetary policy tricks the West has tried fifteen years later -- monetary easing, bailing out banks, and the rest. It tried a couple of times to implement the primitive economic prescriptions of the IMF, balance its budget, to disastrous effect.
(Who should be surprised? Economic rubble always follows concerted implementation of the religion of the IMF, and its corporate sponsors.) Only when Japan filled the gap in demand with public spending -- at the cost of a tremendous increase in its deficits and debt -- did it stabilize output. Koo suggests that by buying time in this way, Japan allowed its households and companies to repair their balance sheets and so now they are poised for fundamental health.
Demand Side sees a "balance sheet recession" as fundamentally the same phenomenon as a profit-maximizing expansion, only with negative coefficients. We look at the multiplier, based on the consumption function, as going from positive to negative, that is to below one. Yes, people and businesses are paying down debt -- because there is debt to pay down. Minsky's Ponzi financing structures came to dominate during the boom, and without asset price appreciation, servicing this debt is forced back onto cash flow. Now instead of money being passed along from the butcher to the baker to the barrista, it is getting stuck, or more properly going down into the money pit.
You may remember our podcast on the multiplier, basically lampooning the whole exercise of trying to empirically derive a multiplier, as was tried by Christina Romer among others (Mark Zandi), as if the multiplier were a free-standing number that applied in all economic conditions.
So getting back to the evidence. Japan's government spending did indeed allow it to float along at zero growth, but not collapse with the 87 percent drop in real estate prices. The US stimulus has produced some positive GDP numbers, some less positive income numbers, and even on -- so far -- positive employment number. We doubt, however, that the US will follow Japan much further. And so we doubt that aggregate demand will recover.
But here, from Meredith Whitney, an analyst who famously called the housing collapse and the collapse in bank stocks. She remains bearish on banks. From the Wall Street Journal. On the negative stimulus on the way from government.
May 18Meredith Whitney
[S]tates will approach their June fiscal year-ends and, as a result of staggering budget gaps, soon announce austerity measures that by my estimates will cost between one million to two million jobs for state and local government workers over the next 12 months.
Typically, government hiring provides a nice tailwind at this point in an economic recovery. Governments have employed this tool through most downturns since 1955, so much so that state and local government jobs have ballooned to 15% of total U.S. employment.
However, over the next 12 months, disappearing state and local government jobs will prove to be a meaningful headwind to an already fragile economic recovery. This is simply how the math shakes out. Collectively, over 40 states face hundreds of billions of dollars in budget gaps over the next two years, and 49 states are constitutionally required to balance their accounts annually. States will raise taxes, but higher taxes alone will not be enough to make up for the vast shortfall in state budgets. Accordingly, 42 states and the District of Columbia have already articulated plans to cut government jobs.
So the burden on the private sector to create jobs becomes that much more crucial. Just to maintain a steady level of unemployment, the private sector will have to create one million to two million jobs to offset government job losses.
Herein lies the challenge: Small businesses, half of the private sector (and the most important part as far as jobs are concerned), have been heavily impacted by this credit crisis. Small businesses created 64% of new jobs over the past 15 years, but they have cut five million jobs since the onset of this credit crisis. Large businesses, by comparison, have shed three million jobs in the past two years.
Small businesses continue to struggle to gain access to credit and cannot hire in this environment. Thus, the full weight of job creation falls upon large businesses. It would take large businesses rehiring 100% of the three million workers laid off over the past two years to make a substantial change in jobless numbers. Given the productivity gains enjoyed recently, it is improbable that anything near this will occur.
Unless real focus is afforded to re-engaging small businesses in this country, we will have a tragic and dangerous unemployment level for an extended period of time. Small businesses fund themselves exactly the way consumers do, with credit cards and home equity lines. Over the past two years, more than $1.5 trillion in credit-card lines have been cut, and those cuts are increasing by the day. Due to dramatic declines in home values, home-equity lines as a funding option are effectively off the table. Proposed regulatory reform—specifically interest-rate caps and interchange fees—will merely exacerbate the cycle of credit contraction plaguing small businesses.
Read more: http://www.creditwritedowns.com/2010/05/whitney-the-small-business-credit-crunch.html#ixzz0oIiIBXiy
Notice here that state and local governments are a primary push to the multiplier, since revenues are always and universally spent and spent to an overwhelming degree on middle class jobs which have an additional push to them. When their revenues fall, it is not only the gross spending that falls, but this virtuous feature of amping up the coefficient of the multiplier.
Our divergence is, of course, it is not small business that creates jobs, but effective demand. No business will hire or invest in the face of falling demand for its products or services.
With regard to small business, here is a note from the National Federation of Independent Business:
Small Business Optimism Declines in MarchDemand Side ran an idiot of the week featuring Dunkelberg a year or two ago when he characterized the problems of small business as having to do with federal taxation.
Small business index remains depressed
The National Federation of Independent Business Index of Small Business Optimism lost 1.2 points in March, falling to 86.8. The persistence of index readings below 90 is unprecedented in survey history.
“The March reading is very low and headed in the wrong direction,” said Bill Dunkelberg, NFIB chief economist. “Something isn’t sitting well with small business owners. Poor sales and uncertainty continue to overwhelm any other good news about the economy.”
After a devastating period of employment reductions, employment change per firm hit the “zero line” in March. .... While actual job reductions may have halted, plans to create new jobs remain weak. ... Only nine percent (seasonally adjusted) reported unfilled job openings, down two points and historically low, showing little hope for a lower unemployment rate.
Perhaps the most notable examples of the high deficit, high spending answer to recessions were in the terms of Ronald Reagan and George W. Bush. While the rhetoric was in the direction of limited government, the practice was to increase spending. And since taxes were an evil to both, the gap between revenues and expenditures created enormous deficits. Reagan tripled the national debt -- much of it left over from World War II -- in peacetime.