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Thursday, January 13, 2011

Transcript: 419B Non-Events of 2010, Part II

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It is virtually a theme of the Demand Side podcast to demand that the Fed show some results for its extraordinary interest rates, its unprecedented purchases of toxic securities, and its so-called Quantitative Easing, essentially pushing money into the financial sector in hopes something will happen. We draw the contrast with the problems of Democrats, who tried and failed to sell the line, "It would have been a lot worse without the stimulus."

The Fed, on the other hand, has ready believers when it says lowering rates to zero made a difference. No investment spending, but without it, who knows what would have happened?

Before we go on, we do admit the financial system is still standing because of Fed and Treasury action. A couple of trillion dollars plus several more in implicit guarantees will do that. The operation amounted to widening the lanes and pulling traffic off the roads to prevent the car from crashing, rather than replacing the drunk driver. We have tanked the economy to benefit the people who caused the problem.

In any event, a great deal of credibility accrues to those close to the money, in spite of their not seeing the problem coming. Ben Bernanke, a prime promoter of the Great Moderation, failed to see the largest credit bubble in human history, and still -- to this day -- prefers to deal with the problem by piling on debt.

One of the chief causes of the Fed's impotence is their misunderstanding of money. As we said, this is a point made eloquently and pungently by Australian economist Steve Keen. It was confirmed last week by none other than Federal Reserve Board Governor Elizabeth A Duke in a speech to the Maryland Bankers Association.



........the linkage between the level of reserve balances and the monetary aggregates in the current environment is quite weak. You were probably taught, as I was, that the broad monetary aggregates increase when reserve balances increase because the larger volume of reserves supports increased lending, which in turn leads to a larger volume of reservable deposits. While that argument might hold in normal circumstances, in the current environment excess reserves are many multiples of required reserves, and adding reserves is unlikely to spark a further increase in the volume of deposits. As a result, the textbook linkage between reserve balances, bank loans, and transaction deposits just is not operative at present. Fundamentally, the levels of M1 and M2 are determined by the strength of the economy and the preferences of businesses and consumers for money, which depend on the yields on monetary instruments and competing assets.

Recent experience has again illustrated the difficulty in identifying a reliable relationship between reserve balances and the monetary aggregates. Even though Federal Reserve actions to fight the financial crisis and support the economic recovery added roughly $1 trillion to ... aggregate bank reserves, M1 and M2 rose at relatively moderate rates over the same period.


This is somewhat more bureaucratese than Steve Keen's remark that when the economy is booming, banks make loans and record the deposits, creating money, and go looking for the reserves later. In a downturn, the banks don't make loans, so money is not created.

But we are avoiding the most controversial one, or maybe we're just saving it ....


A distant memory now is the phalanx of V-shapers that descended on the economics media during the first part of the year. Particularly after the stock market rebound, there was little doubt in the minds of the bulls that the economy was back on track. 'V' is not the shape of the recovery.

Eighteen months after the National Bureau of Economic Research, the official arbiter of recession calls, proclaimed the end of the longest recession in postwar history, Demand Side clings to the contention that there is no recovery. Part of the issue is definition. But it is not splitting hairs.

A recovery in the business cycle is not necessarily a return to previous levels of growth and output. It is, instead, the period after the trough. If the economy drops from 100 to 90, and then improves to 91 and continues to improve, the economy is said to be in recovery. Recession is the mirror of this -- when the economy begins to fall from a peak, and continue to fall.

One issue of definition revolves around the measurement of economic activity. For all intents and purposes, the official call is content to rely on GDP growth as the first and last metric of importance. If gross domestic product increases -- GDP grows -- consistently for three quarters, the economy is technically out of recession according to many. The NBER is a bit more sophisticated, but not much.

In the system of national accounts, GDP equals GDI, Gross Domestic Product must equal Gross Domestic Income. Here you begin to see that flaw. If the well-being of an economy has anything to do with the well-being of its citizens, incomes must be rising for at least a significant portion. You cannot have economic recovery except in the Orwellian sense when one percent of the population receives huge increases in income and ninety-nine percent see their incomes decline. Yet that is, in a sense, what we have.

Even median income would be more useful.

But the issue is deeper than this. It is hidden behind the current formulation, "We have recovery, but we do not have self-sustaining recovery." What does this mean? It means housing, employment, and investment may still be in recession, but overall spending, stock markets and corporate profits are recovering. If housing, employment and investment are not the core of an economy, what is? The business cycle has no meaning if these principle elements of the real economy are outside the measurement of its health.

But the listener may ask, How is it possible that real elements are stagnating and financial elements are recovering. It is precisely because of the government's deficit. The great Polish economist Michal Kalecki demonstrated by nothing more than simple, if elegant, algebra that in our situation -- that is, absent real investment, corporate profits equal government deficits. And this unlocks the truth behind the term "self-sustaining recovery." The economy's recovery is not self-sustained, because the huge government deficits are floating it along. The business cycle is now subsidized by government borrowing.

As an aside, it is a thorny political problem for corporate apologists in Congress to at once decry the federal deficit as an example of how business is better than government and at the same time rely on the deficit to drive profits for the corporate sector. The spin problem, as are many, is made simpler by ignorance.

But to us the lie of recovery is exposed by the stagnation of employment. In spite of enormous deficits and stimulus, the unemployment rate has remained month after month in depression territory. Here the spin doctors still trot out the nostrum that unemployment is a lagging indicator. What used to be meant by that was a lag of a quarter or so. Now it apparently means a lag of indefinite duration.

Which brings us to the final event widely reported, didn't really happen


At 9.4 percent official unemployment and 16-plus in the U-6 measure we have an economic crisis. The large number of long-term unemployed, laid off older workers, and college graduates working as barristas is threatening to hollow out the human and capital infrastructure of the nation. Instead of putting people to work by hiring them to do things that need to be done, we are relying on a circuitous and expensive subsidy to banks, corporations and private spending to create consumer demand. This will generate jobs in China or in hair salons, but not the jobs that will bring robust recovery.

That said, the official announcements of private sector job gains which the president hangs his hat on are not only pathetically small compared to the need, but are usually smaller than growth in the number of potential workers.

Even in the recent drop to 9.4 percent, the change was driven more by people leaving the workforce than in the highwater mark in post crash job gains.

Calculated Risk reports from the recent government surveys,


on the declining participation rate.

Only 103,000 jobs were added in December, short of the estimated 150,000 necessary to hold the unemployment rate steady against population increases. The population of potential workers 16 and over increased 174,000, but the labor force decreased 260,000.
Meaning there were more than 300,000 fewer people in the labor force than might have been expected by demographics.

Thus even this unexpected improvement in the unemployment rate resulted more from the decay of the labor force than from any improvement in the economy. At present,

As Calculated Risk concludes, if the participation rate had held steady at 64.5%, then the unemployment rate would have only declined to 9.64%. Almost two-thirds of the decline in the unemployment rate was related to the decline in the participation rate. Some of the decline might be from workers going back to school, but some is probably due to people just giving up, CR says.

Very troubling is that a large portion of the decline in the participation rate was for people in the 16 to 24 age group. According to the BLS, the 16 to 24 civilian labor force declined by 244 thousand. Most of these people will probably return to the labor force as the economy improves - and that will put upward pressure on the unemployment rate. The participation rate has fallen sharply from 66% at the start of the recession to 64.3% in December. That is almost 4 million workers who are no longer in the labor force and not counted as unemployed in U-3, although most are included as "discouraged workers" or "Marginally Attached to Labor Force" in U-6.

So there you have it, the Demand Side annual list of events that were widely reported, but didn't really happen:



I know it's another long podcast, but there was a lot of non-news. We have to acknowledge the main source for today's presentation -- Econ Intersect. Look it up. And we'll add a bonus item largely taken from that very valuable blog, one that may or may not prove to be true.


As we've noted, the housing crisis rivals the great depression's. During the Great Depression, home prices fell 25.9 percent in five years. The U.S. housing market is now down around 25 percent from its peak in 2006. As housing price expert Robert Shiller pointed out in September 2008: Throughout the 1930s, they plunged 30%. That is right where we are now, and with the housing industry a greater part of the economy.

Housing bubbles are now bursting in China, France, Spain, Ireland, the United Kingdom, Eastern Europe, and many other regions.

And the bubble in commercial real estate is also bursting world-wide.

States and Cities In Worst Shape Since the Great Depression, and they, too, are a greater part of the economy than then. Many may default in 2011. California is issuing IOUs for only the second time since the Great Depression.

Loan Loss Rate Higher than During the Great Depression

Indeed, top economists such as Anna Schwartz, James Galbraith, Nouriel Roubini and others have pointed out that while banks faced a liquidity crisis during the Great Depression, today they are wholly insolvent. Insolvency is much more severe than a shortage of liquidity.

Unemployment at or Near Depression Levels when you calculate the rate with the same methodology as they did then. If you look up the unemployment chart at Calculated Risk, you will see a huge bowl for the current employment collapse, one much deeper and wider than any other recession. The bottom of the bowl is flattening, but ... I guess we have to assume it's a bowl. All the others came back up.

1 out of every 7 Americans now rely on food stamps.

Inequality Worse than During the Great Depression

The War Isn’t Working. Ongoing wars have not stimulated the economy out of recession, although they have continued far longer than World War II.

The New Deal had a price tag of only $500 billion in 2008 dollars. The Marshall Plan that enabled the reconstruction of Europe following WWII comes out to approximately $125 billion in 2008 dollars. World War II, when 16.3 million U.S. troops fought in a campaign lasting four years, cost a bit more than five trillion. Here we are in only the third year from the beginning of the recession. Our cost cannot be calculated precisely, but it is in the trillions at least, and there is no end in sight.


  1. The problem for governments is that when the statistics do not suit them they change what they count. After years of high unemployment 6% unemployment was widely regarded as full employment. I would have said that full employment is probably a lot closer to being fact when unemployment is close to 2% or 3% rather than 6%. The difference being structural. Monetary policy does not fix these problems.

    Another problem for governments are that monetary policy is not the only weapon. If you fail to use fiscal policy, then of course problems will build up. Just as they are now.

    The shape of the recovery? I thought way back in 2008 that it would be a L shaped recovery. Until debts are below a manageable level, growth will be problematic. Also without decent wage growth for the middle and working classes the debt over hang will take even longer to clear.

    The decline in the labour participation of the 16 to 24 age group that could easily be explained by the lack of jobs for that sector and they have simply returned to live with their parents. They are simply waiting for the recovery to reach them. I suspect that is also happening amongst older baby boomers moving back with their retired parents.

    As for avoiding the next Depression. I doubt that. Such claims are premature. So far all of the efforts have gone into saving the financial system. Very little has trickled down to main street. House prices falls had been arrested by the massive intervention into the MBS market. The problem is that unless the real economy improves there will be downward pressure on the housing market again and I expect that US property could fall another 20%. If the banks panic and accelerate the foreclosures then it would not surprise me if they fall as much as 40% or even more. Like the problems with the banking sector all the Fed efforts have been to kick the can down the road. There are now even more bubbles to implode and I doubt that the right response will be undertaken. I still expect the US to fall into a depression as all the mal-investment needs to be written off so that a new start can be achieved.

    Housing speculation in europe was mainly confined to a few countries. Ireland and Spain had a huge construction boom. They now have a spectacular bust. In the last quarter of 2008 or 2009 only 135 homes were sold in all of Spain. Ireland and Spain like the US has large numbers of properties built that will probably never be lived in, in huge ghost developments. Germany has had very stable property prices and that protected it from a domestic property problem. Its banks have however been dabbling everywhere else, so have exposures to every toxic asset known. All the EU bailouts have benefited the german banks. Germany suffered when world trade collapsed but now that it has recovered Germany is doing well again, benefiting from a weak euro caused by the PIIGS. Germany's problems will begin when the sovereign defaults pile up and wipe out its banking system.

    The trouble in Tunisia should be a wake up call to all governments. The problems started over unemployment officially only 13% but unofficially double. It mirrors the US. Unemployment officially only 9.4% but in reality closer to 20%. So how long before serious social unrest hits the US?

    History tells us one thing that if you do not learn from the mistakes of the past then you are doomed to repeat them. The US is still at the same stage as in 1931/32 but there is no New Deal coming. There is even greater inequality and that could be a trigger for social unrest. The fact that US unemployment figures no longer count many does not mean that they have gone away. A program to create jobs will be needed soon.

  2. I absolutely agree that full employment is much lower than conventionally thought. The so-called "Natural Rate of Unemployment" is now exposed as a joke, since it relies on changes in inflation to tell us where it is, and inflation is fully exposed as driven by things other than the unemployment rate.