Let’s go through the long list that paints a picture of both short-term and longer-term risk to the economy.
- We are not creating enough jobs to cover the growth of the population.
- The stimulus policy is not working.
- Consumer and business confidence is down.
- For a large number of firms, credit conditions have not improved since the crisis.
- The U.S. faces Europe-like debt/GDP and deficit/GDP ratios.
- Financial reform bill seen by many as institutionalizing the cult of bailouts.
- Discouragement about the massive Gulf spill
- Disappointment about the progress in Afghanistan
What about the good news? Uhhh… Maybe your favorite team advanced in the World Cup?
I have some other thoughts.
The Job Outlook
I think people are finally understanding the jobs data. The fact that the unemployment rate fell to 9.5% was not good news because 652,000 dropped out of the work force. If we counted these people as unemployed, the rate would have increased to 9.9%.
However, you should not simply look at the 652,000 who dropped out in June 2010 — you need to look at all of the months when people were dropping out and not looking for jobs.
In my opinion, the effective unemployment rate is about 13%. The so-called ‘all-in’ or U-6 rate is currently 16.5%. This rate is overstated because it counts all those who are working part-time but really want to be full time as ‘unemployed’. To me, if you are working 20 hours a week, you should be counted as 50% unemployed not 100%..
There were 83,000 private sector jobs created. This is good but not enough to cover the increase in the labor force due to a growing population. We need about 100,000 new jobs each month to cover the demographics.
Hence, we are stuck. People are talking about a double dip.
Stimulus is not working
We have had at least two interesting lessons in the viability of stimulus policies.
First, the Cash For Clunkers. To me, this was an environmental policy rather than a stimulus policy. There was a surge in car buying as people traded in their clunkers and then demand dropped again as soon as the program ended. Car sales continue to be at a very low level. The stimulus just shifted demand.
Second, the new homeowner tax credit. This recently expired. The result? Permits for new housing construction dropped by 30%. Again, the program simply causes a shift in demand – from the future to present. Things look better in the short term – but worse in the longer term.
I am certainly not saying that all stimulus spending is ineffective. However, to me, it is inappropriate to push any more money into housing subsidies. The housing sector is already massively subsidized:
- Very low interest rates on mortgages (partially due to government policy)
- Mortgage interest deductibility for income taxes
- Government now owns all of the GSEs (Fannie, Freddie, etc.) and effectively sponsors (subsidizes) all the mortgage insurance
- Government is propping up many sick banks so that they can try to ride out this recession without foreclosing on too many loans
- Numerous programs such as loan modification.
- A legal system that allows people to walk away from their loans when the loan is worth more than the home – where the bank has little or no recourse in terms of the borrower’s other wealth.
Isn’t that enough support?
Confidence is down
Duke CFO Survey released earlier in the month reflected new weakness. Our diffusion index which measures views about the prospects of the CFOs’ companies, plummeted from 33.2 to 15.4. The diffusion index that looks at the CFOs view of the whole economy dropped from 35.0 to 21.5.
The CFO Survey indices have consistently provided leading information compared to traditional indicators like ISM. The logic is simple. The CFO knows about the firm’s plans before the purchasing manager.
Credit is still crunched
Again, the Duke CFO survey found an extraordinary number of firms (particularly small and medium sized) that said credit conditions had not improved for them since the worst part of the crisis.
Small and medium sized firms are the engine of job creation. If we continue to squeeze them for credit, it is no surprise that there is no job growth.
Europe’s situation is not that different from the U.S. situation
As the U.S. continues to rack up debt by deficit spending, the U.S. situation begins to resemble Europe. However, the U.S. always has the possibility of monetizing the debt. But that is an alternative that no one wants (it would mean an inflation tax on everyone).
As the government sector grows and the government share of debt in the capital markets becomes larger, government debt will be competing with corporate debt for investors. Eventually, rates will rise. This means less corporate investment and fewer jobs in the long-term.
I have already mentioned that stimulus spending can cause a shifting of demand from the longer term to the immediate term. When the program comes off, demand can drop sharply. However, there is another effect — and indirect effect. The debt that is used to finance the stimulus increases the cost of financing for corporations and reduces longer term growth of the economy. Longer term employment growth decreases.
The cult of bailout
There is no time this week to comment on all the details of the 2,000+ page financial reform bill. However, it is fair to say that the bill essentially institutionalizes the notion of bailout. Paradoxically, this could lead to more risk taking.
Aside from the reform bill, we are effectively bailing out (or keeping operational) close to 1,000 banks. This is a huge drag on the economy. Some of these banks can’t make loans. Why not just close them down and redistribute the good parts to strong banks? This could also help alleviate some of the credit crunch.
That’s not my call. My best guess is that the NBER will have a hard time dating the end of the recession in August of 2009 when we still have effectively 10+% of unemployment. Even if they do date the economic trough in 2009, we will face a prolonged period of substandard economic growth and high unemployment.
If you have read my blog, I am more of a ‘short-term pain for long-term gain’ person. Some bold actions are necessary – and they don’t necessarily involve spending more on fiscal stimulus. I would prefer to focus on the financial system. It is been broken for three years and needs repairs. To be clear, this is not free. Closing banks often costs the taxpayer money. However, this is money well spent for the long term economic growth opportunities.
A healthy financial system allows firms to efficiently seize growth opportunities. Right now, many firms have good opportunities (that would cause employment growth) but they can’t get the financing. Again, the Duke CFO Survey reveals key information. 34.8% of participants admitted they are limiting capital spending as a result of funding difficulties. Capital spending creates jobs today and in the future (think of the capital spending necessary to construct a new production facility).