Takes on the Economy--Mine and PK's

[Check earlier economic posts for additional details about the hole we are in which I have decided not to repeat in what follows.].

The following was written before the improvement in the unemployment rate (from 10.2 % to 10.0 %) and the fact that only 11,000 jobs disappeared last month, far fewer than in previous months and far fewer than what was expected. If, early in the year, the detection of green shoots had little reality, this is a genuine improvement.

And yet, it falls short of being reassuring. The fundamental problems are still very much with us. I know some may think Paul Krugman (and I and Roubini and others are too pessimistic–and can I trot out Simon Maierhofe from a Yahoo posting or Dallas Federal Reserve President, Richard Fisher, and other sources I collect) but here is Krugman’s reaction to the decrease in unemployment and job disappearances: “Today’s unemployment report was good news. But in a real sense good news is bad news, because this month’s not-too-bad number deflates the sense of urgency. The fact remains that realistic projections show unemployment staying disastrously high for many years. The chart above is from the minutes of the Fed’s Open Market Committee. Unemployment above 8 percent in the fourth quarter of 2011; above 7 percent in the fourth quarter of 2012.

And what are we going to do about it? The de facto consensus is, not much — that we can’t and/or shouldn’t take any significant further action.
It’s a tragedy, wrapped in a weird complacency.”
*****

I. Below are two pessimistic economic prognoses by Paul Krugman, from his blog (not his NY Times column). In one, he mentions his increased fear of a double dip–that is, a return to a declining economy or if you prefer, a recession within the Great Recession (in the new economic lettering, a W, although the symmetries of the downs and ups may not exist). Before dismissing Krugman’s fears as that of a perennial pessimist, which in my view he is not–he is a liberal realist--one should consider the following.

There are two kinds of double dips. The more conventional way of viewing one is when a recovery from a recession quickly loses steam and we go back into a decline. An example, perhaps, is the recession of 1980, followed by the second dip, the recession of 1981-2. The second dip was far more serious than the initial decline, though, because the Federal Reserve under Paul Volcker was determined to rid the economy of double-digit inflation and pushed interest rates up to unprecedented levels–mortgage rates peaked at about 17-18% and the prime rate for a brief moment reached as high as 21 ½ % (it is now, by contrast, 3 1/4%).

But there is a second type of double dip, one carefully researched by President Obama’s chairwoman of the Council of Economic Advisers, Christina Romer. It was the decline, during the Great Depression, in 1937-38, and is known as the recession within the Depression. It was brought on mostly by tight money but also by contractionary fiscal policy–primarily tax increases. It was serious and pushed unemployment which had dropped from a high of 25% in 1933 to about 12% in early
1937, only to rise to the upper teens in 1938. This latter kind of double dip is only possible now if the deficit hawks have their way and cut the deficit through spending cutbacks (or tax increases, although deficit hawks are rarely inclined to favor tax increases as an answer to a deficit) or if Bernanke and the Fed cave in to the hawks and start raising rates. While this is possible, and I don’t think Bernanke is to be trusted, I doubt he and the Fed will do this as long as unemployment rates are in double digits. But watch out if rates dip to 8 or 9 percent!

Interestingly, looking at the history of business cycles in the US since they began shortly before the Civil War, most expansions were only for a few years (say, two, three or four), followed by relatively short recessions. If this pattern still existed, we would be due for a recession before the election of 2012. But this pattern seems no longer to exist. It was undermined in the 1930's because of the seriousness of the Depression, which lasted for more than a decade (at least in terms of high unemployment). In the post-WW II period, I think it fair to state that the Federal Reserve did a better job than it had previously done, and of course prior to 1913, there was no Federal Reserve (and unless Ron Paul has his way, we will continue to have a Federal Reserve, which for all its faults keeps the economy working better, I think, than if it didn’t exist–an unprovable conjecture since, in the last analysis, we can’t compare reality to a hypothetical). But monetary policy, in the current situation, is all but useless. Rates can’t be dropped any lower than what they already are.

Of course, there was the lengthy expansion in the 1960's–almost a decade of expansion--but this was associated not only with a tax cut early on designed to stimulate the economy, but more important there was the stimulus provided by the Vietnam War. I don’t know the ins and outs of this, but I am certain that wartime spending then provided more stimulus than wartime stimulus does now.

There was also the relatively long period of advance, from the end of the recession of 1982 to 1990, but I would attribute this to the deepness of the recession that the Fed created to counter inflation. Once it let up, the economy could slowly overcome obstacles and advance for a longer period than usual, since wage pressures were weak, given the unemployment left over from the recession and the global situation was less inhibiting–China had not captured as much of our manufacturing as it has now. But while the current recession is more or less equally deep, it was not caused by tight money. I doubt we should use the eighties as any kind of precedent.

Finally, there was the expansion of the Clinton era, actually beginning before he came to power, but in its first years it was so weak, and unemployment so high, that Clinton kept reminding himself during the 1992 campaign to keep hammering at Bush’s economic woes by reciting to himself: “it’s the economy, stupid.” One reason the expansion lasted until 2001 was the tax increase Clinton pushed through in 1993, which fortunately did not push us off the expansion track, but helped create not only a balanced budget but a considerable surplus by the end of the decade. But in the final analysis what made for the lengthy expansion was, of course, the dot-com bubble of the 2nd half of the 1990's. It helped to explain both the continued prosperity (and the official unemployment rate actually dipped below 4%) as well as the surpluses just mentioned.

The Bush “expansion”–the old terminology of boom and bust no longer seems appropriate when expansions are weak--was, to be sure, longer than what used to exist, except that it was anything but a boom for the average worker and only lasted as long as it did only because there was the incredible housing-financial bubble that we are still trying to recover from.

II. Given the past history of expansions and given the special factors that are preventing us from climbing back on the path to growth–to be mentioned shortly and which Krugman points to–it would not be surprising to see the economy relapse into a recession although whether it should be considered a “double dip” or simply a new recession is perhaps a matter of taste. I suppose declines that are considered double dips occur when a previous level of output is not reached or when unemployment has not dropped to anything near what one could call “full employment,” although Krugman is fearful (and correctly so) that prosperity will be defined down and that 8 or 9% or “maybe even 10%” will be “the new normal.”

Krugman’s recent posts indicate that the growth and employment effects of the stimulus are coming to an end. But one has only to look at newspaper headlines to realize that the debt and banking situation is a long way from normal. As Times reporter David Leonhardt reports, the quaking in Dubai has not brought a collapse, but banking woes lurk wherever you look. Most important, banks are still not making the kinds of loans needed to stir a more vigorous upturn. Nor are the desires of businesses to borrow at high levels since capacity utilization (indicating the extent businesses are using their factories) is unusually low, at about 70%. Consumers are spending but warily. Perhaps most important, I believe no recovery has ever made it, or made it big, without a strong construction component. Yet, both housing and commercial real estate spending are in the doldrums, a oft-used but rarely defined word that simply means “stagnating,” with no end in sight. Finally, on the international scene, Europe and Japan are operating at sub-par levels–you can take Roubini’s word for it.

What is also true is that the picture is worse than what the numbers suggest, especially when one chooses to use the conventional measure of unemployment, which is just over 10 percent. As Elizabeth Warren-- http://www.huffingtonpost.com/elizabeth-warren/america-without-a-middle_b_377829.html--puts it, in an excellent article (12/3/09)–she is Chair of the Congressional Oversight Panel created to oversee the banking bailouts, and an absolute winner, “one in five Americans is unemployed, underemployed or just plain out of work. One in nine families can’t make the minimum payment on their credit cards. One in eight mortgages is in default or foreclosure” and she goes on and on. And the context for all this is even more upsetting–the article is titled, “America Without a Middle Class.”–“the wages of the average fully-employed male have been flat since the 1970's.”

Whether or not there is a double dip, we are still in a deep economic crisis. And there is no end in sight.

If so, one might ask, why is the stock market doing so well. Partly, it is because the market anticipated a deeper decline, and sank very low, leading people to buy what they considered a bargain. Of course, if there is a double dip, or even a sharp slowdown, which Krugman, Roubini and others believe, the stock contraction might be sharper than its current buyers might expect.

Easy money and low interest rates have also lead people to borrow and buy something–and why not stocks, when the economy seems to be edging up. Finally, there is herd behavior or might I actually say it, what appears to be the reappearance of a bubble mentality, at least in this area of the economic arena.

In point of fact, the price-earnings ratio (p/e) of the S&P 500 has probably averaged about 15 over the last 125 years, peaking at about 32 in 1929 and at about 43 in 2000. It is now over 20, a level it should only be at if expected earnings are expected to be rising rapidly, which few anticipate. Roubini expects a rush to the door out of the market soon. I think he’s right

In short, we are far from out of the woods.

*****Krugman’s*****

December 1, 2009, 11:30 am

Double dip warning

I’ve never been fully committed to the notion that we’re going to have a “double dip” — that the economy will slide back into recession. But it has been clear for a while that it’s a serious possibility, for two reasons. First, a large part of the growth we’ve had has been driven by the stimulus — but the stimulus has already had its maximum impact on the growth of GDP, will hit its maximum impact on the level of GDP in the middle of next year, and then will begin to fade out. Second, the rise in manufacturing production is to a large extent an inventory bounce — and this, too, will fade out in the quarters ahead.

Two stories this morning highlight the risks. The WSJ has a report on highway construction titled Job Cuts Loom as Stimulus Fades:

Highway-construction companies around the country, having completed the mostly small projects paid for by the federal economic-stimulus package, are starting to see their business run aground, an ominous sign for the nation’s weak employment picture.
Meanwhile, the ISM for manufacturing suggests that industrial growth is already slowing down.

I’d be more sanguine about all of this if there were any indications that private, final demand is taking off — consumers, business investment, whatever. But I haven’t seen anything suggesting that sort of thing.

The chances of a relapse into recession seem to be rising.
***********************

November 30, 2009, 2:09 pm

Things to come

What’s going to happen, economically and politically, over the next few years? Nobody knows, of course. But I have a vision — what I think is the most likely course of events. It’s fairly grim — but not in the approved way. This vision lies behind a lot of what I’ve been writing, so it might clarify things for regular readers if I laid it out explicitly.

Start with the short-term economics. What we’re in right now is the aftermath of a giant financial crisis, which typically leads to a prolonged period of economic weakness — and this time isn’t different. A bolder economic policy early this year might have led to a turnaround, but what we actually got were half-measures. As a result, unemployment is likely to stay near its current level for a year or more.
And politically it’s hard to do anything about that. Those economic half-measures have landed the Obama administration in a trap: much of the political establishment now sees stimulus as having been discredited by events, so that it’s very hard to come back and scale the policy up to where it should have been in the first place. Also, with the apocalypse on hold, the deficit scolds have come back into their own, decrying any policy that actually involves spending money.

The result, then, will be high unemployment leading into the 2010 elections, and corresponding Democratic losses. These losses will be worse because Obama, by pursuing a uniformly pro-banker policy without even a gesture to popular anger over the bailouts, has ceded populist energy to the right and demoralized the movement that brought him to power.

Despite all this, the midterms probably won’t give Republicans the majority in the House. But the losses will be big enough to deny Obama a working majority for any major initiatives in the rest of his first term. (My guess is that he’ll be reelected thanks to the true awfulness of the Republican nominee). Since Republicans are dead set against any of the things I think could help pull the economy out of its rut, this means more economic stagnation.

Along with this will come a process of defining prosperity down. All the wise heads will tell us that 8 or 9 percent unemployment — maybe even 10 percent — is the “new normal”, and that only irresponsible people want to do anything about the situation.
So what I see is years of terrible job markets, combined with political paralysis.

I hope I’m wrong about all this. But my sense is that to have any hope of breaking out of this trap, Obama and company have to take risks — they have to propose new initiatives that might not pass, and be prepared to run against the do-nothing Republicans if the initiatives fail. That’s not happening now; as best as I can tell, the administration strategy is to insist that only a few minor course corrections are needed, and to wait for the jobs to start coming in.

Maybe they’ll get lucky. But hope is not a plan.

What can the rest of us do? Progressives have to keep the pressure on. The time for trusting the administration to do what’s necessary is past — all indications are that it won’t, not on its own. But maybe, just maybe, the president can be brought to see the danger he’s running by playing it safe.