UPDATED
Regular readers of The Daily Capitalist know I think we are headed for a decline in economic growth in 2010 and that the data is starting to show this.
Why isn’t our economy recovering? I ask that question often and have written about it many times. Perhaps a better question is: what needs to happen in order to make our economy grow? I offer some solutions.
There are many problems seen as hindering recovery. Here are the common ones I wish to examine:
- Too much debt encumbering consumers;
- The lack of consumer demand to fuel growth;
- Too much debt encumbering banks; and
- The government’s interference in the economy.
There are a host of other issues that are also important but let me focus on these points and show what can be done to fuel a recovery.
Numbers 1 and 2 (debt/demand) are related.
Our economy is consumer driven and we are reminded over and over again that consumer consumption is 70% of our economy. To put this in perspective, for Germany it is about 57% of GDP.
Our economy is built on consumption which is fine as long as it is supported by real savings, productivity growth, and wage growth. The data reveal that most of the consumption binge of the boom phase of this current cycle was financed directly or indirectly by debt related to rising home values. Personal savings declined to almost zero. Now savings are back up to 4%.
Here is why this is seen as a problem for recovery: PCE will decline as consumers pay down debt and increase savings. Spending drives the economy and the economy will decline.
Is this really a problem?
Saving is a process necessary for a recovery. Consumers are acting rationally to uncertainty and they will give us the signal when they are ready to spend again. About $10 trillion in household net worth was wiped out during the bust. Until consumers see unemployment decrease, wages go up, and their debt go down, they aren’t going to spend anyway.
But savings is never bad for an economy. Economists often fail to look at the other side of savings which is an increase in capital necessary to fuel future growth. In a normal cycle, increased savings reduces interest rates, which sends a signal to producers of capital goods that consumers don’t want to buy consumer goods right now, and that there is opportunity for them to increase production of durable goods such as machines, homes, and basic equipment. They use the loan funds to pay workers who will spend which, as this capital works its way through the economy, will create new and real economic activity.
While manufacturers have been increasing production in response to normal business cycle activity (inventory recovery; weak dollar advantages), they are just utilizing current capacity. If they wanted to expand, unless they are a large company with access to money center capital, they now report they are having trouble getting a bank loan.
What does this mean? It means they can’t expand and hire new workers whose spending will take up the slack from consumers who save. The government and the Fed have confused our ability to make economic decisions because they are artificially lowering interest rates.
What can we do to fix this? Savings is the fix. There is nothing that should be done to prevent this from occurring. In the longer term it will prepare the economy for new growth. See No. 4 for why flogging a dead horse is harmful to recovery.
The question is: why can’t we get loans?
Number 3 is that banks have too many bad loans and, as a result, have too little capital.
The Fed and the Administration’s economic advisers are very concerned that banks aren’t lending. On Monday, Chairman Bernanke in a speech said that getting credit to America’s small businesses was crucial to a recovery because they hire half the workers in America and create 60% of new jobs. After he went through his reasons for the credit crunch he came to this startling conclusion:
Though we believe that our and others’ efforts are making a difference, we also know more must be done, and that additional effective action requires hearing firsthand from knowledgeable people who can speak from diverse perspectives about the challenges facing small businesses. The insights we obtained from small business owners, lenders, and others in this series of meetings have given us a more nuanced understanding of the problem and will help us identify areas where we might be able to do more. Not surprisingly, these meetings confirmed that facilitating small business financing is not a simple or straightforward matter.
Let me translate this for you: nothing we’ve done has worked and we don’t have any ideas how to make it work.
I have explained in great detail why banks aren’t lending in previous articles (e.g., Will We Have Inflation, Deflation, or Hyperinflation?). That is, they made a ton of bad loans as the result of cheap Fed money which created fake wealth in the form of a housing boom. Most of the troubling loans encumbering regional and local banks are for commercial real estate and it is tying up their balance sheets. They are afraid to extend credit to middle America because they know their CRE loans will need to be written down as real estate prices continue to decline and they will need to come up with more capital to satisfy regulatory requirements. Also, it is apparent that when banks do wish to lend, they aren’t finding quality borrowers to whom they would like to extend credit.
What can we do to fix this? This one is easy.
Until those bad CRE loans are written down, written off, banks liquidated, banks raise more Tier 1 capital, they will continue to be reluctant to lend and the credit crunch will continue. The government’s programs of extend and pretend, delay and pray, mark-to-make-believe, only serve to delay the healing process. Meanwhile valuable capital is locked up in failing or failed banks and the economy can’t get credit (unless you have access to the big money center banks or the Fed’s discount window). Do away with these policies, get rid of failed or failing banks, let the economy heal itself, and credit will return.
I urge you to read my above mentioned article on the inflation-deflation debate which goes into great detail on this topic.
That gets us to point 4, the government’s interference in the economy.
Artificially stimulating spending is counter-productive to a recovery since such economic activity is not based on organic, market based consumer demand. In other words, since the spending is not being generated by increased business activity caused by consumer demand, no lasting economic activity is produced. Once the stimulus spending stop, the effect goes away and the economy resumes its decline. This is what is happening now. It makes no economic sense to encourage consumers to take on more debt after they have just suffered the results of the biggest debt binge in history.
Today Mrs. Romer, Chief Shaman of the Obama Administration’s Council of Economic Advisors, reported that such stimulus spending is working, that it has achieved a Keynesian multiplier of 3:1, that is, for every dollar spent by the government, three dollars of private economic activity. Further they claim that they have saved or created three million jobs. They also claim that they increased GDP by between 2.7% and 3.2%. The only problem with this report is that it is wrong, misleading, and, how shall I say it, politically motivated. Another way to say it is that they are lying to make the Administration look good.
While Keynesians, such as Paul Krugman, argue for more government spending, there is no believable evidence that this is working now, that more spending will work, or that it has ever worked in the past. It’s a fake science.
If government could create economic growth by either printing money or taking your money and spending on government-favored projects, then we’d all be gloriously rich. Of course Japan is the poster child of the failure of Keynesian economics. Professor Krugman told them they ought to spend more too. They did and the results were debt and stagnation.
Here is what Mrs. Romer and her staff are doing. They skew the numbers so that they represent the most favorable result under their faith-based assumptions, and then they claim that the results are caused by government spending. This is a logical fallacy known as post hoc, ergo propter hoc, or, because B event followed A event, then A caused B. I looked on Recovery.gov and they claim there that they have “funded” 682,370 jobs as of March 31. Is Mrs. Romer saying they added another 2.3 million jobs since March?
These Keynesian seem to equate private sector jobs with government jobs. A “job” in the economic sense isn’t just paying someone to do something. A private employer will hire a person only if he sees market opportunities that will make him more money. If he hires someone just to be nice, and there isn’t enough revenue to support the wages of this employee, he could go broke. His payments would be considered to be charity.
The government has never created a job, if you define a job as wages based on market productivity. If you define a job as the payments by the government to do something, it isn’t work based on market forces. It’s like welfare.
Now before you jump on me, I will admit that some government workers who maintain the commercial infrastructure, such as our roads, water and power systems, and enforce laws that support private property, personal safety, and commerce (commercial, tort, and criminal natural law–I know this is a big topic but ignore it for this discussion), then you could argue that it is a productive activity. Any job they do could most likely be done by private industry better and more cost effective, but … we are saddled with what we have.
There is only one thing that the government can do to create jobs: get out of the way of businesses and entrepreneurs who create them.
As I have argued, the only result of government stimulus will be a stagnating economy saddled with a large government debt. The greater the government’s percentage of GDP, the less productive will be the private sector (the Rahn Curve). The less productive the private sector is, the fewer jobs they will create.
Let me suggest my fixes for the economy:
- Stop all government stimulus programs immediately. They are a waste, create no lasting benefit, and result only in a burden on present and future taxpayers and are a drag on the economy.
- Encourage savings rather than consumption. Immediately repeal taxes on interest and dividend income. Allow all citizens to put an unlimited amount of savings into tax free vehicles like IRAs. Tax them only on the cash removed from the vehicle. (I would opt for a different tax structure entirely, but, let’s work within the system for now).
- End all federal programs that encourage consumption, such as Cash for [Your industry here] and home buyer tax credits or subsidies. End Fannie, Freddie, Ginnie, and the FHA, and the myriad of other government backed loan guarantee programs.
- Let banks fail. Require banks to mark-to-market the assets securing their loans, and raise more capital or go out of business. Establish a program similar to the Resolution Trust Corporation (RTC) to quickly dispose of the assets of failed banks. Substantially raise leverage requirements for banks.
- End or suspend tax policies that require borrowers to incur phantom income as a result of real estate debt relief.
- Immediately raise the Federal Funds rate to stabilize money supply. We are in great danger of creating another boom-bust cycle, actually I think we are headed for a bust-bust (lose-lose) cycle of stagflation.
- Pass legislation that would prevent the government from bailing out private institutions. There is no such thing as too big to fail. It is a myth created out of the Great Panic of 2008, when Paulson and Bernanke panicked. We are now suffering the consequences whereby the bailed out institutions are still taking risks yet we are saddled with the cost of these programs. Let Citi or Morgan Stanley or AIG go down and there will be fewer gamblers in the future (“moral hazard”). Don’t believe the propaganda that we can’t do without them. They confuse Wall Street with the economy.
- Immediately cut all government spending 20% across the board, including the military. This should just be the start.
- Repeal Obama Care as soon as possible before an entitlement mentality sets in.
- Reform the Medicare structure by getting rid of the government as the manager of the system and give the elderly a voucher to spend on private health insurance.
- Reform Social Security by capping benefits now, push retirement ages out further, allow private option investment by young taxpayers, and prevent Congress from spending FICA payments.
Do these things, even just points 1 through 6, and I guarantee you that we will see an expanding economy and rising employment. If you want economic stagnation, high taxes, and a further rise in big government, stick with Obama, the Democrats and the Republicans. We know what we need to do.
This is a pretty interesting analysis. Jeff, what would you say to those who work in areas such as San Francisco, and see signs of recovery all around them? What would you say to those who point at increasing home sales, increasing consumer activity, heck, increasing traffic as a sign that the recovery is here?
It seems that you don’t believe a real recovery is here (and I am inclined to agree with you), so what would you offer as a reasonable explanation to these people whose own personal confirmation biases seem to suggest otherwise?
I would have to assess the unemployment level in SF, consider the fact that tech is booming as companies seek efficiencies, that home prices are bottoming out in CA and demand is up in Bay Area. I think we are seeing the result of stim money that is wearing out (nationally) and that consumer demand is sinking. Perhaps a bit of new liquidity. It looks good but mfg is slipping and retail is slipping. I don’t know how this will play out but H2 will be soft.
[...] raise rates again, when it could turn out to be premature? We could very well be headed for a decline in economic growth for the next half of the year, which would lessen the pressure for interest rates to [...]
Americans have to decide if they want government policies that encourage individual responsibility or dependency.
Every dependency based policy that creeps into being simply moves the margin further towards a neutered, uncreative, unmotivated and weak populace.
I’d go further than you; I’d eliminate subsidies for college education, home ownership, farm policies and let as much as possible every entity stand on its own. Why not phase out all of these things so the “shock” to the system won’t be too horrible?
This would be a “strong” policy for American growth…..and confidence. Right now, can anyone see anything political, virtually on any level, that isn’t advocating “weakness” policies?
to invest it wisely,
i too live in the bay area. we happen to live in an insulated economy that has alot of cash flows (government spending, UC berkeley, stanford, livermore lab, silicon valley, tourism, port of oakland, vibrant commerce, napa valley, great weather). but if you work in construction, housing, manufacturing, CRE, leasing, automobile trade, or several other industries, then you will know that this is not a recovery. these industries are hurting.
i would say your personal confirmation biases need less bias and alot more investigation of the numbers and the industries in the bay area. there is only one place more la-la-land-economy-disconnected than SF, and thats washington dc. if SF wasnt the #1 tourism destination of the US, no one would dare do business there. i own a small construction business and SF is the worst place to work in the state. i would say make more, wider ranging observations. drive thru concord on monument blvd for example. look around at all the auto dealers and empty stores. look at a home depot parking lot. find new houses in the framing stage, if you can. check the classified jobs section.
[...] This post was mentioned on Twitter by Politiconomic and Dona Rafaiel, joe barber. joe barber said: How To Start An Economic Recovery via The Daily Capitalist – Regular readers of The Daily Capitalist know I … http://tinyurl.com/22oo94y [...]
“Repeal Obama Care as soon as possible before an entitlement mentality sets in.”
Too late.
[...] By Jeff Harding, The Daily Capitalist [...]
Yes, but not yet for this program, Doc.
I put this up at Zero Hedge in response to this article and though I’d stick it here too:
We need to reconsider the concept of a debt based currency. Three hundred years ago it was a good idea because there were no economic measures to determine how much the money supply needed to grow and debt tends to grow in proportion to production. The problem is that production has to grow to pay off the debt and debt has to grow to finance production. The result is that every resource must be exploited as rapidly as possible to maintain production and a class of super-rentiers is established that must continually find ever more ways to invest their store of notational wealth. The result is this economic cyclone destroying human civilization and the environment it needs to exist.
This first occured to me in trying to figure out how Volcker cured inflation by raising interest rates. Inflation results from loose monetary policies, but higher rates reduce the demand for capital, while rewarding those with a surplus. So how did they bring supply in line with demand by penalizing demand? Obviously by having the Treasury run up the deficit at the same time. The difference between the Fed selling debt it is holding and the Treasury issuing new debt is that while both draw down surplus capital, by paying off those with a surplus of capital, the Fed just retires it, while the Treasury spends it back in ways the private sector wouldn’t, from infrastructure to the military to welfare. All of which encourage increased private sector spending and investment, even though some of it isn’t very productive in the long run. This increase in the private sector further absorbs excess capital, which also brings inflation down.
Of course, it is not politically viable to observe that large excesses of wealth are not economically useful, since those with it control whatever sectors of the economy and political structure they need to perpetuate it.
It would be easy enough to develop a viable budgeting process for the government. Simply break the bills into their constituent line items and have every legislator assign a percentage value to each one. Then put them back together in order of preference and have the president draw the line at what would be funded. Since the narrow range of items that would be close to the line would have far more people paying for them, than receiving the benefits, the political impulse to gratify voters would be much reduced. This is what actual budgeting is, drawing up one’s priorities and deciding what can be afforded. The problem is that it would eliminate all that government debt that is the alter ego of saved wealth.
What caused the mortgage crisis wasn’t the deadbeats taking out more loans than they could afford, but the need to find ways to invest savings, whether of actual rich people, or enormous pension plans. The same is true for derivatives as well. They are not about benevolently providing liquidity, but finding ways to create it, in order to create the illusion of ever more wealth.
Thinking that wealth can be maintained by simply loaning credit to people and governments which will never be able to pay it back is a joke. Money is drawing rights to productivity and we need to develop a production based currency, not a debt based one.
A market needs a medium of exchange and whomever controls that medium controls the market. Do we really want this medium to be a private business, or do we want it to be a public utility, like a road system? There are various public functions, like courts, police, military etc, which no sane person with any knowledge of history would like to see run as private enterprise. I suspect we will eventually find that banking and control of the money is a public function. Just as we have layers of government, from the local, to the national, a public banking system would be equally divided, so that the profits from managing a public currency would flow back into the communities and levels of the economy which generate that wealth in the first place and not have it drained off, either into large banks in NYC, or big government in Washington. In this way, such things as retirement plans, education spending, roads, etc. would be paid for locally and there wouldn’t be as much need for an enormous national government.
John Merryman, are you advocating an employer of last resort system over a banker of last resort system?
caleb,
I’m not sure of the connotations. As I see it, there are no perfect models, political, economic or religious. We just build on what we have, until it gets top heavy and falls down. So the question is what lessons do we learn and where do we go from here. I don’t think capitalism and free markets are synonymous, because capital tends to gravitate to itself and this leads to power centers and monopolies. Whatever we build, it has to start with a strong foundation and that means viable and sustainable economies. I think these work best on levels where personal trust can be maintained, in order to minimize what would be necessary regulation. So local economies that are generally self sustaining, but still function within larger networks. Mostly I think what we have now is going to collapse and there needs to be some generally workable model to start with and build on. The problem with how we treat currency now is that as private property, we like to hoard it, but as a medium of exchange, more money than productivity will cause the system to crash. So if we treat it only as a public utility, than people will be far more careful converting value into it, as it becomes a form of public property, so they will maintain value in social networks and environmental resources. It really is that way anyway. Just try printing some, if you think otherwise. By treating it as personal property, we essentially give the government and the banking system a hook into every transaction we make.
Jeff:
As always, great analysis and info.
I agree that none of our current leaders (Obama, Bernanke, Dems or Republicans) can “solve” the problems in this economy. I do think that stimulus that leaves behind improved roads, electric grid, broadband infrastructure, etc… is infrastructure worth focusing on in a slowing economy. Though it does not leave behind permanent jobs, it leaves behind better tools for the private sector to use (and improve efficiency).
I agree that we need to let banks and financial institutions fail. The amend/extend/pretend crap is just delaying true economic pricing of assets. I have been in real estate for 30+ yrs and I know that there is always plenty of real estate and small business financing available when assets trade at market pricing. The sooner we get to “market” the sooner lending will return.
I also agree that we have to encourage savings, not spending. Though this will slow the economy in the short run, we will eventually recover from a much sounder economic base.
I think one of the biggest problems that we have is that the process of compromise and legislating is just a field day for corporate lobbyist. The big lie is not that large corporations and the wealthy hate Washington, they hate when Washington doesn’t create rules that favor them over competitors. Look how bank regulators and minerals management were so infected with industry insiders that we actually ended up with huge bureaucracies that did NO regulating.
No matter who is in Washington, I have no confidence that any of these problems will be addressed. But keep up the great work and keep pounding away.
It is important that banks can fail, and it’s also important that debt that will never be paid back needs to be resolved to payable levels.
Regarding Keynes: Productivity is produced with division of labor, when a large number of labor is taken out, productivity drops, there is a decrease in earnings, labor, and production. So getting people back to work as quickly as possible isn’t as much of a zero sum game as you propose.
[...] I wonder if President Obama reads the same data as I do? Aside from the fact that the numbers the White House presented are false, the data are revealing the beginning of an economic slowdown which are clearly contra to the Administration’s claims that the economy is growing. The Fed is clearly worried as shown below in the minutes of its June meeting. In fact they expect years of slow growth. I wonder if Mrs. Romer talked to Chairman Bernanke before she boasted about her fake numbers? [...]
I agree with jag. I would add that we need to deregulate wherever possible. The “green rush” in california is due to deregulation. Keep that mindset going, and remove the programs that favor “weakness” – as you put it.