The employment numbers that came out today (Friday) were very bad and caught most economists and analysts by surprise. Nothing the Fed has done has worked. Once again the ranks of the unemployed grow, wages flatten out, manufacturing weakens, GDP declines, and savings are spent to maintain lifestyles. The U.S. and much of the rest of the world is heading toward stagnation, if not recession. Yet, despite the failures of central bank policies, they will persist in doing the same wrong thing again. Here we review the data and explain why things are heading south.
The U.S. recovery appears to be tracking a similar pattern of the past three years, in which the economy gains steam during the winter only to run down in the spring and summer. But the situation this time is puzzling, given that there hasn’t been a gas-price spike—prices instead have fallen–or a disaster, such as last year’s Japanese earthquake and tsunami.
The above comment is from the Wall Street Journal’s story on today’s poor employment report from the BLS. Piled on top of this was news that manufacturing is softening, wages and hours are declining, and the manufacturing PMIs for the UK, Eurozone, and China are declining. And we were informed yesterday that GDP is sinking. The U.S. markets reacted badly: most were down about 2.5%, with the Russell 2000 down 3.2%.
The given explanations for these events are all wrong and they have been wrong since 2008 as mainstream economists are “surprised” on a regular basis. The news media on Friday offered no valid explanations of current events, and as I listened to the news, commentators were making it up as the went along, trying to make sense of what looks like a worldwide slowdown. Our fellow homo sapiens can’t not try to explain events they don’t understand.
What is causing the worldwide slowdown are not natural events but rather the result of manmade policies from central banks and governments. Yet economists continue to recommend the same policies that caused the economic decline. Will things ever change?
Let’s examine the data first.
Employment, the chief motivator of politicians and central bankers, was “surprisingly” (again, that word) weak. Here is a quick summary from Econoday:
New job creation was weak, the unemployment rate increased, hourly earnings were weak, disposable personal income was weak, the work week went down, and the all-important (to the Fed) PCE price index declined (April). This is not what our leaders expected. Here’s a picture:
For those of you looking for the detail on U-6, long-term unemployed, here is the table:
If I were Ben Bernanke or President Obama, I would like to see these data going the other way if I wanted to keep my job.
There is always a lot of controversy about the actual rate of employment as reflected in the number of employed versus the population at large or as compared to the workforce population. The official numbers are as follows: the population to employment ratio is 58.6% and the workforce to population ratio is 63.8%.
My fellow blogger Mish always does an excellent take on the dubious BLS calculations based on the birth-death model of business creation, the real ratio of a growing population to employed, and the dropout rate. I would refer you to his excellent article on these data.
Whatever the real story is, it isn’t good.
Part of the data that I believe is most important, other than the headline numbers of growing unemployment, is the PCE price index and the personal savings rate.
As I mentioned above, the PCE price index went down in April (+0.1%) compared to March (+0.2%). To the Fed this smells like (i) recession and (ii) deflation.
The personal savings rate went down as well, to 3.4% in April as compared to 3.5% in March. This tells us that consumers are funding PCE with savings, since disposable personal income is flat (+0.2% in April, same as March).
What the fallout of these data is for planning purposes is:
1. The Administration is seriously concerned since an election is only 5 months away.
2. The Fed is seriously concerned since none of their monetary policies are working as planned.
3. “Inflation” as the Fed defines it is looking more like the much feared “deflation.” The Fed will not let “deflation” happen.
4. The only thing the Fed really knows how to do is print money, and since the inflation hawks on the FOMC have nothing to complain about, it makes another round of quantitative easing likely. And soon.
5. The decline in savings further diminishes the chances of a recovery since what the economy needs is (i) to liquidate the bad investments made during the boom (malinvestment) and (ii) capital from real savings to make it grow again. While one could argue that such “savings” are the product of two prior rounds of QE and not “real savings” as defined by Austrian economic theory, I don’t think that is the case. A substantial part of these savings is “real savings” and it is being destroyed.
Mainstream economists treat our current mini-cycles as somewhat natural events, divorced from any action by the Fed and the Administration (see opening quote). One only need to look at Fed policies (QE, ZIRP, and money supply) as we “Austrians” do to get the real answers.
The theory part of the problem is that this administration still believes that Keynesian economics is valid and therefore you can spend your way out of problems. More on that later.
The core problem is that over the past dozen years there was a major shift of manufacturing jobs into China. The true affects of that “structural” change were masked by the housing bubble which created a lot of good paying construction jobs. So after the housing bubble burst there were no manufacturing jobs or construction jobs and any money printed borrowed twisted or eased flowed out of the country bringing back goods that added little to GDP. It also financed the deficit but that is a story for another day as well.
The point is that because of the structural change that occurred none of the old methods will or can work — all that will happen is we will run up the debt in much greater proportion than any stimulus that might be created. The really bad part of our problem is that we are apparently teaching an economic theory that does work in our universities today.
Keynesian Economics Debunked
John Maynard Keynes, an English mathematician, developed a set of theories during the Great Depression that were published in his 1935 book titled The General Theory of Employment Interest, and Money. Keynes developed his theories to explain why we had the Great Depression and how to get us out and further to prevent it from happening again. His theories of an active federal government are those that our government is using today in an attempt at getting us out of the jobs predicament that we are now in.
The General Theory was designed to replace Laissez-faire (minimum government) economics as first promoted by Adam Smith in his 1776 book An Inquiry into the Nature and the Causes of the Wealth of Nations. Smith’s free market is the exact opposite of Keynes’ views that savings were bad and that government should borrow money to spend during a down turn and then pay it off on the upside. Although there was some good in Keynes’ work all the politicians heard was that savings were bad so they could tax wealth and that deficit spending was required to promote consumption.
Milton Friedman along with Anna Schwartz published a book in 1965 titled A Monetary History of the United States, 1867-1960 which along with other work of his got him a Nobel Prize in Economics. They showed how the Great Depression was caused by the actions of the Federal Reserve first in allowing the credit bubble that lead to the market crash of 1929 and then in collapsing the U.S. banking system by raising the interest rate. This was the first explanation of what actually caused the Depression and this and later works showed how Keynes was wrong about savings and deficit spending.
Without getting into all the gory economic details there are two problems associated with Keynesian economics as practiced today. The first problem is deficit spending, one of the key parts of an active government (meaning one that tries to control economic activities), where all governments find it very easy to spend but impossible to not spend more. The second is that when government spends with taxed or borrowed money it is incapable of spending on the right things since all the spending is controlled by politics (meaning getting money into areas that will benefit their campaign contributors) and the inherent bureaucracy and red tape means that it can not be done quickly.
The American Recovery and Reinvestment Act of 2009 just like FDR’s programs didn’t solve the problem because the government created the problem and then made things worse fixing the wrong problem. Gretchen Morgenson and Joshua Rosner in their 2011 book Reckless Endangerment showed how the government was a major player in the cause of the housing bubble and then Michael Grabell in his book Money Well Spent? The Truth behind The Trillion-Dollar Stimulus, The Biggest Economic Recovery Plan in History shows, not intentionally, how the stimulus money was squandered.
In both the 1929 and the 2008 events, the bubble was caused by the Federal Reserve and its cheap money policies. That easy money was then followed by blaming the problem on others and then conducting massive government spending programs that didn’t address the core issues and therefore resulted in a prolonged jobless recovery.
In the early 1930’s after the crash when everything went to hell after the Fed collapsed the banking system the government tried to spend its way out of the predicament that it had created. FDR’s works programs did some good but that didn’t fix the broken banking system and so it took WW II to get things moving again. Send the men to war instead of giving them jobs?
In 2009 after the crash when everything went to hell after the FED allowed the housing bubble to develop the government put its stimulus money into pet projects and earmarks known as “pork” that as of today have done little to get the jobs back. But very little was done to stop the home foreclosures that were destroying the middle and lower classes and which was the heart of the problem. Will it take another world war to fix the problem? On top of this they fixed a non existent problem in the Affordable Health Care act of 2010 that put an additional burden on business by making it more expensive to have workers. This was insane to do when the lack of jobs was the problem.
Keynes made a critical error in his theories on saying that savings were bad for without savings there could be no investment and without investment there could be no growth. In fact, if taken literally as Keynes wrote it and there was no savings (he thought that would give full employment) then we would use up our capital stock and within a short period of time have no production everything would be broken and there would be nothing to replace it. Mark Skousen explains this in his 2007 book The Big Three in Economics Adam Smith Karl Mark and John Maynard Keynes. And the flaws in Keynes work were known about long before this book was published.
The American academic élites tell us how we need to listen to them as they know best because they are so smart. Read David Haiberstam’s 1972 book The Best and the Brightest on how we got into Vietnam and you may question that. Apparently none of those that put the Stimulus together had ever bothered to read the real reasons for the Great Depression and why Keynes theories were not valid. This was obvious in Grabell’s book as the government economists were trying to duplicate what FDR did — and they did. They spend a lot of money and got little for it just like FDR.
The American intellectuals tell us how smart they are and therefore they should have known that the Stimulus program would not work, but they went ahead with doing it anyway. It seems that it was more important to them to get all their transformative programs passed so they could make us more like a centrally planed economy such as those in the EU. We know the EU is doing very well today unlike us and so following their lead does make perfect sense.
Capitalism is not obsolete what is obsolete are the politicians and their supporters making laws to favor various groups that then distorts the free market and leads to all the various bubbles that have created so much havoc in our country. The Sovereign debt bubble that has also been created is now about to burst and it will be worse then 2008.
David,
I followed your argument above and mostly agree with it.
One item jumped out at me: ‘…the market crash of 1929 and then in collapsing the U.S. banking system by raising the interest rate.’ Explain how raising the interest rate collapsed the banking system. Higher interest rates will lead to greater savings (money in the bank) but also fewer loans being made (but paying a higher rate of interest) and more interest paid to depositors. Were interest rates the biggest reason for banks going out of business? I suspect non-performing loans due to a brutal economy (bankrupt people and businesses) were the biggest factor.
Considering deflation was the occurring, why on earth would the Fed RAISE interest rates?!
And
You note nothing is being done about home foreclosure this time around. What can be done? If people paid way too much for thier house and have a huge mortgage and then lose thier job and can’t make the payments, what govt policies can fix that?
There were multiple events going on back then and the interest rate was only one of them you need to read Friedman’s work but the reason it was raised was to prevent Gold from moving out of the country. Although you are correct in that high interest rates bring greater savings and then more investment it also means that less money is being spent in the economy. That is the reason that Bernanke is lowering the rate today. Unfortunately back then after ’29 some banks failed and then with the factional reserve system the FED in essence tighten up credit so people pulled out savings to live on. Then by pulling out all the Gold a run on the banks started and the FED doubled down on the policy that was collapsing the system. There were three waves of collapse over 3 or 4 years — its been a while since I studied this so bear with my limited explanation.
You can still get “A Monetary History of the United States, 1867-1960″ on Amazon if you want to get the real story from the two that figured it out.
The key to John Maynard Keynes and his solution was that any savings were bad and that all it did was pull money out of the system which meant higher unemployment. A somewhat similar view that Karl Marx had with the labor theory of value. The problem with government intervention is that it is always driven by politics and so by definition it is never going to be what is really needed.
As to the question on housing — we spent a lot of time and money doing a lot of things that had nothing to do with housing such as the stimulus affordable health care and financial reform while home prices were plummeting. Not that I agree with government intervention but if they took all that money they wasted and instead bought all the bad mortgages from the banks and then did a managed collapse it might have been better. But then they would not have been able to actually do that so we are stuck where we are.
And where we are is at the start of a second recession as the sovereign debt bubble collapses.
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Actually, Milton Friedman was just a conservative Keynesian when you analyze what he concludes. He fails to understand that the problem is not the bust, but the bubble. By reflating the economy, you do nothing to solve problems of malinvestment caused by the bubble, which, as you correctly point out, was caused by the Fed. A much better explanation of the Great Depression is Murray Rothbard’s “America’s Great Depression.”
Actually I can’t fathom how you could think that since he did not believe in government spending. All his work showed how it was impossible for government to do much of anything right. He did make suggestion as to how to do things better if there was no way to not do something like the negative income tax and how to manage the money supply if you didn’t get rid of the FED. Have you actually read is work?
He believed that money supply pumping was a key to avoiding recessions. It’s like trying to stop the thermometer from going higher. He never understood the real causes of boom and bust. He was correct on fiscal stimulus, and in that respect is why I see him as a conservative Keynesian. Monetarism is a failed theory. The Fed is the problem not the solution. I recommend any number of works on monetary theory from the Austrian perspective which you will find in my Reading List page, above. Thanks for your comments.
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