Goldman Sachs and bubbles
Listen to this heated debate on whether Goldman Sachs manipulated the market and engineered every bubble since the Great Depression. I reckon it's hard to justify such claim but without correcting the perverse incentives on Wall Street, traders of Goldman Sachs and alike will soon again risk the whole financial system in order to earn their big fat bonuses. I don't blame Goldman Sachs; I blame the misaligned incentive system. (source: On Point)
Bernanke: The Fed’s exit strategy
Ben Bernanke again (see his previous speech) outlines how the Fed will drain the liquidity out of the system in order to avoid the danger of inflation. The Fed got plenty of tools; but these are not what matter. What matters is whether the Fed can keep its independence in conducting monetary policy, and whether the Fed can find the right timing to tighten. I put 80% chance on that the Fed can keep its independence; but 20% chance on the Fed can find the right timing, given their failure to spot the housing bubble and the previous dot.com bubble. (Warning: this piece requires readers to have some basic understanding of Fed's balance sheet and common monetary policy tools)
The depth and breadth of the global recession has required a highly accommodative monetary policy. Since the onset of the financial crisis nearly two years ago, the Federal Reserve has reduced the interest-rate target for overnight lending between banks (the federal-funds rate) nearly to zero. We have also greatly expanded the size of the Fed’s balance sheet through purchases of longer-term securities and through targeted lending programs aimed at restarting the flow of credit.
These actions have softened the economic impact of the financial crisis. They have also improved the functioning of key credit markets, including the markets for interbank lending, commercial paper, consumer and small-business credit, and residential mortgages.
My colleagues and I believe that accommodative policies will likely be warranted for an extended period. At some point, however, as economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road. The Federal Open Market Committee, which is responsible for setting U.S. monetary policy, has devoted considerable time to issues relating to an exit strategy. We are confident we have the necessary tools to withdraw policy accommodation, when that becomes appropriate, in a smooth and timely manner.
The exit strategy is closely tied to the management of the Federal Reserve balance sheet. When the Fed makes loans or acquires securities, the funds enter the banking system and ultimately appear in the reserve accounts held at the Fed by banks and other depository institutions. These reserve balances now total about $800 billion, much more than normal. And given the current economic conditions, banks have generally held their reserves as balances at the Fed.
But as the economy recovers, banks should find more opportunities to lend out their reserves. That would produce faster growth in broad money (for example, M1 or M2) and easier credit conditions, which could ultimately result in inflationary pressures—unless we adopt countervailing policy measures. When the time comes to tighten monetary policy, we must either eliminate these large reserve balances or, if they remain, neutralize any potential undesired effects on the economy.
To some extent, reserves held by banks at the Fed will contract automatically, as improving financial conditions lead to reduced use of our short-term lending facilities, and ultimately to their wind down. Indeed, short-term credit extended by the Fed to financial institutions and other market participants has already fallen to less than $600 billion as of mid-July from about $1.5 trillion at the end of 2008. In addition, reserves could be reduced by about $100 billion to $200 billion each year over the next few years as securities held by the Fed mature or are prepaid. However, reserves likely would remain quite high for several years unless additional policies are undertaken.
Even if our balance sheet stays large for a while, we have two broad means of tightening monetary policy at the appropriate time: paying interest on reserve balances and taking various actions that reduce the stock of reserves. We could use either of these approaches alone; however, to ensure effectiveness, we likely would use both in combination.
Congress granted us authority last fall to pay interest on balances held by banks at the Fed. Currently, we pay banks an interest rate of 0.25%. When the time comes to tighten policy, we can raise the rate paid on reserve balances as we increase our target for the federal funds rate.
Banks generally will not lend funds in the money market at an interest rate lower than the rate they can earn risk-free at the Federal Reserve. Moreover, they should compete to borrow any funds that are offered in private markets at rates below the interest rate on reserve balances because, by so doing, they can earn a spread without risk.
Thus the interest rate that the Fed pays should tend to put a floor under short-term market rates, including our policy target, the federal-funds rate. Raising the rate paid on reserve balances also discourages excessive growth in money or credit, because banks will not want to lend out their reserves at rates below what they can earn at the Fed.
Considerable international experience suggests that paying interest on reserves effectively manages short-term market rates. For example, the European Central Bank allows banks to place excess reserves in an interest-paying deposit facility. Even as that central bank’s liquidity-operations substantially increased its balance sheet, the overnight interbank rate remained at or above its deposit rate. In addition, the Bank of Japan and the Bank of Canada have also used their ability to pay interest on reserves to maintain a floor under short-term market rates.
Despite this logic and experience, the federal-funds rate has dipped somewhat below the rate paid by the Fed, especially in October and November 2008, when the Fed first began to pay interest on reserves. This pattern partly reflected temporary factors, such as banks’ inexperience with the new system.
However, this pattern appears also to have resulted from the fact that some large lenders in the federal-funds market, notably government-sponsored enterprises such as Fannie Mae and Freddie Mac, are ineligible to receive interest on balances held at the Fed, and thus they have an incentive to lend in that market at rates below what the Fed pays banks.
Under more normal financial conditions, the willingness of banks to engage in the simple arbitrage noted above will tend to limit the gap between the federal-funds rate and the rate the Fed pays on reserves. If that gap persists, the problem can be addressed by supplementing payment of interest on reserves with steps to reduce reserves and drain excess liquidity from markets—the second means of tightening monetary policy. Here are four options for doing this.
First, the Federal Reserve could drain bank reserves and reduce the excess liquidity at other institutions by arranging large-scale reverse repurchase agreements with financial market participants, including banks, government-sponsored enterprises and other institutions. Reverse repurchase agreements involve the sale by the Fed of securities from its portfolio with an agreement to buy the securities back at a slightly higher price at a later date.
Second, the Treasury could sell bills and deposit the proceeds with the Federal Reserve. When purchasers pay for the securities, the Treasury’s account at the Federal Reserve rises and reserve balances decline.
The Treasury has been conducting such operations since last fall under its Supplementary Financing Program. Although the Treasury’s operations are helpful, to protect the independence of monetary policy, we must take care to ensure that we can achieve our policy objectives without reliance on the Treasury.
Third, using the authority Congress gave us to pay interest on banks’ balances at the Fed, we can offer term deposits to banks—analogous to the certificates of deposit that banks offer their customers. Bank funds held in term deposits at the Fed would not be available for the federal funds market.
Fourth, if necessary, the Fed could reduce reserves by selling a portion of its holdings of long-term securities into the open market.
Each of these policies would help to raise short-term interest rates and limit the growth of broad measures of money and credit, thereby tightening monetary policy.
Overall, the Federal Reserve has many effective tools to tighten monetary policy when the economic outlook requires us to do so. As my colleagues and I have stated, however, economic conditions are not likely to warrant tighter monetary policy for an extended period. We will calibrate the timing and pace of any future tightening, together with the mix of tools to best foster our dual objectives of maximum employment and price stability.
—Mr. Bernanke is chairman of the Federal Reserve.
What India must do to become an affluent country
Martin Wolf writes on FT on what India must do to catch up with China and become an affluent country in a generation. Compared to China, in my mind, India enjoys the advantage of being a democratic country (Indians may not feel the same way), but its caste system, poor infrastructure, and bureaucracy are really dragging its feet.
I am a true believer of competitions, including competitions between countries. Without China’s fast growth since 1978, India may not have had the urge to initiate its own reform in mid 90s; and without India rising in IT and innovation, China may still have specialized in manufacturing only. Competition can produce win-win situation. Most politicians focus on how to grabbing a bigger share of the same pie; economists, fundamentally optimists, focus on how to create a much bigger pie, even sharing a smaller part of it.
What India must do if it is to be an affluent country
What will the world economy – indeed, the world – look like after the financial crisis is over? Will this prove to be a mere blip or something more fundamental? Much of the answer will be provided by the performance of the two Asian giants, China and India. Rightly or wrongly, it is widely accepted that China will continue to grow very rapidly. But what is the likely future for India?
I attended debates on this question in Mumbai and Delhi two weeks ago. The occasion was the launch of a report prepared by the Centennial Group for this year’s Emerging Markets Forum.* It addresses a provocative question: what would need to change if India were to become an affluent country in one generation? The answer is: a great deal. But one thing is clear: after the performance of the past three decades, the goal is not laughable.
Since 1980 the average living standards of Chinese and Indians have, for the first time in the histories of these two ancient civilisations, experienced a sustained and rapid rise. In one generation, India’s gross domestic product per head rose by 230 per cent – a trend rate of 4 per cent a year. This would seem a fine accomplishment if China’s had not increased by 1,090 per cent – a trend rate of 8.7 per cent. Yet even if India has lagged behind, the change has been large enough for aspiration to replace resignation as the ethos of a large and rising proportion of Indians.
The recent past offers at least four further reasons for optimism. First, the rate of growth has been accelerating: over the five years up to and including 2008, the average annual rate of economic growth was 8.7 per cent, up from 6.5 per cent at the previous peak in 1999. Second, vastly higher savings and investment underpin this acceleration, with gross domestic savings up to 38 per cent of GDP in the financial year 2007-08. Third, India’s economy has globalised, with the ratio of trade in goods and services up to 51 per cent of GDP in the last quarter of 2008, up from 24 per cent a decade before. This was not far behind China’s 59 per cent of GDP (see chart below).
Finally, the democratic political system, for all its frailties, works. Indian democracy is a wonder of the political world. What happened in the past election seems a big development – the re-election of a Congress-led government, with a big increase in the party’s seats. It is widely believed that this reflects a choice of competence over caste and secularism over sect. Not least, the electorate registered approval of the competence and integrity of Manmohan Singh, the prime minister. I have been lucky to have known Dr Singh for three and a half decades. I admire nobody more. I only hope he is prepared to use his possibly final period in office boldly.
So what needs to happen if Indians are to enjoy an affluent lifestyle? The answer, suggests the report, is that India must sustain growth at close to 10 per cent a year over a generation. This is not inconceivable: China has managed that, from a lower base, over three decades. But it is a massive task, particularly for so huge, diverse and complex a country. Extraordinary change would have to occur, inside India and in India’s relationships with the world.
For this to be conceivable, at least four things would have to happen: the world must remain peaceful; the world economy must remain open; India must avoid the stagnation into which many middle-income countries have fallen; and, finally, the resource and environmental implications of its rise to affluence must be managed.
Moreover, India itself must overcome three big challenges: maintaining, indeed strengthening, social cohesion at a time of economic and social upheaval; creating a competitive and innovative economy; and playing a role in its region and the world commensurate with the country’s size and rising importance. In fundamental respects, India must turn itself into a different country.
Not least, as the report makes clear, India would have to be governed quite differently. In India a vigorous, albeit too often corrupt, democratic process has been superimposed on the “mindsets, institutional structures and practices inherited from the British Raj”. India has prospered despite government, not because of it. It is a miracle that the giant has fared as well as it has. But if this country is to prosper it must create infrastructure, provide services, promote competition, protect property and offer justice. The country must move from what the report calls “crony capitalism and petty corruption” to something different. The quality of government, widely believed to be deteriorating, must, instead, radically improve.
Just how far the transformation would have to go is shown by the “seven inter-generational issues” on which this report focuses: first, tackling disparities, not least among social groupings, but without further entrenching group-based entitlements and group-based politics; second, improving the environment, including the global environment; third, eliminating India’s pervasive infrastructure bottlenecks; fourth, transforming the delivery of public services, particularly in India’s ill-served cities; fifth, renewing education, technological development and innovation; sixth, revolutionising energy production and consumption; and, finally, fostering a prosperous south Asia and becoming a responsible global power.
I take two big things from the analysis in this report, one for India and another for the world.
For India, I conclude that even sustaining recent performance is going to be very hard. The era when the country could prosper just by stopping government from getting in the way is ending. India now requires efficient, service-providing government by competent technocrats and honest politicians. Of course, many foolish interventions still need to be removed. The government also needs to refocus its limited energy and resources on its essential tasks. But it must be able to perform these tasks far more effectively than it can today.
What I take for the world is that India, for all the huge challenges it confronts, is likely to continue its rise, if more slowly than the report assumes. The job of adjusting the familiar western ways of thinking about the world to the new realities has hardly begun. Within a decade a world in which the UK is on the United Nations Security Council and India is not will seem beyond laughable. The old order passes. The sooner the world adjusts, the better.
Remembering Peter Bernstein
I have planned to send out this earlier, but somehow I forgot. Peter Bernstein, one of the few shining stars in investing, co-founder of Journal of Portfolio Management, and author of nearly a dozen popular investment books, including Against the Odds, passed away in June. Here is a piece remembering him from WSJ (the highlights are mine). I truly enjoyed this piece, and his wisdom.
Mr. Bernstein saw the boom and bust of the 1920s first-hand in New York. In 1929, Mr. Bernstein’s father, Allen, sold the family leather factory “for a price he never dreamed he would get” and put all the proceeds into the stock market, buying “other people’s companies at prices they never dreamed they would see, either,” Mr. Bernstein recalled, paraphrasing his father.
Then the stock market crashed, nearly wiping out the family.
Mr. Bernstein never forgot the lesson. Seven decades later, he wrote: “What we like to consider as our wealth has a far more evanescent and transitory character than most of us are ready to admit.” He urged investors to regard their gains as a kind of loan that the lender — the financial market — could yank back at any time without any notice.
A classmate of John F. Kennedy in Harvard College’s class of 1940, Mr. Bernstein entered finance in 1941, joining the research department of the Federal Reserve Bank of New York.
After the U.S. was attacked by Japan, Mr. Bernstein tried to enlist as a pilot in the Air Force, but his poor eyesight made him ineligible. Instead, he served as an intelligence officer for the Office of Strategic Services in London during the Blitz, where he said he learned mental resilience.
In his almost 70-year career, he taught economics at Williams College, worked as a portfolio manager at Amalgamated Bank and ran the investment-counseling firm of Bernstein-Macaulay, co-founded by his father and Frederick Macaulay, who invented the modern discipline of bond investing.
In 1974, as Wall Street was suffering its worst market decline since 1929, Mr. Bernstein co-founded the Journal of Portfolio Management to improve risk management with insights from academic research.
His introduction to the maiden issue reads as if it were written yesterday: “How could so many have failed to see that all the known parameters were bursting apart?…It was precisely our massive inputs and intimate intercommunication that made it impossible for most of us to get to the exits before it was too late.”
He was the author of 10 books, five of which he published after the age of 75. Two of them, “Capital Ideas,” a history of modern finance, and “Against the Gods,” a dazzling survey of probability and risk, were international best sellers. With his wife and business partner, Barbara Soskin Bernstein, Mr. Bernstein also published “Economics & Portfolio Strategy,” a biweekly newsletter.
Mr. Bernstein generally shunned making black-and-white predictions, but in an interview with The Wall Street Journal in early 2008, he warned that “we are going to have an extremely risk-averse economy for a long time….The people who think we will have turned [the corner economically] in 2009 are wrong.”
Late in his life, Mr. Bernstein often joked that he had made his living for decades by repeatedly “telling people what they know only too well already.”
In 1970, he asked rhetorically, “What are the consequences if I am wrong?” and said “no investment decisions can be rationally arrived at unless they are [based upon] the answer to this question.” He counseled investors to take big risks with small amounts of money rather than small risks with big amounts of money.
The same focus on the consequences of error was one of the main themes of “Against the Gods,” which he published more than a quarter-century later.
Also in 1970, Mr. Bernstein wrote: “We simply do not know what the future holds.” Over the ensuing decades, he returned again and again to that phrase in his speeches, articles and books, because he felt it captured the central truth about investing.
Asked in 2004 to name the most important lesson he had to unlearn, he said: “That I knew what the future held, that you can figure this thing out. I’ve become increasingly humble about it over time and comfortable with that. You have to understand that being wrong is part of the [investing] process.”
Greenspan on the threat of inflation
In this FT piece, Maestro Greenspan identifies another channel that inflation may be the real threat down the road. He hypothesizes that equity market does not purely reflect or predict what is going on in the real economy; but it causes the real economy to swing both ways, and it operates through company's balance sheet. "I recognize that I accord a much larger economic role to equity prices than is the conventional wisdom. From my perspective, they are not merely an important leading indicator of global business activity, but a major contributor to that activity, operating primarily through balance sheets."
Having dealt with the Congress for many years, Greenspan is really worried about politicians messing up with the Fed. "But I see inflation as the greater future challenge. If political pressures prevent central banks from reining in their inflated balance sheets in a timely manner, statistical analysis suggests the emergence of inflation by 2012."
Adding to the problem is the bleak fiscal health in the country and the huge budget deficits will induce politicians to print more money to finance the debt.
With Greenspan on board, now in the inflation camp, we have John Taylor (the author of Taylor Rule), Fred Mishkin (former Fed governor), Jim Grant, Marc Farber and Jim Rogers (all legendary investors); in the deflation camp, we have Paul Krugman (2008 Nobel prize winner in economics), Robert Shiller (owner of Case-Shiller index), David Rosenberg (former ML chief economist), Ben Bernanke (Fed chairman) and Janet Yellen (SF Fed president). With so much divide in both academics and the profession, and so much uncertainties ahead of us, prudent investors should always hedge the inflation risk in their portfolio. Both TIPs and gold serve the purchase. If the Fed manages to rein the liquidity in a timely manner and inflation is under control, you are unlikely to lose your investment value on both; if inflation runs rampant, you are a sure winner.
Now here I give you Alan Greenspan:
Inflation – the real threat to sustained recovery
The rise in global stock prices from early March to mid-June is arguably the primary cause of the surprising positive turn in the economic environment. The $12,000bn of newly created corporate equity value has added significantly to the capital buffer that supports the debt issued by financial and non-financial companies. Corporate debt, as a consequence, has been upgraded and yields have fallen. Previously capital-strapped companies have been able to raise considerable debt and equity in recent months. Market fears of bank insolvency, particularly, have been assuaged.
Is this the beginning of a prolonged economic recovery or a false dawn? There are credible arguments on both sides of the issue. I conjectured over a year ago on these pages that the crisis will end when home prices in the US stabilise. That still appears right. Such prices largely determine the amount of equity in homes – the ultimate collateral for the $11,000bn of US home mortgage debt, a significant share of which is held in the form of asset-backed securities outside the US. Prices are currently being suppressed by a large overhang of vacant houses for sale. Owing to the recent sharp drop in house completions, this overhang is being liquidated in earnest, suggesting prices could start to stabilise in the next several months – although they could drift lower into 2010.
In addition, huge unrecognised losses of US banks still need to be funded. Either a stabilisation of home prices or a further rise in newly created equity value available to US financial intermediaries would address this impediment to recovery.
Global stock markets have rallied so far and so fast this year that it is difficult to imagine they can proceed further at anywhere near their recent pace. But what if, after a correction, they proceeded inexorably higher? That would bolster global balance sheets with large amounts of new equity value and supply banks with the new capital that would allow them to step up lending. Higher share prices would also lead to increased household wealth and spending, and the rising market value of existing corporate assets (proxied by stock prices) relative to their replacement cost would spur new capital investment. Leverage would be materially reduced. A prolonged recovery in global equity prices would thus assist in the lifting of the deflationary forces that still hover over the global economy.
I recognise that I accord a much larger economic role to equity prices than is the conventional wisdom. From my perspective, they are not merely an important leading indicator of global business activity, but a major contributor to that activity, operating primarily through balance sheets. My hypothesis will be tested in the year ahead. If shares fall back to their early spring lows or worse, I would expect the “green shoots” spotted in recent weeks to wither.
Stock prices, to be sure, are affected by the usual economic gyrations. But, as I noted in March, a significant driver of stock prices is the innate human propensity to swing between euphoria and fear, which, while heavily influenced by economic events, has a life of its own. In my experience, such episodes are often not mere forecasts of future business activity, but major causes of it.
For the benevolent scenario above to play out, the short-term dangers of deflation and longer-term dangers of inflation have to be confronted and removed. Excess capacity is temporarily suppressing global prices. But I see inflation as the greater future challenge. If political pressures prevent central banks from reining in their inflated balance sheets in a timely manner, statistical analysis suggests the emergence of inflation by 2012; earlier if markets anticipate a prolonged period of elevated money supply. Annual price inflation in the US is significantly correlated (with a 3½-year lag) with annual changes in money supply per unit of capacity.
Inflation is a special concern over the next decade given the pending avalanche of government debt about to be unloaded on world financial markets. The need to finance very large fiscal deficits during the coming years could lead to political pressure on central banks to print money to buy much of the newly issued debt.
The Federal Reserve, when it perceives that the unemployment rate is poised to decline, will presumably start to allow its short-term assets to run off, and either sell its newly acquired bonds, notes and asset-backed securities or, if that proves too disruptive to markets, issue (with congressional approval) Fed debt to sterilise, or counter, what is left of its huge expansion of the monetary base. Thus, interest rates would rise well before the restoration of full employment, a policy that, in the past, has not been viewed favourably by Congress. Moreover, unless US government spending commitments are stretched out or cut back, real interest rates will be likely to rise even more, owing to the need to finance the widening deficit.
Government spending commitments over the next decade are staggering. On top of that, the range of error is particularly large owing to the uncertainties in forecasting Medicare costs. Historically, the US, to limit the likelihood of destructive inflation, relied on a large buffer between the level of federal debt and rough measures of total borrowing capacity. Current debt issuance projections, if realised, will surely place America precariously close to that notional borrowing ceiling. Fears of an eventual significant pick-up in inflation may soon begin to be factored into longer-term US government bond yields, or interest rates. Should real long-term interest rates become chronically elevated, share prices, if history is any guide, will remain suppressed.
The US is faced with the choice of either paring back its budget deficits and monetary base as soon as the current risks of deflation dissipate, or setting the stage for a potential upsurge in inflation. Even absent the inflation threat, there is another potential danger inherent in current US fiscal policy: a major increase in the funding of the US economy through public sector debt. Such a course for fiscal policy is a recipe for the political allocation of capital and an undermining of the process of “creative destruction” – the private sector market competition that is essential to rising standards of living. This paradigm’s reputation has been badly tarnished by recent events. Improvements in financial regulation and supervision, especially in areas of capital adequacy, are necessary. However, for the best chance for worldwide economic growth we must continue to rely on private market forces to allocate capital and other resources. The alternative of political allocation of resources has been tried; and it failed.
The writer is former chairman of the US Federal Reserve
Two American Models: California vs. Texas
California is broke; Texas performs the best during this recession.
A debate on two different American models and who may have America’s future. From my favorite On Point with Tom Ashbrook at local Boston station.
Forever, it seemed, California was the bright horizon of the American dream. The Golden State, with surf and mountains, high tech and endless bounty.
Now, California is broke. Worse than broke. And if you look at the economic numbers, the new American champ among the fifty states is… Texas. The Lone Star State. Immigrants, ranchers, oil men, builders. The fastest-growing population in the country.
So, is this the very different new horizon of the American dream? Texas?
This Hour, On Point: California, Texas, and the debate over who may have the model for the American future.
China is building strategic reserve in commodities
The earlier evidence was further confirmed by more data recently that China has been stockpiling copper and other commodities strategically. This is a smart move on Chinese side, but it shows the recovery in China was not strong as the commodity price would have indicated. Read this analytical piece from WSJ.
What is China going to do with all that copper? Move the futures markets, for one thing.
Bolstered by stockpiling, the country’s imports of the red metal in the first half jumped 69% from year-earlier levels. Seizing upon last year’s drop in prices, China’s State Reserve Bureau now holds at least 235,000 metric tons of copper, nearly as much as the London Metal Exchange warehouses hold to back futures trading.
Arbitragers followed suit, after the SRB’s buying helped push copper prices inside China well above those abroad. Deutsche Bank estimates factories and warehouses in the country hold as much as one million metric tons of copper in total — equivalent to nearly a month’s global consumption.
![[copper]](https://s.wsj.net/public/resources/images/AM-AG376_COPPER_NS_20090715055228.gif)
Meanwhile, LME copper futures are up 63% since February. What next? The market’s already proved its susceptibility to speculation about the SRB’s next move. In June, reports the government had turned seller fueled a sharp price retreat.
A paucity of information doesn’t help. An official from China’s National Development and Reform Commission last month said stockpiling had ceased. But not everyone’s convinced. After all, with copper still well below last year’s peak of nearly $9,000 a metric ton, China might want to keep building its position.
Bulls also say investment in power-generation capacity, a recovering construction industry, and buoyant car sales may see China gobbling up its copper reserves. This is all causing a wide divergence in views for the second half of the year. Price targets range from $3,500 a metric ton, a 31% drop from current levels, to $7,000 a metric ton, a 37% rise. Even more than usual, the outcome will be in Beijing’s hands.
The Economy Is Even Worse Than You Think
Opinion piece from WSJ: Unemployment is worse than you think. This does not bode well for consumptions, which accounts for 70% of American economy, and may dash any hope of a quick turnaround.
The recent unemployment numbers have undermined confidence that we might be nearing the bottom of the recession. What we can see on the surface is disconcerting enough, but the inside numbers are just as bad.
The Bureau of Labor Statistics preliminary estimate for job losses for June is 467,000, which means 7.2 million people have lost their jobs since the start of the recession. The cumulative job losses over the last six months have been greater than for any other half year period since World War II, including the military demobilization after the war. The job losses are also now equal to the net job gains over the previous nine years, making this the only recession since the Great Depression to wipe out all job growth from the previous expansion.
Here are 10 reasons we are in even more trouble than the 9.5% unemployment rate indicates:
![[Commentary]](https://s.wsj.net/public/resources/images/ED-AJ832_zucker_D_20090713172744.jpg)
– June's total assumed 185,000 people at work who probably were not. The government could not identify them; it made an assumption about trends. But many of the mythical jobs are in industries that have absolutely no job creation, e.g., finance. When the official numbers are adjusted over the next several months, June will look worse.
– More companies are asking employees to take unpaid leave. These people don't count on the unemployment roll.
– No fewer than 1.4 million people wanted or were available for work in the last 12 months but were not counted. Why? Because they hadn't searched for work in the four weeks preceding the survey.
– The number of workers taking part-time jobs due to the slack economy, a kind of stealth underemployment, has doubled in this recession to about nine million, or 5.8% of the work force. Add those whose hours have been cut to those who cannot find a full-time job and the total unemployed rises to 16.5%, putting the number of involuntarily idle in the range of 25 million.
– The average work week for rank-and-file employees in the private sector, roughly 80% of the work force, slipped to 33 hours. That's 48 minutes a week less than before the recession began, the lowest level since the government began tracking such data 45 years ago. Full-time workers are being downgraded to part time as businesses slash labor costs to remain above water, and factories are operating at only 65% of capacity. If Americans were still clocking those extra 48 minutes a week now, the same aggregate amount of work would get done with 3.3 million fewer employees, which means that if it were not for the shorter work week the jobless rate would be 11.7%, not 9.5% (which far exceeds the 8% rate projected by the Obama administration).
– The average length of official unemployment increased to 24.5 weeks, the longest since government began tracking this data in 1948. The number of long-term unemployed (i.e., for 27 weeks or more) has now jumped to 4.4 million, an all-time high.
– The average worker saw no wage gains in June, with average compensation running flat at $18.53 an hour.
– The goods producing sector is losing the most jobs — 223,000 in the last report alone.
– The prospects for job creation are equally distressing. The likelihood is that when economic activity picks up, employers will first choose to increase hours for existing workers and bring part-time workers back to full time. Many unemployed workers looking for jobs once the recovery begins will discover that jobs as good as the ones they lost are almost impossible to find because many layoffs have been permanent. Instead of shrinking operations, companies have shut down whole business units or made sweeping structural changes in the way they conduct business. General Motors and Chrysler, closed hundreds of dealerships and reduced brands. Citigroup and Bank of America cut tens of thousands of positions and exited many parts of the world of finance.
Job losses may last well into 2010 to hit an unemployment peak close to 11%. That unemployment rate may be sustained for an extended period.
Can we find comfort in the fact that employment has long been considered a lagging indicator? It is conventionally seen as having limited predictive power since employment reflects decisions taken earlier in the business cycle. But today is different. Unemployment has doubled to 9.5% from 4.8% in only 16 months, a rate so fast it may influence future economic behavior and outlook.
How could this happen when Washington has thrown trillions of dollars into the pot, including the famous $787 billion in stimulus spending that was supposed to yield $1.50 in growth for every dollar spent? For a start, too much of the money went to transfer payments such as Medicaid, jobless benefits and the like that do nothing for jobs and growth. The spending that creates new jobs is new spending, particularly on infrastructure. It amounts to less than 10% of the stimulus package today.
About 40% of U.S. workers believe the recession will continue for another full year, and their pessimism is justified. As paychecks shrink and disappear, consumers are more hesitant to spend and won't lead the economy out of the doldrums quickly enough.
It may have made him unpopular in parts of the Obama administration, but Vice President Joe Biden was right when he said a week ago that the administration misread how bad the economy was and how effective the stimulus would be. It was supposed to be about jobs but it wasn't. The Recovery Act was a single piece of legislation but it included thousands of funding schemes for tens of thousands of projects, and those programs are stuck in the bureaucracy as the government releases the funds with typical inefficiency.
Another $150 billion, which was allocated to state coffers to continue programs like Medicaid, did not add new jobs; hundreds of billions were set aside for tax cuts and for new benefits for the poor and the unemployed, and they did not add new jobs. Now state budgets are drowning in red ink as jobless claims and Medicaid bills climb.
Next year state budgets will have depleted their initial rescue dollars. Absent another rescue plan, they will have no choice but to slash spending, raise taxes, or both. State and local governments, representing about 15% of the economy, are beginning the worst contraction in postwar history amid a deficit of $166 billion for fiscal 2010, according to the Center on Budget and Policy Priorities, and a gap of $350 billion in fiscal 2011.
Households overburdened with historic levels of debt will also be saving more. The savings rate has already jumped to almost 7% of after-tax income from 0% in 2007, and it is still going up. Every dollar of saving comes out of consumption. Since consumer spending is the economy's main driver, we are going to have a weak consumer sector and many businesses simply won't have the means or the need to hire employees. After the 1990-91 recessions, consumers went out and bought houses, cars and other expensive goods. This time, the combination of a weak job picture and a severe credit crunch means that people won't be able to get the financing for big expenditures, and those who can borrow will be reluctant to do so. The paycheck has returned as the primary source of spending.
This process is nowhere near complete and, until it is, the economy will barely grow if it does at all, and it may well oscillate between sluggish growth and modest decline for the next several years until the rebalancing of excessive debt has been completed. Until then, the economy will be deprived of adequate profits and cash flow, and businesses will not start to hire nor race to make capital expenditures when they have vast idle capacity.
No wonder poll after poll shows a steady erosion of confidence in the stimulus. So what kind of second-act stimulus should we look for? Something that might have a real multiplier effect, not a congressional wish list of pet programs. It is critical that the Obama administration not play politics with the issue. The time to get ready for a serious infrastructure program is now. It's a shame Washington didn't get it right the first time.