Swans Commentary » swans.com October 18, 2010  



The Economy Is Not Coming Back
Part II: The Reasons it Won't


by Gilles d'Aymery





Read the first part of this essay, "A Short History of the Maelstrom."


(Swans - October 18, 2010)  The thinking in some quarters where so-called "experts" abound is that the road to recovery and the creation of much needed jobs ought to be driven by demand. Consumption spending, goes that thinking, will lead businesses to invest in productive assets, banks to lend again, and bring the unemployed masses back into the workforce. Since the private sector is unable or unwilling to do its part, it is then up to the government to pick up the tab and stimulate the economy. As an economic mini-commentator has put it, "[G]overnment spending must increase to make up for the slack in demand and reduce unemployment. That means larger budget deficits until households have patched their balance sheets and can spend again at pre-crisis levels." (1) This is a perfectly reasonable Keynesian methodology that has worked in times past. However, it misses the fact that the economic crisis is the result of both over-production -- a tremendous overhang of productive assets -- and over-consumption fueled by cheap credit and ballooned household debt, compounded by the shenanigans of the financial sector (2) orchestrated at the highest levels of political power by "brilliant" men. (3) It also misses the point that this crisis is the "mother of all crises." It has hit production, consumption, public and private debts, ecological disasters, all in the midst of a financial system that remains in shambles, as Raghuram Rajan clearly explains in an October 12, 2010, Der Spiegel interview. (4)

In the wake of these tsunamis, the Federal Reserve (Fed) and the US Treasury went to work and injected trillions of dollars in the financial sector through monetary and fiscal policies and in Main Street through an economic stimulus. Although some economists argue that the Obama stimulus package ($850 billion-plus) has been insufficient as it did not match the output gap -- that it was, in the words of Larry Summers, only a tool to avoid "catastrophic failure" (real, deep, 1930s-like Depression), a sort of "insurance package" -- these policies have served their purpose. Deep depression has so far been forestalled and unemployment kept in check, albeit at a hidden increasing rate. But recovery has not taken place. Why? And why won't it?

As stated in Part I, the U.S. is in a latent depression. No public stimulus or austerity measures can overlook or change the actualities. The system is in a bind.

First of all, the country is crippled by a staggering amount of household debt. According to the Fed, household debt amounted to almost $14 trillion in the second quarter of 2010, only $200 billion less than a year ago. Credit card liabilities declined to $832 billion from $915 billion for the same period, largely the result of bank write-offs (known as charge-offs). Defaulters, of course, lose their credit rating and won't be able to borrow in the future, except at usurious rates. (Some homeowners stopped paying their mortgage in order to pay their revolving debts.) (5) Total student loan debt is a mere $830 billion. ("The cost of a college education has risen, in real dollars, by 250 to 300 percent over the past three decades," according to Christopher Shea of The Boston Globe.) (6)

Secondly, these debts have been compounded by the residential real estate crash -- the mother of all bubbles -- in which some $8 trillion in equity have vanished. Median house prices have dropped between 20 and 30 percent (and even more in some states like Florida and California). Over six million households have already lost their homes to foreclosure. Another 4.2 million are in or near foreclosure. At the peak of the market in 2006, 69 percent of Americans "owned" (through their lenders) a home. It is now down to 65 percent, and notwithstanding the recent foreclosure moratorium there may be over 3 million other homes lost in the next couple of years. Which means that there is a huge oversupply of houses on the market. Note that this situation has a direct impact on job creation since people, unable to sell their homes without bearing a substantial loss, can hardly relocate (even if they could get a job elsewhere). In other words, the work force has lost its mobility due to the real estate freeze. Add to this dire state of affairs the soaring commercial vacancies (and defaults) that has also led to a huge oversupply of office buildings and stores, and it then becomes quite understandable that the construction sector, the major engine of the US economy, is going to remain in the doldrums for years to come. (7)

So, the U.S. is confronted with both an overhang of debt and an oversupply of depreciated or idle assets (which includes not only construction, but many other sectors, especially in transportation).

Thirdly, the country is also confronted with the Baby-Boom Generation that will begin retiring next year. According to Wikipedia, "The United States Census Bureau considers a baby boomer to be someone born during the demographic birth boom between 1946 and 1964." That's about seventy-six million people or close to 25 percent of the population. Over 4 million will be retiring every year until 2030. The boomer generation is also known as the spending generation. Boomers have kept the consuming pedal to the floor for the past 40 years, and, but for a minority, are utterly unprepared for retirement, many depending on their home equity (and Social Security) to make ends meet, and seeing that equity melt like an Alpine glacier. The few that managed to save see those savings being quickly eroded by the monetary policies enacted by the Fed (near-zero interest rates, rampant inflation that most probably will increase in the future due to, again, deliberate Fed actions). Older people do naturally spend less -- except in health care -- but older people who have lost a big chunk of their assets (both in equity and in cash) have to become by necessity a thrifty lot. Their spending is not coming back and there are no new spenders to replace them.

Fourthly, any increase in consumption spending directly leads to a rise in the US trade deficit, which for 2010 may reach $500 billion. (8) While about 47 percent of US importations are what is called "related party trading" -- that is, US-funded companies that have moved their manufacturing facilities to low-wage countries and repatriated their vast profits for the benefit of their shareholders -- imports have only a marginally positive effect on domestic employment (a few high-end engineering and some low-paid retail jobs), (9) except for dock workers and transportation. Simply put, foreign trade is not going to boost the economy. Manufacturing, or "reindustrialization" -- that fetish of politicians and unions -- won't do the trick either, because as Jagdish Bhagwati, a professor of economics and law at Columbia University, has shown, "There is no proof that economic health depends on manufacturing." The issue is nonetheless moot, for the manufacturing jobs that have been "relocalized" over the years will not come back anytime soon. Why would anyone want to pay, say, $1,000 for an iPod made in America with a tiny profit margin for Apple, when one can get the same device made in China for a fraction of the price (and a huge profit margin for Apple)? A manufacturing facility would be built in the U.S. and workers hired, but the device would no longer be affordable -- a self-defeating proposition that would lead inevitably to layoffs and plant closing. One cannot escape the logic and the contradictions of the system -- call it capitalistic or not.

One could throw into the mix the continued contraction of wages, which certainly won't help consumers increase their spending, and the massive upsurge in government anti-poverty programs, (10) but enough depressing news for today!

To recap: Evident over-production and over-supplies worldwide, a crippling US-led debt burden, trade imbalances that may well turn into proactive protectionist policies (i.e., trade wars), an entire generation drifting toward graveyards (not just in the U.S.), unable to spend any longer, manufacturing dreams that cannot be realized as people are willing to work pennies on the dollar to desperately dig their way out of poverty, and a dearth of intellectual knowledge are not going to bring the economy back to what it should not have been in the first place.

However, since the USA is a gambling nation par excellence (and history), it appears that the elites are going to do a double-down bet.

Ben Bernanke, a so-called "expert" on the Great Depression and head of the Fed, who has been wrong every step of the way, (11) intends to further monetize the federal debt through a second round of quantitative easing. He may also recommend a more direct injection of liquidity targeted to consumers through a suspension of the payroll tax. Meanwhile, in an effort to help American exports (and weaken the exports of European competitors and emerging countries), he keeps weakening the dollar -- an action that is creating new distortions in the global economy as Raghuram Rajan explains in the Der Spiegel interview, and could turn into an ugly global currency war and lead to a world of beggar-thy-neighbour policy. (12) (The US Congress, quick to blame China for America's ills, is calling for the imposition of tariffs on Chinese products.)

As made plain above, American consumers who have kept the world economy growing through their irresponsible credit binge are not going to "spend again at pre-crisis levels" for a long time, if ever. They simply cannot afford the game anymore. No one can, and no one should. There are externalities that are much larger than daily life. Pre-crisis spending should be dwarfed in light of the ecological disasters humanity faces.


[Author's note: This article, initially intended to be a three-part series, will have to turn into a four-part. The issue of ecological destruction -- a fundamental topic -- needs to be highlighted, which will be done in Part III.]


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About the Author

Gilles d'Aymery on Swans -- with bio. He is Swans' publisher and co-editor.   (back)


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1.  "Red Flags for the Economy", by Mike Whitney, CounterPunch, July 6, 2010.  (back)

2.  The theoretical analysis by John Bellamy Foster on how money got disconnected from productive endeavors, and how the financial sector ended accounting for 40 percent of profits in the U.S. explains in great details this point. See, "The Financialization of Accumulation," Monthly Review, October 2010.  (back)

3.  One sterling example is Larry Summers, who oversaw the repeal of Glass-Steagall, successfully helped engineer the deregulation of financial markets, blocked all attempts to regulate derivatives, etc. In 1999, Summers was a member of the triumvirate with Robert Rubin and Alan Greenspan known as the "Committee that Saved the World" -- neoliberal ideologues that have consistently been proven wrong and are directly responsible for the long-term socio-economic crisis that will carry on for many years. See Professor Bill Mitchell (University of Newcastle, NSW Australia) December 2009 blog entry "Being shamed and disgraced is not enough" for a pertinent analysis of their exploits. Mitchell cites Ayn Rand saying in 1959, "I am opposed to all forms of control. I am for an absolute laissez fair free unregulated economy. Let me put it briefly I am for the separation of state and economics."  (back)

4.  Raghuram Rajan, currently an economics professor at the Booth School of Business at the University of Chicago, used to be Economic Counsellor and Director of the IMF's Research Department Financial Markets, Financial Fragility, and Central Banking (September 2003 - January 2007). On August 27, 2005, Rajan delivered a speech at A Symposium Sponsored by the Federal Reserve Bank of Kansas City in Jackson Hole, Wyoming, entitled, "The Greenspan Era: Lessons for the Future." In that speech, which at this writing remains posted on the IMF Web site, Rajan warned in very diplomatic terms of the looming dangers of "a catastrophic financial crisis" and called for what he modestly called "Prudential supervision" of the financial sector. According to Charles Ferguson, the director and producer of the recently released documentary Inside Job, "When Rajan finished speaking, Summers rose up from the audience and attacked him, calling him a 'Luddite,' dismissing his concerns, and warning that increased regulation would reduce the productivity of the financial sector. (Ben Bernanke, Tim Geithner, and Alan Greenspan were also in the audience.)" -- see "Larry Summers and the Subversion of Economics," in The Chronicle Review, October 3, 2010.  (back)

5.  See "Bank Losses Lead to Drop in Credit Card Debt," by Christine Hauser, The New York Times, September 24, 2010.
http://www.nytimes.com/2010/09/25/business/25credit.html  (back)

6.  Christopher Shea: "The End of Tenure?" The New York Times Book Review, September 5, 2010, p.27.  (back)

7.  One could make the case that a means to resolve the housing crisis would be to actually bulldoze all vacant homes and building development. It would create jobs in the short term for hordes of demolition crews and then, once the swamp is sanitized, construction workers would start building again -- the good old creative destruction paradigm. Problem is that the banks would go the way of the Dodo and the Masters of the Universe tends to shy away from their own demise.  (back)

8.  As an example: This household had to rebuild a rotten deck from scratch: The pressure-treated wood and plywood came from Canada. The stainless steel screws (2,400 of them!) were made in Thailand. Only the composite boards (Trex) were made in the U.S. We also bought a LCD/DVD TV combo (a Toshiba 19"), which was made in Thailand. A small adjustable gate to keep the dogs on the deck was made in China, and four pair of socks were made in South Korea. One would think that a clay "Superstone" covered baker (to bake bread) by "Sassafras" -- a small business located in Chicago -- would have come from either Italy or France, but one would be wrong. It was made in Taiwan. We also had to put in place a new leach field for our recurring clogged septic tank. Here, at least, our hardship benefited the US economy, as the needed rocks and labor originated locally, though the pipes and the contractor's backhoe may well have been manufactured abroad.  (back)

9.  For further exploration on the topic of trade (and manufacturing), see Bill Mitchell's blog entry "What you consume or what you produce?" in which he refers to a 2009 UC Irvine study that examined the pros and cons of manufacturing Apple's iPods in China, and found that "the iPod supports nearly twice as many jobs offshore as in the U.S., yet wages paid in the U.S. are over twice as much as those paid overseas."  (back)

10.  Excerpted from "Record number in government anti-poverty programs," by Richard Wolf, USA TODAY, August 31, 2010: More than 50 million Americans are on Medicaid, up 17 percent since December 2007. More than 40 million people get food stamps, up almost 50 percent in the same period. More than 4.4 million people are on welfare, an 18 percent increase. Close to 10 million receive unemployment insurance. Unemployment insurance trust funds in 30 states are insolvent.  (back)

11.  To grasp Bernanke's real "expertise," one has to only read the comments he made in 2005 and 2006:

July 1, 2005: Bernanke: "We've never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don't think it's going to drive the economy too far from its full employment path, though." (We did have an actual decline in house prices in the early 1990s.)

February 15, 2006: Bernanke: "Housing markets are cooling a bit. Our expectation is that the decline in activity or the slowing in activity will be moderate, that house prices will probably continue to rise." (The housing market was beginning to implode at the very time Bernanke made this statement...)  (back)

12.  Brazil's finance minister Guido Mantega recently said, "We're in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness." See "Currencies clash in new age of beggar-my-neighbour," by Martin Wolf, The Financial Times, September 28, 2010. (Free registration required.)  (back)


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Published October 18, 2010