Cross-posted from New Deal 2.0.
Our Treasury Secretary has conceded that it is still a "tough economy" for most Americans, and warned it's possible the unemployment rate will go up for a couple of months before it comes down. Given the constellation of recent economic data that has come out, Tim Geithner is probably correct.
The US economy is showing signs of slowing, as the fiscal stimulus is dissipating and spending contractions at the state and local government level increasingly undermine the injections from the federal sphere. Worse, it appears that much of the growth has resulted largely from a replenishment of inventories, a process which largely seems to have run its course. Excluding this inventory re-stocking, underlying growth was a very tepid 1.5% annualized. Fiscal drag from state spending contraction could well reduce overall consumption even further in the quarters ahead, an ominous trend for future growth and employment prospects. While we may not experience a "double dip" in purely technical terms, it will certainly feel like a return to recession for most Americans if Geithner's assessment is anywhere close to being accurate.
At this stage, there is a widespread belief that government fiscal stimulus has run up against its "limits" on the grounds of "fiscal sustainability" and the need to retain "the confidence of the markets." Consequently, goes this line of reasoning, as private credit conditions improve the private sector must pick up the baton of growth where the public sector leaves off. If this proves insufficient, there is room for an expansion of monetary policy via "quantitative easing."
Recent speeches by the Fed suggest that they are indeed laying the groundwork for such a return to quantitative easing, or "QE2" as the markets are now calling it. It's not the name of a ship-liner: quantitative easing essentially means that the central bank buys up high yielding assets and exchanges them for lower yielding assets. The premise is that the central bank floods the banking system with excess reserves, which will then theoretically encourage the banks to lend more aggressively in order to chase a higher rate of return. Not only is the theory plain wrong, but the Fed's fixation on credit growth is curiously perverse, given the high prevailing levels of private debt. More borrowing is the last thing the highly stressed and leveraged American household requires today.
As we have argued many times in the past, credit growth follows creditworthiness, which can only be achieved through sustaining job growth and incomes. That means embracing stimulatory fiscal policy, not "credit-enhancing" measures per se, such as quantitative easing, which will not work. QE is based on the erroneous belief that the banks need reserves before they can lend and that this process provides those reserves. But as Professor Scott Fullwiler has pointed out on numerous occasions, that is a major misrepresentation of the way the banking system actually operates:
In the U. S., when a bank makes a loan, this loan creates a deposit for the borrower. If the bank then ends up with a reserve requirement that it cannot meet by borrowing from other banks, it receives an overdraft at the Fed automatically (at the Fed's stated penalty rate), which the bank then clears by borrowing from other banks or by posting collateral for an overnight loan from the Fed. Similarly, if the borrower withdraws the deposit to make a purchase and the bank does not have sufficient reserve balances to cover the withdrawal, the Fed provides an overdraft automatically, which again the bank then clears either by borrowing from other banks or by posting collateral for an overnight loan from the Fed.
The point of all this is that the bank clearly does not have to be holding prior reserve balances before it creates a loan. In fact, the bank's ability to create a new loan and along with it a new deposit has NOTHING to do with how many or how few reserve balances it is holding.
What is required to drive lending is a creditworthy borrower on the other side of the bank lending officer's desk, which means an employed borrower, whose income allows him to sustain regular repayments. Absent that, there will be no lending activity. It is pointless to blame the evil bankers for this of state affairs, since they don't control fiscal policy, which is the remit of the Treasury.
For all the talk from policy makers about not repeating the mistakes of Great Depression, we seem to be perilously close to doing precisely that. This is largely based on a poor understanding of the economic dynamics of that period, even by that noted scholar of the Great Depression, Ben Bernanke.
Most people believe the economy crashed between 1929 and 1932 and then remained depressed until the Second World War, which finally mobilized the economy's idle resources and brought about a full recovery. That's complete bunk if you calculate the unemployment data correctly (see here for an explanation) . Even leaving aside the unemployment calculations, it is abundantly clear that, once the Great Depression hit bottom in early 1933, the US economy embarked on four years of expansion that constituted the biggest cyclical boom in U.S. economic history. For four years, real GDP grew at a 12% rate and nominal GDP grew at a 14% rate. There was another shorter and shallower depression in 1937 largely caused by renewed fiscal tightening (and higher Federal Reserve margin requirements). This second depression has led to the misconception that the central bank was pushing on a string throughout all of the 1930s, until the giant fiscal stimulus of the wartime effort finally brought the economy out of depression.
That's incorrect. The financial dynamics of the huge economic recovery between 1933 and 1937 are extremely striking. Despite their insistence that changes in the stock of money were behind all the cyclical ups and downs in U.S. economic history, even economists Milton Freidman and Anna J. Schwartz in their "Monetary History of the United States" conceded that the money aggregates did not lead the U.S. economy out of the depression in 1932-1933.
More striking, private credit growth seemingly had nothing to do with the takeoff of the economy. Industrial production, off the 1932 low, doubled by 1935. By contrast, bank credit to the private sector fell until the middle of 1935. Because of the collapse in nominal income during the depression, the U.S. private sector was more indebted than ever in the Depression lows. Yet somehow it took off and sustained its takeoff with no growth in private credit whatsoever. The 14% average annual increase in nominal GDP from early 1932 to 1935 resulted in huge private deleveraging, largely as a consequence of aggressive fiscal stimulus.
Tim Geithner should be aware of this, but like his old colleagues at the Fed, his main obsession remains deficit reduction, which is why he is now expending considerable political capital on allowing the Bush tax cuts for the wealthy to expire. Ironically, one of the more amusing aspects of this particular issue is the sight of Republicans such as Mike Pence and Eric Cantor arguing that job creation is more important to Americans than deficit reduction (hence, we should extend the Bush tax cuts for the wealthy, even as their party fought vociferously against extending unemployment insurance benefits for the past several months).
The reasoning of Cantor and Pence is perverse, but on balance -- however disingenuous and politically insincere -- we support the GOP's born again support for job creation over deficit reduction. We just wish they would refocus on something that would really help reduce unemployment, such as a Job Guarantee Program. A disproportionate amount of the stimulus program has been enjoyed by those who least need it. We would like to see the Obama Administration at least begin to make the case that fiscal stimulus, whether via tax cuts or direct public investment, is still required to generate more demand and employment. They should not concede anything in this area to the politically insincere GOP, which never met a tax break for the top 2% of the population that they didn't like.
There might well be very good reasons, on grounds of social equity, to minimize the income gap between the rich and the poor, but Geithner and Obama are not making the case for the elimination of the tax breaks on these grounds. Rather, they continue to do so on the basis that this is the "fiscally responsible" thing to do. This is also consistent with the President's odd championing of a "bipartisan commission" to study entitlement "reform," where the focus appears to be on cutting Medicare and Social Security -- in effect gutting the Democrats' most substantial social legacy of 20th century.
The only concern about government deficit spending should be a whether it generates inflation, in which case it should of course be slowed down. None of those who critique the ongoing fixation on fiscal sustainability, or "pork," or "entitlement reform," do so on the basis that there are "no limits" on government deficit spending, as has been alleged. What we do argue is that deficit cutting per se, devoid of any economic context, is not a legitimate goal of public policy for a sovereign nation. Deficits are (mostly) endogenously determined by the performance of the economy. They add to private sector income and to net financial wealth. They will come down as a matter of course when the economy begins to recover and as the automatic stabilizers work in reverse (i.e. tax receipts rise and social welfare expenditure comes down). When our policy makers begin to understand this, we can stop with the counsel of despair and actually do something that reduces unemployment today, not years from now -- when it will be far too late.
More tax cuts for the rich, and more tax incentives for corporate manufacturing companies to ship jobs overseas.
Then all the private equity firms (like the one Mitt Romney used to run) can buy up MORE American businesses, saddle them with debt, dismantle them, and sell the manufacturing rights to various products to Asian companies.
Then, as stated in the the sound economic theory deemed "Supply Side" (Trickle Down, or as I call it; P!$$ on the working class), all of the capital and "disposable income" will be willingly injected back into the economy, creating jobs and ushering in an era of abundance, just like the 80's and the 20's!
There's no way the richest of the rich (especially trans-national corporations with no allegiance to the United States) will hoard their money, or try to hide it in offshore tax shelters. It's also unlikely that they will use their their immense influence over the political system to bring about a series of deregulatory legislation that will completely dissolve any oversight whilst they gamble with trillions of dollars on the stock market!
It's fool proof!
Why can't people understand that?
Supply side idiocies rule.
No wonder the economy continues southward bound.
The US now produces 10% of the GDP in tangible goods at home, 20 years ago we produced 25%.This economic shift has been coming since Japanese electronics started to invade the US in the 1960's. The industrial great lakes and east coast producers first began moving to southern states to save money in the 60's and 70's, after that they began moving out of the country. NAFTA was passed with the promise of more markets for US goods. Instead manufacturing left the states for low cost labor and was then imported to sell in the USA, exactly the opposite of what NAFTA was supposed to do. One of the mantras of capitalism is that producing at low prices means more of the populace can benefit from lower priced goods. The worlds economy was beginning to perfom a balancing act as cheap foreign labor was taking US manufacturing jobs and some of our success was being transfered to other countries. Many US corporations would have went out of business years ago if they had not moved manufacturing out of the US toward lower priced labor markets.
If interested read the following comment: 2 of 2
We can't just sell foreign goods, insurance, financial, legal services and pre-existing real estate to eachother and have a consumer driven economy at home, real wealth comes from the production of tangible items. Rhetorical question: If everyone in the world was a banker or salesman without tangible goods being produced, what would the richest banker have to purchase? Answer: Eventually nothing, nothing that would still function as parts and produts are no longer made.
When the trade imbalance had accumulated along with accumulation of household debt and the national debt was still climbing, the system, having been given too much rope, was now strangling itself. Going further into debt to buy more foreign goods will eventualy lead to bankruptcy. If we can't competitvely produce in the global market what are we going to sell the world in order to pay off our debts? Weapons?
"It is pointless to blame the evil bankers for this state of affairs, since they don't control fiscal policy, which is the remit of the Treasury."
Would regulations by definition set or influence some of the parameters available when making fiscal policy? Don't the bank lobbyists influence regulations, and therefor fiscal policy to some degree if not a large degree?
However, even though waves of Americans came out to vote for striking change, and even though, at the start, even the corporate media was positive with portrayals of Obama as FDR, the President chose to turn away from such grand notions.
He never turned back; it is highly doubtful that he will demand much more of a stimulus, much less a needed public works program.
Again Repubs have no clue what they are talking about. They have proven again they are masters of the gab and their willingness to twist anything to dupe the unsuspecting. The budget deficit bogeyman is a scare tactic to sow mistrust in this govt and win votes for themselves, period. For an economy driven largely by domestic consumption, if unemployment persists, budget deficits are the last thing anyone will worry about. Only when unemployment goes down and the economy stabilizes can we start to solve the deficit problem.
A more balanced approach by the Obama administration that incorporates both would seem to be more appropriate.
I will add this which you won't like.
Since this recession, our family has tried 3 times to secure loans for a variety of investments. The first inquiry was to either purchase another farm, or buy a large tract of land. We have done this several times in our lives with ZERO debt left for any of those purchases. So we currently have NO DEBT. We have a secure income - at least as far as anybody today can predict. The first bank told me I should be grateful to have what I have. The next inquire with another bank was "absolutely no". They no longer lend money on any land or farms. The 3rd inquiry was to expand a very busy and profitable business. The answer has been "not interested".
Credit worthiness? That sounds logical, but it is not why loans are not being made. It isn't just the banks that are refusing to help support this economy, but local government that has access to grants is stalling as well. The grants are being written that do to apply to the area. So putting restrictions on building size when there are no such buildings that size in the town means the government never really intended to lend that money at all.