By Mike Whitney
Monday, December 24th, 2012
The reason the US economy is still sluggish 4 years after Lehman Brothers defaulted, is of lack of demand. Demand dropped off after the housing bubble burst and has never really recovered. Economist Dean Baker calculates that hit to demand is somewhere in the neighborhood of $1 trillion per year, a sum that’s been impossible to replace. Here’s how Baker breaks down the costs in terms of GDP and weak consumption:
“We saw a sharp falloff of residential construction as we went from a near record boom, with construction exceeding more than 6.0 percent of GDP at the 2005 peak, to a bust where it fell below 2.0 percent of GDP. This meant a loss in annual demand of more than $600 billion a year.
We also saw a large falloff in consumption due to the loss of $8 trillion in housing wealth. The housing wealth effect is one of the oldest and most widely accepted concepts in economics. It is generally estimated people spend between 5 and 7 cents each year per dollar of housing wealth. This means that the collapse of the bubble would be expected to cost the economy between $400 billion and $560 billion in annual demand.
There is no mechanism that would allow the economy to easily replace the combined loss of between $1 trillion and 1.2 trillion in demand that would be predicted from the collapse of the housing bubble.” (“Underwater Homeowners Cannot Explain the Weak Recovery, Dean Baker, CEPR)
So, while household indebtedness, off-shoring of jobs and so called “onerous” regulations may have dampened overall activity, the proximate cause of the slowdown is the housing bubble which blasted a trillion dollar hole in demand.
The Obama administration tried to address the situation in 2009 by implementing the American Recovery and Reinvestment Act (ARRA). The $800 billion fiscal stimulus package narrowed the output gap, reduced unemployment and raised GDP, but it failed to produce the strong and sustainable recovery that was promised. That said, the ARRA did lift the economy out of recession and put 3 million people back to work, which is certainly a step in the right direction. The administration used the budget deficits exactly as British economist John Maynard Keynes suggested they be used, to sustain activity when the private sector had dramatically cut-back on spending and investment. When the businesses and consumers cannot sustain demand, then government must increase its spending or the economy will slip into a long-term slump. (Compare the recovery in the US to developments in the eurozone where discredited contractionary “austerity” policies have pushed the 17 member monetary union deeper into recession and social malaise.)
Of course there are other factors that have weighed heavily on demand, too, like high unemployment (7.7 percent) and wage stagnation.. According to economist Jared Bernstein, the real “pretax” earnings of middle wage workers have never grown more slowly than they have in 2012. (See chart here.) Also, the Commerce Department reports that employee pay is a smaller share of the economy today than it has been since the government started collecting wage and salary data. (which dates back to 1929.) Naturally, if wages are shrinking and unemployment is high, then demand is going to be weak and the economy is going to underperform. And that’s exactly what’s happening.
And then, there is growing inequality. Check this out from Pam Martens at Wall Street on Parade:
“A study conducted by Edward N. Wolff for the Levy Economics Institute of Bard College in March 2010 made the following findings:
‘The richest 1 percent received over one-third of the total gain in marketable wealth over the period from 1983 to 2007. The next 4 percent also received about a third of the total gain and the next 15 percent about a fifth, so that the top quintile collectively accounted for 89 percent of the total growth in wealth, while the bottom 80 percent accounted for 11 percent.
Debt was the most evenly distributed component of household wealth, with the bottom 90 percent of households responsible for 73 percent of total indebtedness.
Wealth concentration in too few hands while the general populace is saddled with too much debt to buy the goods and services produced by the corporations, is a replay of the conditions leading to the crash of 1929 and the ensuing Great Depression.” (“Consumers Have Powerful Weapons Against Wall Street’s Bad Practices”, Pam Martens, Wall Street on Parade)
While the upward distribution of wealth speaks to the implicit unfairness of the system, its impact on demand can be offset by increases to government spending vis a vis fiscal stimulus. Unfortunately, policymakers have abandoned fiscal policy altogether and transferred de facto control of the economy to the Central Bank. The Fed is not just calling all the shots, it’s doing so in a way that reflects its bias towards big finance. This is why the recovery has been so abysmal, because the policy has focused on boosting profits for Wall Street instead of revitalizing the broader economy. Even so, Fed chairman Ben Bernanke has acknowledged that the real reason unemployment is still so high, is not “structural”, (as conservatives argue) but lack of demand. Here’s what he said in a recent appearance before Congress:
“Is the current high level of long-term unemployment primarily the result of cyclical factors, such as insufficient aggregate demand, or of structural changes, such as a worsening mismatch between workers’ skills and employers’ requirements? … I will argue today that, while both cyclical and structural forces have doubtless contributed to the increase in long-term unemployment, the continued weakness in aggregate demand is likely the predominant factor.”
Bernanke’s admission is further underscored by a McKinsey survey of corporate managers from around the world which found that “the single greatest fear among executives everywhere is weak consumer demand for their companies’ products and services.” (CBS News)
So the question we should be asking ourselves is this: Why is so hard to get a second round of fiscal stimulus when Keynesian remedies have been used for more than 60 with great success? What’s changed?
What changed is the orientation of the people in power, most of whom are either closely-aligned to or former employees of Wall Street. Today’s political class is a subsidiary of the financial oligarchy. And that goes double for the Fed who invariably puts the interests of the big investment banks and brokerages above those of ordinary working people. Proof of “regulatory capture” is evident in the manner that the recovery has been managed. (or mismanaged!) Trillions of dollars in loans and bailouts have been showered on the banks and financial institutions while homeowners, consumers and working stiffs have been asked to cut back on vital social programs for the sick, elderly, and unemployed. These policies are largely responsible for today’s anemic, sputtering recovery, a condition that’s ideal for restructuring the economy in a way that better serves the interests of the big corporations and Wall Street.
Why, for example, would the Fed want to reduce unemployment if high unemployment pushes down labor costs and boosts profits for its corporate constituents? And why would Bernanke want to rev-up the economy when the ongoing crisis creates the rationale for gutting social programs and slashing public spending? And why would the Fed want to normalise interest rates, when the low rates force savers and retirees on fixed income back into the stock market, while–at the same time– provide unlimited sums of money to the banks at zilch cost to themselves?
The wretched state of the economy is no accident. It is by design. And it’s easy to figure out who’s benefiting from the present arrangement by tracing the torrent of capital that flows upwards to the corporate boardrooms and off-shore hideaways where the 1% stash their loot. Check this out: “Corporate profits as a share of GDP is at an all-time high while wages and salaries are at all-time lows“, The Big Picture)
The fact is, that the ongoing slump helps some while it hurts others. Regrettably, it’s the sick, the elderly, and working people who are hurt most by Central Bank policy.
So how effect has quantitative easing (QE) had on demand?
Not much, really. In fact, housing sales and refinancings have actually dropped since Bernanke launched QE3 in September. At the same time, private sector borrowing is still in the doldrums, which means that Bernanke’s zero rates and bond buying programs haven’t sparked another credit expansion. Even worse, QE might be doing some real harm as Bloomberg analyst Michael Mckee points out in a recent interview. Here’s what he said:
“Look at the corporate bond market, we’re seeing a rush of corporate bond sales at the end of the year, but not to invest in the economy, but in order to pay special dividends before tax rates go up at the end of the year.” (Bloomberg)
So, QE hasn’t boosted investment after all, in fact, it’s triggered a selloff in bonds as corporations take-the-money-and-run instead of trying to find productive outlets for future investment. What does that tell you? It tells you that Bernanke’s wacky theory is weakening demand by discouraging investment. The whole thing has backfired. This point is further confirmed by economist Frances Coppola who summed it up like this in a recent post:
“QE is effective in bringing down real interest rates – but not for borrowers at commercial banks. They are paying as much or more than two years ago. The effective interest rate is depressed because of lower rates paid to savers, not lower rates charged to borrowers. Credit spreads are widening.
This suggests that QE, far from being a stimulus, is actually contractionary for the real economy. If rates to both savers AND borrowers were falling, and bank lending volumes were normal, then QE could be said to be a stimulus, because it would encourage more borrowing, and falling returns to savers might encourage them to spend rather than save. But that’s not the case. Lending volumes are reduced and interest rates to borrowers remain high, while interest rates to savers are depressed: people on fixed incomes are spending less, not more, because their income is reduced, and borrowers faced with high interest rates are choosing to cut spending in order to maintain debt repayments. The overall effect is to take money from the real economy and transfer it to banks, who use it to shore up their damaged balance sheets. This raises questions about exactly what QE is supposed to stimulate and who it is supposed to help.” (“QE: The problem, not the solution”, The Coppola Comment)
So, QE is actually contractionary?
It sure looks that way. If the banks are not passing along the savings from the Fed’s low rates to consumers, but skimming heftier profits for themselves on the widening spreads, then the net-impact of the low rates is zero. In other words, QE will not lead to another credit expansion because the transmission mechanism (“the banks”) is not functioning as Bernanke had hoped. The banks have sabotaged the policy in order to make more money for themselves. What a surprise!
On Wednesday, the Mortgage Bankers Association produced more proof that QE is not working. The MBA announced that mortgage applications had decreased by 12.3 percent in the last week. Even though mortgage rates are lower now than anytime in history, people are still turning up their noses at housing. QE is not working.
So how do you shore up demand when monetary policy is ineffective? How do you shore up demand when small-business optimism has plunged to levels not seen since the middle of the financial crisis? (“NFIB small-business optimism index plunges“, Marketwatch)
How do you shore up demand when workers’ wages are shrinking? (“Modest Job Growth, Less Take-Home Pay Is Recipe for Depressed Consumer“, Wall Street Journal)
How do you shore up demand when the consumer is under pressure and disposable income is dwindling? (“Consumer Spending Wobbles“, Wall Street Journal) Here’s an excerpt from the article:
“U.S. consumer spending, a rare pillar of economic strength in recent months, is showing signs of weakening….In recent weeks government data have shown spending was slower over the summer than previously believed, and it has started off the final three months of the year on an even weaker footing.” (WSJ)
How do you shore up demand when businesses are hoarding cash and handing out dividends instead of reinvesting in the economy? (“$8.4 trillion: Number of the Week: As Companies Borrow More, Where Is Money Going?“, Wall Street Journal)
How do you shore up demand when unemployment is stuck at 7.7 percent, when the labor force is shrinking, when consumer spending is falling (“Consumer Spending Declines 0.2%”, Wall Street Journal) when manufacturing is contracting, when consumer sentiment is slipping, and when the “the median net worth of U.S. households has dropped by 47 percent in the last 4 years? (“The Recession’s Toll: How Middle Class Wealth Collapsed to a 40-Year Low“, The Atlantic)
Finally, how do you shore up demand when business investment has fallen off a cliff? Check this out from the Wall Street Journal:
“U.S. companies are scaling back investment plans at the fastest pace since the recession, signaling more trouble for the economic recovery.
Half of the nation’s 40 biggest publicly traded corporate spenders have announced plans to curtail capital expenditures this year or next, according to a review by The Wall Street Journal of securities filings and conference calls.
Nationwide, business investment in equipment and software—a measure of economic vitality in the corporate sector—stalled in the third quarter for the first time since early 2009. Corporate investment in new buildings has declined. At the same time, exports are slowing or falling to such critical markets as China and the euro zone as the global economy downshifts, creating another drag on firms’ expansion plans. (“Investment Falls Off a Cliff,” Wall Street Journal)
Keyenes provides a straightforward antidote for weak demand, that is, increase government investment via fiscal stimulus. That means using the budget deficits to reduce unemployment, boost growth, and put the economy back on solid footing. Monetary policy alone will not produce a strong, self sustaining recovery, which is a point that Keynes makes in Chapter 12 of “The General Theory of Employment, Interest and Money”. Here’s what he says:
“For my own part I am now somewhat sceptical of the success of a merely monetary policy directed towards influencing the rate of interest. I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organising investment; since it seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital, calculated on the principles I have described above, will be too great to be offset by any practicable changes in the rate of interest.” (John Maynard Keynes, “The General Theory of Employment, Interest and Money”, marxists.org, 2002)
So there you have it; governments have a role to play in maintaining demand. By “directly organising investment” the state can ease the business cycle, reduce unemployment, and mitigate the impact of financial crises and recessions.
In that same vein, economist James K. Galbraith thinks we should be pursuing a long-term strategy that includes “government jobs programs”, “an infrastructure bank, a four-day work week, and expansion of Social Security, an early retirement option, a systematic program of general revenue sharing to support state and local governments.” Here’s how Galbraith summed it up in an article in The Washington Monthly:
“Today the largest problems we face are energy security and climate change—massive issues because energy underpins everything we do, and because climate change threatens the survival of civilization. And here, obviously, we need a comprehensive national effort. Such a thing, if done right, combining planning and markets, could add 5 or even 10 percent of GDP to net investment…
What is required are careful, sustained planning, consistent policy, and the recognition now that there are no quick fixes, no easy return to “normal,” no going back to a world run by bankers—and no alternative to taking the long view.” (“No Return to Normal”, James K Galbraith, Washington Monthly)
Progressive economists like Galbraith have figured out how to sustain demand and address our most pressing ecological and energy problems at the same time. This is the best way forward, not Quantitative Easing which has largely been a bust.