Saturday, July 25, 2009

Is the Recession Over?

For the third month in a row the index of leading economic indicators rose. This is the first time this has occurred since 2004. And, it gives us some sign that maybe the economic recession that we have been in since December 2007 is reaching its climax. James W. Paulson, chief investment strategist at Wells Capital Management, is quoted in the Wall Street Journal as saying “We’ve got tons of information telling us we’ve turned the corner.” Ataman Ozyildirim, an economist at the Conference Board which produces the report, states that “The process of coming out of the recession, although still fragile, may be starting.”

I hope that these people are right and that we are coming out of the recession. There are fears of a “W” (not Bush) or a “double-dip” recession and these should not be discounted. But, we don’t really want the recession to carry on in any form; we really don’t want the risks associated with the down-side.Even though we may be at or near the bottom of the recession there are still plenty of concerns to deal with.

My continued concern is that the collapse in the economy was primarily due to a supply side shift and was not initiated by a fall in aggregate demand. This I have tried to capture in posts like my June 22 effort: If the recession was, in fact, initiated by supply shifts then there are structural dislocations in the economy that need taking care of that cannot be satisfied by just increasing aggregate demand to put people back in the jobs in which they were formerly occupied. We cannot just return to factories that are only being partially used or have been cvacated. Trying to push things back to where they were just postpones the restructuring of the economy that needs to take place.

In the past twenty years or so, we, in the United States, have experienced two credit bubbles or credit inflations. These bubbles have created excess growth first in information technology in the 1990s and then in the housing sector of the economy in the 2000s. But, these credit bubbles were not just restricted to the United States.There was a credit inflation throughout the whole world. Evidence of this has just been released in a report by Close Brothers Corporate Finance in the UK. (See “UK is Europe’s capital of distress” in the Financial Times: The report claims that “The UK has western Europe’s highest percentage of financially distressed companies after being the leveraged buy-out capital over the past decade.” But, the report goes on to show that the credit bubble resulted in the serious collapse of the European manufacturing sector, as well as in the retail and leisure sectors. And, of course, there is the case of Japan in the 1990s and 2000s.

The problem created by credit bubbles or credit inflations (in addition to the excessive amounts of debt created) is that too much capacity is created in areas of the economy that cease to be needed any more once the bubble has burst. The normal response of the economy is to restructure so as to eliminate the excess capacity that exists and re-deploy resources into areas that are experiencing growth and development. A Keynesian effort to “pump up” aggregate demand is just an effort to re-employ resources in the same areas that formerly prospered but that now need to be “down-sized.”

This does nothing to get rid of the excess capacity and postpones the restructuring of the economy. Furthermore it retains the misallocation of financial capital that evolved during the period of the credit inflation or credit inflations.

The drop in capacity utilization in the United States since the start of the recession has been extremely dramatic. Firms have gone from using about 81% of their capacity to using only 68%, a drop of 16%. This is the steepest drop for the longest period of time in the data series.But, even more important in my mind is that capacity utilization has been dropping steadily since 1967.

Obviously, capacity utilization drops in periods of economic recession. Yet, as the economy has recovered in every economic cycle in the United States since the 1960s capacity utilization, after a recession, has never returned to the peak level it reached in the previous period of economic expansion. Thus, capacity utilization has trended lower throughout this time, evidence that there has been a shift in the structure of manufacturing in the United States.

Although the United States has grown around 3% compounded annually over the last forty years and employment, through most of the period, has been at relatively high rates, there are still two pieces of information that are rather unsettling. The first is the continuing decline in capacity utilization just mentioned. The second is the decline in the civilian participation rate. For the United States, this rate peaked in the 1990s a little above 67.0% and has declined through the late 2000s remaining below 66.2% since 2004. This may not seem like much of a fall but it indicates that a lot of people have left the labor force!The latter problem can be confirmed by figures from the Bureau of Labor Statistics.

There are major sectors of employment in the United States that have experienced significant reductions in jobs and employment. These are in industries that one could seriously argue were in substantial need of restructuring. (I will return to this topic soon in another post.) The question is, should people to be pushed right back into these jobs again by a government stimulus program of increasing aggregate demand? Instead, it seems as if there needs to be a significant education of a large portion of the civilian population that would like to participate in the labor force again.

If there are structural problems in the United States and in the world that result from the existence of excess capacity in industries that are declining or less technologically relevant, shouldn’t we let these industries decline or try to become technologically relevant rather than stagnant? Should we try and keep people producing buggy whips when there are means of transportation evolving other than buggies?So, to reclaim full economic health there is a need to reduce the excess capacity that has been built up in industries that are not so relevant any more and a need to deleverage financial structures. Unfortunately, a large portion of the needed financial deleverging is connected with firms that have excess capacity.
Furthermore, there is a need to restructure U. S. manufacturing and business, and train more of the workforce to fit into twenty-first century jobs so as to get the labor participation rate up.

In my study of the Great Depression, this is one of the reasons why it took so long for the United States economy, and the world economy, to recover through the 1930s. The structural change in the United States taking the country from an agricultural society to an industrial society did not really take place until the beginning of the Second World War My concern is that the needed current economic restructuring will be delayed if Washington continues to focus on companies with redundant capacity by stimulating the re-employment of the same workers that used to work in them. The economic statistics (the leading economic indicators) may continue to improve in such cases, but the economic recovery will continue to languish.

1 comment:

The Arthurian said...

An interesting statement, sir. (I won't have anything else to say about it until I ponder it a while.)

Some time back (30 Jan 09) you did a review of Martin Wolf's book. I tucked it away for safekeeping until I read Thomas DiLorenzo's "Mises Daily" post of 7-21-09. What DiLorenzo references as "yellow peril" and attributes to Alan Greenspan... Wolf references as "savings glut" and attributes to Ben Bernanke.

I tend to agree with you (I think) and lean more to the "money glut" explanation. However, the terminology is new to me and the mental processing takes time....

I guess I'm writing to say I have enjoyed reading these few posts of yours. And thanks for giving me more to think about.