Monday, February 1, 2010

It's the Mood of the Workers, Stupid!

Robert Shiller of “Irrational Exuberance” has given us the answer to our problems in the Sunday New York Times. See “Stuck in Neutral? Reset the Mood!” Shiller argues that, “In reality, business recessions are caused by a curious mix of rational and irrational behavior. Negative feedback cycles, in which pessimism inhibits economic activity, are hard to stop and can stretch the financial system past its breaking point.”

“Solutions for the economy must address not only the structural instability of our financial institutions, but also these problems in the hearts and minds of workers and investors—problems that may otherwise persist for many years.”

The solution: people must believe in the cause! “Reset the Mood!” “In most civilian fields, job satisfaction may not be a life-or-death matter, but a relatively uninterested, insecure work force is unlikely to bring about a vigorous recovery.”

But, the problem goes beyond the current malaise. Shiller advises us to look at the whole post-World War II period. He cites data from the Bureau of Labor Statistics and states that the annual growth of business output per labor hour averaged 3.2% from 1948 to 1973. From 1973 to 2008 the growth rate was 1.9%. He quotes Samuel Bowles of the Santa Fe Institute who has argued that the causes of this slowdown “are to be found as much in the loss of ‘hearts and minds’ of workers and investors as in the technology.”

A cause of this “loss of ‘hearts and minds’ of workers and investors” is not presented. Let me provide a possible cause: inflation!

Since January 1961 through 2009, the purchasing power of $1.00 has declined by about 85%, depending upon the price index used. That is, a $1.00 that could purchase $1.00 when John Kennedy became president could only purchase around $0.15 in 2009.

The “guns and butter” expenditure pattern of the federal government in the 1960s resulted in the wage and price freeze that came about in August 1971 along with the separation of the United States dollar from gold. The excessive inflation of the latter part of the 1970s resulted in the Federal Reserve tightening of monetary policy which finally broke the back of inflation in the early 1980s. Yet, even though the United States went through a period of moderate price inflation during the next twenty years or so (the Great Moderation) credit inflation continued. (For a review of what I mean by credit inflation see

This period of inflation had two major impacts on the United States economy. First, American manufacturers worried less about productivity than they did about getting products to market. Inflation does this to producers. Why? Because the pressure is on manufacturers to quickly get in new equipment so that they can meet the rising demand for goods and this means that executives focus less on the longer-lived, more productive plant and equipment and give their attention to more short-lived investments. As a consequence, productivity suffers!

The impact of this change in the composition of the capital stock of the United States is reflected in two other measures. First, capital utilization in manufacturing industry has continued to decline from the 1960s to the present time. (See chart: For example, capacity utilization was above 90% in the middle of the 1960s. Through all the cycles in capacity utilization over the next 45 years, the peak rate constantly declined. In February 1973 the rate was slightly below 89%. The next peak was in December 1978 and was below 87%; then about 85% in January 1989; and again in January 1995 and in November 1997. The next peak came in August 2006 at about 81%. The most recent trough in capacity utilization came in June 2009 and has rebounded to 72% in December 2009. Expectations: it will not reach 81% again.

In addition, labor force participation has changed dramatically during this time period. Labor force participation increased substantially from the latter part of the 1960s until the latter part of the 1980s, primarily due to more women taking part in the measured labor force. Since the late 1980s the growth of total labor force participation began to slow down and in the 200s total labor force participation began to decline as more and more people became discouraged in looking for a job or only could find temporary employment. In 2009 the number of under-employed individuals of working age amounted to between 17%-18% of the labor force. Thus, we have unused capacity in the labor force as well.

The second major impact this period of inflation had on the United States economy was on the use and creation of debt. Inflation is good for debt creation! But, the foundation for the increase in debt during this time was the Federal Government, as the gross federal debt increased at an annual rate of 7.85% per year for the period of time from fiscal 1961 through fiscal 2009. The federal debt held by the public rose by 7.31% over the same time period.

Private debt, of course, increased very, very rapidly during this time period as did the financial innovation that spread debt further and further through the economy. Inflation is good for debt and it is also good for employment in the area of finance and financial services. As is well known there was a tremendous shift in the work force during this time from non-financial firms to financial firms. Furthermore, labor productivity does not increase as much annually in the finance industry as it does in non-finance.

Why should the labor force put its “hearts and minds” behind the future of the United States economic machine?

One sees no end to the environment of “credit inflation” created by the federal government. Estimates of federal government budget deficits still range in the $15-$18 trillion range for the next ten years which would more than double the gross federal debt that now exists. Then there are questions relating to the Federal Reserve’s inflation of the monetary base and the possibility that the central bank can pull off a magical “exit” strategy where the Fed removes roughly $1.1 trillion “excess” reserves from the banking system without causing any disruptions. The eminent scholar of the Federal Reserve System, Allan Meltzer, seems to have serious doubts about the Fed being able to pull this off. (See The failure to succeed here, along with the rise in the federal debt, would just further underwrite credit inflation in the whole economy.

The international investment community continues to have concerns over the ability of the United States to do anything different from what it has done over the last 50 years or so. There is nothing to indicate anything more than “business as usual” in Washington, D. C. If this is true, then we will see continuing credit inflation, sluggish performance in labor productivity, continued declines in labor force participation, and further softness in capacity utilization. And, if the environment of credit inflation continues, finance and financial innovation will continue to thrive.

We don’t need a change in the “hearts and minds” of the labor force. The change in “hearts and minds” that is needed is in the politicians in the federal government.

1 comment:

Anonymous said...

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