In this globalized world, international capital mobility must be taken as a given.
According to modern international economic theory, if international capital mobility is a given, then there are only two other policy choices left a nation, but that nation can only choose one of the two. The first is a fixed exchange rate and the second is the ability to run an independent government economic policy. By independent is meant that a nation’s economic policy can be run according to the internal goals and objectives of that nation without regard to the economic policy of any other nation in the world.
The assumption has been that a nation can follow an independent path internally so as to achieve high levels of employment as well as other social goals like attempting to put every family in the country in its own home.
The United States began following a fully independent economic path in the 1960s and with the growing mobility of capital globally following World War II, the Nixon administration found it could not continue keeping the value of the dollar tied to a gold standard. In August 1971, President Nixon released the dollar and allowed its value to float.
The basic assumption of this move was that the value of the dollar would adjust in international markets so that the United States government could inflate the economy so as to achieve full employment of its labor force. As credit inflation took place within the country, the value of the dollar would decline causing exports to increase which would keep the labor market fully engaged.
One problem: this assumed that the United States economy would stay competitive with other nations. Unfortunately, this assumption did not hold as the credit inflation within the United States resulted in a deterioration of the competitive base of American industry.
A consequence of this deterioration is that American exports could not keep up with the competition in world markets. As the value of the dollar declined, exports did not expand as the economic model predicted. Charles Kadlec reported in the Wall Street Journal that as the value of the dollar declined dramatically over the 42 years following 1967 “net exports have fallen from a modest surplus in 1967 to a $390 billion deficit equivalent to 2.7% of GDP today.” (http://professional.wsj.com/article/SB10001424052748703440004575548451304697496.html?mod=WSJ_Opinion_LEFTTopOpinion&mg=reno-wsj)
Hello?
Is the market trying to tell us something?
In my post yesterday, I presented information cited by Tom Freidman in the New York Times who focused on a report from the National Academies listing how the United States has declined from being a leader in innovation and technology. The conclusion from this report is that the United States just is not as competitive in the world as it was fifty years ago.
Bloomberg adds further evidence that the world is shifting in terms of competitive action. How do you like this headline? “IPOs in Asia Grab Record Share of Funds as U. S. Offers Dry Up.” (http://www.bloomberg.com/news/2010-10-27/ipos-in-asia-grab-record-share-of-global-funds-as-u-s-offerings-dry-up.html)
“‘What the market needs and wants is a lot more IPOs coming out of China,’ said Jeff Urbina, who oversees emerging-market strategy at Chicago-based William Blair, which manages more than $41 billion. ‘That’s where the growth is.’”
The article states that “Record demand for initial public offerings in Asia is reducing the share of U. S. IPOs to an all-time low as companies from China to Malaysia and India flood the market with more equity than ever.”
Who says the world is not shifting?
And, then, in another blow to American pride, we learn that the Chinese have built a supercomputer that has 1.4 times the horsepower of the fastest computer that exists in the United States. (http://www.nytimes.com/2010/10/28/technology/28compute.html?hp)
Maybe, just maybe, the United States needs to take a hard look at the economic philosophy it has based economic policy on over the past fifty years. Maybe an economic policy based upon credit inflation is not productive in the longer run after all.
There is substantial information being produced by the market place to indicate that maybe the predominant economic model in the United States, the “Keynesian” model, does not produce the results that we want. In fact, the information is pointing to the fact that, in the long run, the results that are produced by this model are exactly the opposite of what people were trying to achieve.
However, the real Keynes argued that when the facts seemed to point away from the models currently in use, one should change the models that are being used.
Maybe, just maybe, we should listen to this Keynes and not to the “Keynesian” true-believers that preach the fundamentalist gospel that has dominated economic policy making over the past fifty years.
Showing posts with label Keynesian economics. Show all posts
Showing posts with label Keynesian economics. Show all posts
Thursday, October 28, 2010
Tuesday, October 26, 2010
The Basics of Turnarounds: the United States Situation
A part of my life has been connected with company turnarounds, bank turnarounds to be more precise. I would suggest that the United States is in a turnaround situation right now but its leaders claim that the economic model it is using is still relevant and that all that is needed is a little more time and a little more co-operation from others and everything will turn out alright.
My experience has led me to some conclusions about what is needed in a turnaround situation. (By-the-way, all my turnarounds were successful and I can say that now because I am not doing turnarounds any more.) We don’t have much space to discuss these things so let me just summarize what I believe to be the four most important factors in achieving a turnaround: the business model; information coming from the market place; the need for transparency and openness; and the existing business culture.
Although these factors relate to a business situation, I believe that they can be applied to any “turnaround” situation, including the “turnaround” of a government.
First, and foremost, an organization gets into trouble because its business model, or economic model, is not working. But, because a leader or a management team believes that the organization has gotten where it is because of that business model, they tend to stick with the model and apply the model even more forcefully.
In some cases, the success of the model has come because of the timing of the model’s use and not because of any inherent characteristics of the model are correct. To justify this statement I refer the reader to the book “Fooled By Randomness,” by Nassim Nicholas Taleb.
In terms of the economic model that the United States government is applying, and has been applying for a very long time, there is no real evidence that it works. I am, of course, speaking of the Keynesian macro-economic model.
Ever since the 1930s when the model was first presented, all I have ever heard in times of difficulty is that the reason the Keynesian model falls short is that not enough stimulus has been forthcoming. Keynesian economists contend that the Great Depression continued on for as long as it did because governments did not create sufficient budget deficits. Only the war effort, World War II, got the US out.
This criticism has been applied over and over again during the last fifty years. All we have been hearing from the fundamentalist preacher Paul Krugman is that the Obama stimulus package must be greater. He has been consistent in applying this remedy since early on in the Great Recession. More spending, more, more!
Maybe the economic model the government is using is wrong!
The application of this model over the past fifty years has produced falling capacity utilization, rising under-employment, and greater income inequality.
Maybe the economic model has not been applied correctly!
Defensive comments like these are heard over and over again within a company that is in decline.
Second, it seems that others recognize the decline in the company even though the leaders and management of the organization do not. That is, the market recognizes that the model of the organization is not working and that the organization is in decline.
And, what is the response of the leaders or managements of the targeted organization. The response is “The market doesn’t understand us!” I don’t know how many CEOs I have heard express this sentiment in the face of a falling stock price.
The thing is, the market does understand the company and the fact that the company is applying an inappropriate business model.
The market response to the economic policy of the United States? Well, the behavior of the United States government in the 1960s resulted in the need for the United States to go off the gold standard. Since the United States has been off the gold standard, the value of the United States dollar has declined almost constantly (with the two exceptions, when Paul Volcker was the Chairman of the Board of Governors of the Federal Reserve system and during the 1990s when Robert Rubin was the Secretary of the Treasury).
Obviously, for the value of the United States dollar to substantially fall, almost continuously, over a fifty year period, indicates that something must be wrong with the economic model the government is using. During the past fifty years, the government has relied on a credit inflation whose foundation is a federal deficit that has resulted in the federal debt increasing at an annual compound rate of growth of more than 9% over this time period. The government has created other avenues of credit inflation through programs like those built for housing and home ownership. The whole economic model was based upon inflating the economy causing people to constantly “leverage up” and take on more and more risk.
Third, transparency and openness goes by the wayside as organizations experience decline. Cover ups abound! President Obama came into office declaring that he was going to change the way things are done in Washington. Yet, his administration is now charged with opaqueness and obfuscation like every other presidential administration. Even little bits of information, like the recent report by the special inspector of the TARP program, only adds to the accusation that this administration is hiding things. This was in all the papers this morning. (See “Treasury Hid A. I. G. Loss, Report Says,” http://www.nytimes.com/2010/10/26/business/26tarp.html?ref=business.) This does not help!
Fourth, the culture of an organization begins at the top. In a turnaround situation, a new culture
must be implemented and that culture must begin with Number One. The new leader that takes on a turnaround situation must change the way things are done and introduce a new business or economic model into the organization.
However, this new business model cannot be introduced or implemented if the (new) leader assumes that little or nothing needs to be changed. And, this implementation cannot be carried off unless the members of his or her team are all on board.
In my view, things need to be changed in Washington, D. C. The evidence in the market place is hard to ignore, although Washington has done its best to shift attention to others. But, the weakness of the United States position has been observed and others (China, Brazil, and India, and others) have moved into the void to take advantage of it. (See my post http://seekingalpha.com/article/229112-the-imf-bowl-u-s-vs-china.)
Even if the philosophy of economic policy used by the United States government was appropriate forty or fifty years ago, things have changed since then. (See my post http://seekingalpha.com/article/232044-maybe-things-have-changed.) The United States needs to be “turned around”. But, to do a turnaround, those that are in leadership positions must accept the fact that a turnaround is necessary. I don’t see this happening any time soon.
My experience has led me to some conclusions about what is needed in a turnaround situation. (By-the-way, all my turnarounds were successful and I can say that now because I am not doing turnarounds any more.) We don’t have much space to discuss these things so let me just summarize what I believe to be the four most important factors in achieving a turnaround: the business model; information coming from the market place; the need for transparency and openness; and the existing business culture.
Although these factors relate to a business situation, I believe that they can be applied to any “turnaround” situation, including the “turnaround” of a government.
First, and foremost, an organization gets into trouble because its business model, or economic model, is not working. But, because a leader or a management team believes that the organization has gotten where it is because of that business model, they tend to stick with the model and apply the model even more forcefully.
In some cases, the success of the model has come because of the timing of the model’s use and not because of any inherent characteristics of the model are correct. To justify this statement I refer the reader to the book “Fooled By Randomness,” by Nassim Nicholas Taleb.
In terms of the economic model that the United States government is applying, and has been applying for a very long time, there is no real evidence that it works. I am, of course, speaking of the Keynesian macro-economic model.
Ever since the 1930s when the model was first presented, all I have ever heard in times of difficulty is that the reason the Keynesian model falls short is that not enough stimulus has been forthcoming. Keynesian economists contend that the Great Depression continued on for as long as it did because governments did not create sufficient budget deficits. Only the war effort, World War II, got the US out.
This criticism has been applied over and over again during the last fifty years. All we have been hearing from the fundamentalist preacher Paul Krugman is that the Obama stimulus package must be greater. He has been consistent in applying this remedy since early on in the Great Recession. More spending, more, more!
Maybe the economic model the government is using is wrong!
The application of this model over the past fifty years has produced falling capacity utilization, rising under-employment, and greater income inequality.
Maybe the economic model has not been applied correctly!
Defensive comments like these are heard over and over again within a company that is in decline.
Second, it seems that others recognize the decline in the company even though the leaders and management of the organization do not. That is, the market recognizes that the model of the organization is not working and that the organization is in decline.
And, what is the response of the leaders or managements of the targeted organization. The response is “The market doesn’t understand us!” I don’t know how many CEOs I have heard express this sentiment in the face of a falling stock price.
The thing is, the market does understand the company and the fact that the company is applying an inappropriate business model.
The market response to the economic policy of the United States? Well, the behavior of the United States government in the 1960s resulted in the need for the United States to go off the gold standard. Since the United States has been off the gold standard, the value of the United States dollar has declined almost constantly (with the two exceptions, when Paul Volcker was the Chairman of the Board of Governors of the Federal Reserve system and during the 1990s when Robert Rubin was the Secretary of the Treasury).
Obviously, for the value of the United States dollar to substantially fall, almost continuously, over a fifty year period, indicates that something must be wrong with the economic model the government is using. During the past fifty years, the government has relied on a credit inflation whose foundation is a federal deficit that has resulted in the federal debt increasing at an annual compound rate of growth of more than 9% over this time period. The government has created other avenues of credit inflation through programs like those built for housing and home ownership. The whole economic model was based upon inflating the economy causing people to constantly “leverage up” and take on more and more risk.
Third, transparency and openness goes by the wayside as organizations experience decline. Cover ups abound! President Obama came into office declaring that he was going to change the way things are done in Washington. Yet, his administration is now charged with opaqueness and obfuscation like every other presidential administration. Even little bits of information, like the recent report by the special inspector of the TARP program, only adds to the accusation that this administration is hiding things. This was in all the papers this morning. (See “Treasury Hid A. I. G. Loss, Report Says,” http://www.nytimes.com/2010/10/26/business/26tarp.html?ref=business.) This does not help!
Fourth, the culture of an organization begins at the top. In a turnaround situation, a new culture
must be implemented and that culture must begin with Number One. The new leader that takes on a turnaround situation must change the way things are done and introduce a new business or economic model into the organization.
However, this new business model cannot be introduced or implemented if the (new) leader assumes that little or nothing needs to be changed. And, this implementation cannot be carried off unless the members of his or her team are all on board.
In my view, things need to be changed in Washington, D. C. The evidence in the market place is hard to ignore, although Washington has done its best to shift attention to others. But, the weakness of the United States position has been observed and others (China, Brazil, and India, and others) have moved into the void to take advantage of it. (See my post http://seekingalpha.com/article/229112-the-imf-bowl-u-s-vs-china.)
Even if the philosophy of economic policy used by the United States government was appropriate forty or fifty years ago, things have changed since then. (See my post http://seekingalpha.com/article/232044-maybe-things-have-changed.) The United States needs to be “turned around”. But, to do a turnaround, those that are in leadership positions must accept the fact that a turnaround is necessary. I don’t see this happening any time soon.
Monday, September 27, 2010
Questions for a Monday Morning
Beginning in 1961 with the inauguration of President John F. Kennedy, the United States government has basically operated from a “Keynesian” economic philosophy. The economists that Kennedy brought into his administration were avowedly Keynesian and the Kennedy tax cuts that followed were developed from a Keynesian model.
This has been a bi-partisan effort and Republicans are as guilty as anyone in terms of the emphasis upon stimulative government budgets. President Richard M. Nixon confessed in the early 1970s that “we are all Keynesians, now!”
Government economic policy was written into legislation beginning with the The Employment Act, Act of Feb. 20, 1946 which was followed by the Humphrey-Hawkins Employment Act, the Full Employment and Balanced Growth Act, enacted in October 1978. Congress enacted laws that required the government to produce economic growth policies that were aimed at high levels of employment.
A growing economy and high levels of employment became a necessary goal of any presidential candidate running for election (“Get the economy growing again,” and “It’s the economy, stupid!”) or for re-election.
And, what was the result?
Since 1960 through 2009 the United States economy has grown at an average annual compound rate of growth of around 3.2%. Economists in the 1960s calculated that full-employment growth in the economy was about 3.2% and so economic policy was targeting a potential for growth in the United States economy of 3.2%.
If, after 50 years, these economists were to look back they might be astounded that the economy grew roughly at what they presumed to be the rate at which the economy could potentially grow during that time period.
Yet, not all is well with the world.
These economists could argue that fiscal policy really worked. The gross federal debt grew at an average annual rate of more than 9% during this 50 year period. Fiscal policy must have worked?
Financial innovation in the United States government was astounding during this period. As Niall Ferguson has claimed in several of his history books that governments have always been the number one innovator in finance historically. The United States government certainly proved this to be true over the last 50 years.
Certainly, credit inflation was the name of the game during this time period as the private sector came to emulate the government sector in terms of creating financial innovation and financial leverage became the necessary means of competition for firms to gain an edge in financial performance.
On the way to the bank, however, certain other things happened…and these raise some serious questions.
During all of this time period, in the United States industrial sector, capacity utilization went from over 90% of capacity to about 75% of capacity. If growth was proceeding at 3.2% a year, how come our industrial base has been used less and less over this period?
Also, the big concern in terms of unemployment was that we reach and sustain a 4% unemployment rate. Yet the unemployment rate has progressively increased and the under-employment rate, hardly different from the unemployment rate in the 1960s, is now above 20%. Why hasn’t the economic stimulus put more people to work?
Housing, which used to be the backbone of the private sector is now primarily the realm of the federal government. Who owns most of the mortgages in the country?
In the 1960s there were over 14,000 commercial banks in the United States. Now, there are less than 8,000 and, in my view, we are going to 4,000 in the next several years.
We had a vibrant sector of thrift institutions in the 1960s. By the end of the 1980s the thrift industry was almost gone. By the end of 2011, the thrift industry will be gone. This was the result of sound fiscal policies?
Income inequality has risen dramatically over the last 50 years. We have found out that the wealthy or the financially savvy can protect themselves during times of inflation and credit inflation. The blue collar worker, the less financially sophisticated, the middle class cannot protect themselves nearly as well during times when hedging or speculation becomes the way to financial wealth. Weren’t the Keynesian policies supposed to help the less well off by keeping them employed?
The “piggy bank” that the middle class and finally the less-well-off were supposed to exploit and protect themselves against inflation and lead them into a better financial future eventually busted. Housing was the “piggy bank” that many were supposed to ride to retirement leisure. But, falling house prices and foreclosures are turning the dream of many into nightmares? Couldn’t credit inflation keep this ball in the air?
There are many other question going around right now. The concern is the validity of the economic model that has been the foundation of our economic policies over the past 50 years. It appears as if we got the economic growth. What happened to all the other benefits we were supposed to receive once we achieved this economic growth?
This has been a bi-partisan effort and Republicans are as guilty as anyone in terms of the emphasis upon stimulative government budgets. President Richard M. Nixon confessed in the early 1970s that “we are all Keynesians, now!”
Government economic policy was written into legislation beginning with the The Employment Act, Act of Feb. 20, 1946 which was followed by the Humphrey-Hawkins Employment Act, the Full Employment and Balanced Growth Act, enacted in October 1978. Congress enacted laws that required the government to produce economic growth policies that were aimed at high levels of employment.
A growing economy and high levels of employment became a necessary goal of any presidential candidate running for election (“Get the economy growing again,” and “It’s the economy, stupid!”) or for re-election.
And, what was the result?
Since 1960 through 2009 the United States economy has grown at an average annual compound rate of growth of around 3.2%. Economists in the 1960s calculated that full-employment growth in the economy was about 3.2% and so economic policy was targeting a potential for growth in the United States economy of 3.2%.
If, after 50 years, these economists were to look back they might be astounded that the economy grew roughly at what they presumed to be the rate at which the economy could potentially grow during that time period.
Yet, not all is well with the world.
These economists could argue that fiscal policy really worked. The gross federal debt grew at an average annual rate of more than 9% during this 50 year period. Fiscal policy must have worked?
Financial innovation in the United States government was astounding during this period. As Niall Ferguson has claimed in several of his history books that governments have always been the number one innovator in finance historically. The United States government certainly proved this to be true over the last 50 years.
Certainly, credit inflation was the name of the game during this time period as the private sector came to emulate the government sector in terms of creating financial innovation and financial leverage became the necessary means of competition for firms to gain an edge in financial performance.
On the way to the bank, however, certain other things happened…and these raise some serious questions.
During all of this time period, in the United States industrial sector, capacity utilization went from over 90% of capacity to about 75% of capacity. If growth was proceeding at 3.2% a year, how come our industrial base has been used less and less over this period?
Also, the big concern in terms of unemployment was that we reach and sustain a 4% unemployment rate. Yet the unemployment rate has progressively increased and the under-employment rate, hardly different from the unemployment rate in the 1960s, is now above 20%. Why hasn’t the economic stimulus put more people to work?
Housing, which used to be the backbone of the private sector is now primarily the realm of the federal government. Who owns most of the mortgages in the country?
In the 1960s there were over 14,000 commercial banks in the United States. Now, there are less than 8,000 and, in my view, we are going to 4,000 in the next several years.
We had a vibrant sector of thrift institutions in the 1960s. By the end of the 1980s the thrift industry was almost gone. By the end of 2011, the thrift industry will be gone. This was the result of sound fiscal policies?
Income inequality has risen dramatically over the last 50 years. We have found out that the wealthy or the financially savvy can protect themselves during times of inflation and credit inflation. The blue collar worker, the less financially sophisticated, the middle class cannot protect themselves nearly as well during times when hedging or speculation becomes the way to financial wealth. Weren’t the Keynesian policies supposed to help the less well off by keeping them employed?
The “piggy bank” that the middle class and finally the less-well-off were supposed to exploit and protect themselves against inflation and lead them into a better financial future eventually busted. Housing was the “piggy bank” that many were supposed to ride to retirement leisure. But, falling house prices and foreclosures are turning the dream of many into nightmares? Couldn’t credit inflation keep this ball in the air?
There are many other question going around right now. The concern is the validity of the economic model that has been the foundation of our economic policies over the past 50 years. It appears as if we got the economic growth. What happened to all the other benefits we were supposed to receive once we achieved this economic growth?
Tuesday, July 20, 2010
The Long-Term Jobless in the Current Economic Malaise
I have been concerned for some time about the changing nature of the United States economy and the structure of the United States labor market. There seems to be a tremendous mis-match between the two and this portends an unhappy near term for economic growth and employment.
An article in the Monday New York Times by Peter Goodman, “After Job Training, Still Scrambling for a Job” captures the whole dilemma (http://www.nytimes.com/2010/07/19/business/19training.html?_r=1&scp=2&sq=peter%20goodman&st=cse). In this article, Mr. Goodman presents a well-developed argument that even after job training, many people in today’s economy cannot find jobs. One of the individuals Mr. Goodman interviewed stated in extreme frustration, “Training was fruitless. I’m not seeing the benefits. Training for what? No one’s hiring.”
Yet, Mr. Goodman argues that some industries are hiring. Some experts point out that “even with near double-digit unemployment, some jobs lie vacant, awaiting workers with adequate skills.”
“’There’s plenty of jobs in health care, in technology,’ said Fred Dedrick, executive director of the National Fund for Workforce Solutions.
Some of the aggregate figures point up this mis-match between labor and industry. First, the capacity utilization figures tell a dismal tale. Since the 1960s, capacity utilization in the United States has fallen. Every cyclical peak of capacity utilization over the past fifty years has been lower than the previous one. In the 1990s, capacity utilization reached a peak of around 85%; in the middle 2000s, the peak was around 82%; and currently it is languishing around 74%. United States industry does not seem to be “tooled-up” for the right output.
Second, the under-employment of the working-age labor force has grown constantly over the past thirty years or so. The “measured” rate of unemployment indicates that about one out of every ten workers is currently unemployed. My estimate for the under-employed is that about one out of every four workers is under-employed in today’s economy.
How did we get this way?
I believe that the economic policies of the United States government helped to create this employment situation!
The reason I give for this conclusion is that every time economic growth started to slow over the past fifty years, the federal government stepped in to stimulate the economy and put people back into the jobs they had just lost. This was the Keynesian approach to the problem of unemployment.
This approach to stimulating the economy worked well in the short-run but in the longer-run failed to take account of shifting technologies and the job skills of the work force. This mis-match did not show up so much in the short-run because, especially in the earlier years, technology was not changing rapidly. However, as the last fifty years moved along changes in technology occurred at a faster and faster pace. The dislocation between the new technology and the “legacy” industrial capacity in place grew, as did the chasm between many in the labor force and the skills needed to handle the new technology in the new industries being created.
This is an unusual happening for it is nothing more than the working out of Joseph Schumpeter’s concept of “Creative Destruction”.
Applying Keynesian fiscal stimulus to this problem over and over again just exacerbated the situation. Why? Because people were either put back into “legacy” jobs or were given minor training and shoved back into the job market. Goodman writes, “Most job training is financed through the federal Workforce Investment Act, which was written in 1998—a time when hiring was extraordinarily robust. Then simply teaching jobless people how to use computers and write résumés put them on a path to paychecks.”
Goodman quotes Labor economist Carl E. Van Horn: “A lot of the training programs that we have in this country were designed for a kind of quick turnaround economy, as opposed to the entrenched structural challenges of today.”
The conclusion to this story is that over time the continued application of these Keynesian stimulus efforts causes a loss in impact. Each cycle this policy prescription seems to be less and less effective as the cumulative effect on industrial capacity and human capital grows. Capacity utilization declines and more and more workers become under-employed.
Given this conclusion, one can ask whether or not there comes a time when the fiscal stimulus program becomes almost totally ineffective? Have we reached a point where the cost/benefit tradeoff of more fiscal stimulus becomes almost all cost and very little benefit?
This, however, is not the only point that needs to be mentioned at this time. Most of the advocates of Keynesian fiscal stimulus policies are very concerned about the growth in income and wealth inequality over the past thirty years or so. The continued application of Keynesian-type fiscal stimulus packages during the past fifty years, I believe, has contributed substantially to the greater inequality in income and wealth that has occurred in the United States.
There are three primary reasons for this growth in inequality. First, the fiscal stimulus programs put people back to work in the jobs that they formerly held. The largest number of the short-term unemployed came from large firms so that the stimulus had to encourage the growth of these companies so that the workers that were laid off could be re-hired. The fiscal stimulus packages “subsidized” the growth and wealth of the big, already implanted companies. Thus, the salaries and employment packages in these areas could continue to grow over time even as the capacity utilization in these industries continued to fall.
Second, as more and more people in these industries became under-employed, their incomes dropped relative to other sectors of the economy and their future prospects also fell. This, however, did not keep these people from piling up debts to buy cars and houses and other consumer items. These people felt confident that over time, they would continue to generate income, even if it might be somewhat sporadic. Furthermore, the inflationary environment of the past fifty years made it sensible for these people to go into debt for the inflation depreciated the value of their debt over time.
Third, the wealthier segment of the economy took advantage of the continued fiscal stimulus of the past fifty years (gross federal debt rose at a compound rate of seven percent every year) and the fact that, on average, inflation rose at a compound rate of more than four percent per year over this time period. Wealthier people have always been able to position themselves better than the less-wealthy, especially when macro-trends become as predictable as the economic policy proscriptions of the United States government, whether Republican or Democrat.
Furthermore, wealthier people have always been able to find their way into the professions that provide, over time, the greatest opportunities to earn income and create wealth. Certainly these professions would include medicine and health, legal, finance, and management some of the biggest gainers over the past fifty years.
Given these factors, how long will it take for the United States economy to re-structure itself? In the 1930s it took a long time. Will it take that long this time around?
An article in the Monday New York Times by Peter Goodman, “After Job Training, Still Scrambling for a Job” captures the whole dilemma (http://www.nytimes.com/2010/07/19/business/19training.html?_r=1&scp=2&sq=peter%20goodman&st=cse). In this article, Mr. Goodman presents a well-developed argument that even after job training, many people in today’s economy cannot find jobs. One of the individuals Mr. Goodman interviewed stated in extreme frustration, “Training was fruitless. I’m not seeing the benefits. Training for what? No one’s hiring.”
Yet, Mr. Goodman argues that some industries are hiring. Some experts point out that “even with near double-digit unemployment, some jobs lie vacant, awaiting workers with adequate skills.”
“’There’s plenty of jobs in health care, in technology,’ said Fred Dedrick, executive director of the National Fund for Workforce Solutions.
Some of the aggregate figures point up this mis-match between labor and industry. First, the capacity utilization figures tell a dismal tale. Since the 1960s, capacity utilization in the United States has fallen. Every cyclical peak of capacity utilization over the past fifty years has been lower than the previous one. In the 1990s, capacity utilization reached a peak of around 85%; in the middle 2000s, the peak was around 82%; and currently it is languishing around 74%. United States industry does not seem to be “tooled-up” for the right output.
Second, the under-employment of the working-age labor force has grown constantly over the past thirty years or so. The “measured” rate of unemployment indicates that about one out of every ten workers is currently unemployed. My estimate for the under-employed is that about one out of every four workers is under-employed in today’s economy.
How did we get this way?
I believe that the economic policies of the United States government helped to create this employment situation!
The reason I give for this conclusion is that every time economic growth started to slow over the past fifty years, the federal government stepped in to stimulate the economy and put people back into the jobs they had just lost. This was the Keynesian approach to the problem of unemployment.
This approach to stimulating the economy worked well in the short-run but in the longer-run failed to take account of shifting technologies and the job skills of the work force. This mis-match did not show up so much in the short-run because, especially in the earlier years, technology was not changing rapidly. However, as the last fifty years moved along changes in technology occurred at a faster and faster pace. The dislocation between the new technology and the “legacy” industrial capacity in place grew, as did the chasm between many in the labor force and the skills needed to handle the new technology in the new industries being created.
This is an unusual happening for it is nothing more than the working out of Joseph Schumpeter’s concept of “Creative Destruction”.
Applying Keynesian fiscal stimulus to this problem over and over again just exacerbated the situation. Why? Because people were either put back into “legacy” jobs or were given minor training and shoved back into the job market. Goodman writes, “Most job training is financed through the federal Workforce Investment Act, which was written in 1998—a time when hiring was extraordinarily robust. Then simply teaching jobless people how to use computers and write résumés put them on a path to paychecks.”
Goodman quotes Labor economist Carl E. Van Horn: “A lot of the training programs that we have in this country were designed for a kind of quick turnaround economy, as opposed to the entrenched structural challenges of today.”
The conclusion to this story is that over time the continued application of these Keynesian stimulus efforts causes a loss in impact. Each cycle this policy prescription seems to be less and less effective as the cumulative effect on industrial capacity and human capital grows. Capacity utilization declines and more and more workers become under-employed.
Given this conclusion, one can ask whether or not there comes a time when the fiscal stimulus program becomes almost totally ineffective? Have we reached a point where the cost/benefit tradeoff of more fiscal stimulus becomes almost all cost and very little benefit?
This, however, is not the only point that needs to be mentioned at this time. Most of the advocates of Keynesian fiscal stimulus policies are very concerned about the growth in income and wealth inequality over the past thirty years or so. The continued application of Keynesian-type fiscal stimulus packages during the past fifty years, I believe, has contributed substantially to the greater inequality in income and wealth that has occurred in the United States.
There are three primary reasons for this growth in inequality. First, the fiscal stimulus programs put people back to work in the jobs that they formerly held. The largest number of the short-term unemployed came from large firms so that the stimulus had to encourage the growth of these companies so that the workers that were laid off could be re-hired. The fiscal stimulus packages “subsidized” the growth and wealth of the big, already implanted companies. Thus, the salaries and employment packages in these areas could continue to grow over time even as the capacity utilization in these industries continued to fall.
Second, as more and more people in these industries became under-employed, their incomes dropped relative to other sectors of the economy and their future prospects also fell. This, however, did not keep these people from piling up debts to buy cars and houses and other consumer items. These people felt confident that over time, they would continue to generate income, even if it might be somewhat sporadic. Furthermore, the inflationary environment of the past fifty years made it sensible for these people to go into debt for the inflation depreciated the value of their debt over time.
Third, the wealthier segment of the economy took advantage of the continued fiscal stimulus of the past fifty years (gross federal debt rose at a compound rate of seven percent every year) and the fact that, on average, inflation rose at a compound rate of more than four percent per year over this time period. Wealthier people have always been able to position themselves better than the less-wealthy, especially when macro-trends become as predictable as the economic policy proscriptions of the United States government, whether Republican or Democrat.
Furthermore, wealthier people have always been able to find their way into the professions that provide, over time, the greatest opportunities to earn income and create wealth. Certainly these professions would include medicine and health, legal, finance, and management some of the biggest gainers over the past fifty years.
Given these factors, how long will it take for the United States economy to re-structure itself? In the 1930s it took a long time. Will it take that long this time around?
Monday, July 5, 2010
Jobs and Skills: the Current Mismatch
For at least 18 months, I have been arguing that the United States economy is going through a transition period that is more than just a cyclical slowdown and recovery. My argument has been that the economy is going through a period of restructuring that will take an extended amount of time to work out all the changes that are necessary.
As a consequence, “blunt-edge” efforts to stimulate jobs by means of the fiscal policy of the federal government will not achieve a great deal of success.
The reason for this in many cases is that the fiscal stimulus of the past 50 years has caused companies to keep aging physical capital in use and has resulted in these companies hiring people to perform jobs related to “legacy” technology.
The evidence I have provided for this is the increasing amount of unused capacity in the manufacturing realm and the growth in the number of employable Americans that are under-employed. To be under-employed, one is either unemployed, not fully employed and looking for full-time work, or discouraged and not seeking a job.
I have argued that this is not unlike the 1930s when the United States economy was going through a transition period in which jobs and employment were shifting from rural and agricultural areas to cities and industrial areas. The restructuring that took place accelerated during World War II and did not really calm down until the 1950s and 1960s.
Two reports came out toward the end of last week that support my claim of an economy that is in the process of restructuring. The first was an article by Motoko Rich that appeared in the New York Times on Friday July 2, with the title “Jobs Go Begging as Gap is Exposed in Worker Skills.” (http://www.nytimes.com/2010/07/02/business/economy/02manufacturing.html?_r=1&scp=2&sq=motoko%20rich&st=cse) Rich writes that “Plenty of people are applying for the jobs. The problem, the companies say, is a mismatch between the kind of skilled workers needed and the ranks of the unemployed.” The subheading to the article reads that “Shifts in Manufacturing are Leaving Many as Unemployable.”
The second report came from the Labor Department on Friday, July 3. Although the unemployment rate declined in May to 9.5 % from 9.7% in April, this was because the labor force shrank as more people left the labor force than were added to payrolls: the labor force shrunk by 0.3% while the number of individuals employed dropped by only 0.2% (due to the loss in jobs connected with the collection of Census data).
The official statistics report that the “underemployment” rate has been in the 17% range for the past year or so. I estimate that, currently, about one out of every four or five individuals that are in the employable age group are under-employed. The reason is that there is a tremendous mis-match between what employers need to be competitive in the future and the pool of skills and experience that are available in the labor market. Products are being made differently now than they were several years ago and this trend will continue. The current downturn has provided additional justification for manufacturers to make the changes that they need to make.
Why do they need this added justification?
Well, over the past 50 years, every time there was a recession (and even in periods when there was not a recession), the federal government provided fiscal stimulus to get people “back-to-work.” Back-to-work, however, meant putting people back into jobs that they were in before the workers were laid off. This is what the government wanted to happen.
However, putting people back to work in “legacy” jobs did not contribute to modernization and improved productivity. It did increase employment and reduce unemployment which is what the federal government wanted to achieve.
Now, businesses can use the excuse of the extreme downturn in the economy to justify the changes in who is hired to meet the reality of changes in training, skill levels, and experience that have occurred. And, this transition will not be completed overnight.
We see the same thing in the use of physical capital in the United States. Since the 1960s, the capacity utilization of manufacturers has declined steadily. As with the increase in the underemployed, the employment of the physical capital in the United States has fallen over time.
In January 1965, American manufacturers were working at 89.4% of capacity. The next peak in manufacturing usage (capacity utilization is very cyclical) came in February 1973 at 88.8% of capacity. The following peaks were: December 1978 at 86.6% of capacity; January 1989 at 85.2% of capacity; December 1997 at 84.7% of capacity; and April 2007 at 81.7% of capacity.
Note that the troughs of the cycles in capacity utilization also fell since the 1960s. In December 1982, manufacturers in the United States worked at 70.9% of capacity and in June 2009, they worked at 68.2%. Currently, manufacturers are working at 74.1% of capacity.
In essence, businesses in the United States have been utilizing less and less human and physical capital over the past 50 years relative to the amounts of these productive factors that have been available. And, the policy makers just don’t seem to get it.
From Rich, in the article cited above, “Christina D. Romer, chairwoman of the Council of Economic Advisers, said the skills shortages reported by employers stem largely from a long-term structural shift in manufacturing, which should not be confused with the recent downturn. ‘I do think that manufacturing can come back to what it was before the recession,’ she said.” So, manufacturing will return to the new, lower level of capacity utilization that was achieved at its previous peak level, roughly 82% of capacity. And, this is good?
My guess is that capacity utilization will hit, maybe, 80% at the next peak. We are still talking about 20% of the manufacturing capital of the United States being underemployed, right in line with the 20% to 25% of employable labor in the United States being underemployed.
The fiscal stimulus proposed by “fundamentalist” Keynesian economists will not do the job. Additional, “blunt-edge” governmental expenditures may alleviate some of the current worker distress, but at the cost of postponing the adjustments that need to be made to restructure the economy, the restructuring that is now going on.
The problem with the “fundamentalist” Keynesian view is that it is constructed from a short term perspective. The basic attitude is that which is attributed to Keynes: “In the long run we are all dead.” This approach leads to a focus on only “current” problems. What is not explicitly stated is that we will deal with the longer-term problems when they become current problems.
The difficulty with this: the longer-term problems may require a different “medicine” than did the short-run problems.
Well, one could argue that the longer-term problems have become current. The short-term solution of forcing many companies to continue to employ people in “legacy” jobs and to continue to use “legacy” plant and equipment has resulted in higher and higher rates of worker under-employment and lower and lower rates of manufacturing capacity utilization.
Just more of the same does not seem to be an adequate answer.
As a consequence, “blunt-edge” efforts to stimulate jobs by means of the fiscal policy of the federal government will not achieve a great deal of success.
The reason for this in many cases is that the fiscal stimulus of the past 50 years has caused companies to keep aging physical capital in use and has resulted in these companies hiring people to perform jobs related to “legacy” technology.
The evidence I have provided for this is the increasing amount of unused capacity in the manufacturing realm and the growth in the number of employable Americans that are under-employed. To be under-employed, one is either unemployed, not fully employed and looking for full-time work, or discouraged and not seeking a job.
I have argued that this is not unlike the 1930s when the United States economy was going through a transition period in which jobs and employment were shifting from rural and agricultural areas to cities and industrial areas. The restructuring that took place accelerated during World War II and did not really calm down until the 1950s and 1960s.
Two reports came out toward the end of last week that support my claim of an economy that is in the process of restructuring. The first was an article by Motoko Rich that appeared in the New York Times on Friday July 2, with the title “Jobs Go Begging as Gap is Exposed in Worker Skills.” (http://www.nytimes.com/2010/07/02/business/economy/02manufacturing.html?_r=1&scp=2&sq=motoko%20rich&st=cse) Rich writes that “Plenty of people are applying for the jobs. The problem, the companies say, is a mismatch between the kind of skilled workers needed and the ranks of the unemployed.” The subheading to the article reads that “Shifts in Manufacturing are Leaving Many as Unemployable.”
The second report came from the Labor Department on Friday, July 3. Although the unemployment rate declined in May to 9.5 % from 9.7% in April, this was because the labor force shrank as more people left the labor force than were added to payrolls: the labor force shrunk by 0.3% while the number of individuals employed dropped by only 0.2% (due to the loss in jobs connected with the collection of Census data).
The official statistics report that the “underemployment” rate has been in the 17% range for the past year or so. I estimate that, currently, about one out of every four or five individuals that are in the employable age group are under-employed. The reason is that there is a tremendous mis-match between what employers need to be competitive in the future and the pool of skills and experience that are available in the labor market. Products are being made differently now than they were several years ago and this trend will continue. The current downturn has provided additional justification for manufacturers to make the changes that they need to make.
Why do they need this added justification?
Well, over the past 50 years, every time there was a recession (and even in periods when there was not a recession), the federal government provided fiscal stimulus to get people “back-to-work.” Back-to-work, however, meant putting people back into jobs that they were in before the workers were laid off. This is what the government wanted to happen.
However, putting people back to work in “legacy” jobs did not contribute to modernization and improved productivity. It did increase employment and reduce unemployment which is what the federal government wanted to achieve.
Now, businesses can use the excuse of the extreme downturn in the economy to justify the changes in who is hired to meet the reality of changes in training, skill levels, and experience that have occurred. And, this transition will not be completed overnight.
We see the same thing in the use of physical capital in the United States. Since the 1960s, the capacity utilization of manufacturers has declined steadily. As with the increase in the underemployed, the employment of the physical capital in the United States has fallen over time.
In January 1965, American manufacturers were working at 89.4% of capacity. The next peak in manufacturing usage (capacity utilization is very cyclical) came in February 1973 at 88.8% of capacity. The following peaks were: December 1978 at 86.6% of capacity; January 1989 at 85.2% of capacity; December 1997 at 84.7% of capacity; and April 2007 at 81.7% of capacity.
Note that the troughs of the cycles in capacity utilization also fell since the 1960s. In December 1982, manufacturers in the United States worked at 70.9% of capacity and in June 2009, they worked at 68.2%. Currently, manufacturers are working at 74.1% of capacity.
In essence, businesses in the United States have been utilizing less and less human and physical capital over the past 50 years relative to the amounts of these productive factors that have been available. And, the policy makers just don’t seem to get it.
From Rich, in the article cited above, “Christina D. Romer, chairwoman of the Council of Economic Advisers, said the skills shortages reported by employers stem largely from a long-term structural shift in manufacturing, which should not be confused with the recent downturn. ‘I do think that manufacturing can come back to what it was before the recession,’ she said.” So, manufacturing will return to the new, lower level of capacity utilization that was achieved at its previous peak level, roughly 82% of capacity. And, this is good?
My guess is that capacity utilization will hit, maybe, 80% at the next peak. We are still talking about 20% of the manufacturing capital of the United States being underemployed, right in line with the 20% to 25% of employable labor in the United States being underemployed.
The fiscal stimulus proposed by “fundamentalist” Keynesian economists will not do the job. Additional, “blunt-edge” governmental expenditures may alleviate some of the current worker distress, but at the cost of postponing the adjustments that need to be made to restructure the economy, the restructuring that is now going on.
The problem with the “fundamentalist” Keynesian view is that it is constructed from a short term perspective. The basic attitude is that which is attributed to Keynes: “In the long run we are all dead.” This approach leads to a focus on only “current” problems. What is not explicitly stated is that we will deal with the longer-term problems when they become current problems.
The difficulty with this: the longer-term problems may require a different “medicine” than did the short-run problems.
Well, one could argue that the longer-term problems have become current. The short-term solution of forcing many companies to continue to employ people in “legacy” jobs and to continue to use “legacy” plant and equipment has resulted in higher and higher rates of worker under-employment and lower and lower rates of manufacturing capacity utilization.
Just more of the same does not seem to be an adequate answer.
Wednesday, June 2, 2010
Why Krugman Is Wrong!
Talk about a fundamentalist preacher! Paul Krugman continues to rely upon his inerrant interpretation of the dogmatic Keynesian worldview as he condemns those “sinners” that have followed another path from the one he draws strength from.
Krugman’s New York Times column on Monday chastises those that take an alternative view: “More and more, conventional wisdom says that the responsible thing is to make the unemployed suffer.” (See “The Pain Caucus”, http://www.nytimes.com/2010/05/31/opinion/31krugman.html.)
He goes on: “What’s the greatest threat to our still-fragile economic recovery? Dangers abound, of course. But what I currently find most ominous is the spread of a destructive idea: the view that now, less than a year into a weak recovery from the worst slump since World War II, is the time for policy makers to stop helping the jobless and start inflicting pain.”
Amen, brother! Alleluia!
Right out of the creed! When you need to protect your economic doctrine, bring out unemployment and the unemployed. This goes back in history at least to Keynes and the Paris Peace Conference in 1919 when there was a fear about the spread of the Bolshevik revolution throughout Western Europe. (See my book review from October 25, 2009 of “John Maynard Keynes and International Relations”, http://seekingalpha.com/article/167893-john-maynard-keynes-and-international-relations-economic-paths-to-war-and-peace-by-donald-markwell.)
To support his argument, Krugman claims that America would be creating a situation not unlike that of Japan in the 1990s if the United States followed the “conventional wisdom” he disdains. “We are, however, looking more and more like Japan….[Recent data] suggests that we may be heading for a Japan-style lost decade, trapped in a prolonged period of high unemployment and slow growth.” (See the article by William Galston, “the Case Against Keynes (With Some Questions for Krugman, Too)” at http://www.tnr.com/blog/william-galston/75228/the-case-against-keynes-some-questions-krugman-too.)
The problem is that Krugman (and other fundamentalist Keynesians) interprets the Japanese situation—and the current situation in the United States—and the current situation in Europe) as “a rare real-world example of Keynes’s famous ‘liquidity trap’ in which monetary policy loses its effectiveness.” (See the Galston article.) The Keynesian solution to such a dilemma is to engage in “pump-priming” government expenditures that, through a cumulative multiplier effect that substantially increasing private demand, initiates a self-sustaining process of economic recovery.
The difficulty with this is that it does not take into account the huge amounts of debt that may have been accumulated through the earlier credit inflation that caused people and businesses to increase their financial leverage and risk taking. It was this credit inflation that ultimately led to the financial collapse that put the economy into the current situation. The other side of a credit inflation is a debt deflation.
The problem? People and businesses (including commercial banks) may find themselves so in debt with loan and interest payments far in excess of their own cash flows that they stop spending because they must repay or write-off large chunks of debt. They choose to become as liquid as possible because they must continue to live and finance their daily needs as much as they can through any wealth they may have accumulated. They do not become liquid because of they are afraid or unwilling to commit to the purchase of investment goods. They become liquid to survive.
Within such an environment, the Keynesian solution of pump-priming which leads to credit inflation becomes the only real response because it leads to inflation. To Krugman, Galston argues, “The root of the Japanese crisis is deflation, and the only remedy is a credible shift to a long-term inflationary policy.”
Although not stated in the “liquidity preference” arguments for such a policy, inflation reduces the debt burden because it reduces the real value of the debt. Inflation is always a way to get out-of-debt. The problem is, inflation encourages more financial leverage and more financial risk taking. This is what we in the United States have been doing for the last fifty years. And, ultimately it does not prevent the problem of a financial correction, it just postpones it.
Getting ones financial books in order is not necessarily a bad thing. It appears that Ireland is pulling out of its crisis situation after enduring “one of the worst recessions of any developed economy since the Great Depression.” (See the Bloomberg article: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a_gxU5nfACkg.)
Also, the United States in the 1990s presents an example fiscal prudence which contributed to a period of sustained economic growth. The Clinton administration pulled off a very successful policy of deficit reduction which was accompanied by the longest post-World War II period of economic expansion on record. So it can be done.
Other countries around the world are showing the fruits of fiscal discipline in the face of the economic slowdown of the past three years. Even with the turmoil in Europe, manufacturing seems to be recovering around the world, in the U. S., in the U. K., in Canada (where the Bank of Canada just raised interest rates yesterday over concerns about its robust economy), and in Australia, Brazil, China, India, and Japan.
The lingering problem connected with the buildup of debt is the “debt overhang” that remains once the peak of the credit cycle has passed. Yes, there may be liquidity problems connected with reversing out of the expanding economy into an economy that is contracting. Any reversal of direction will experience a dislocation of markets. But, the liquidity problem is a short-run phenomenon. Once the short-term problem is eradicated, the issue becomes one of getting the balance sheets of individuals, businesses (including commercial banks) back into a more conservative structure. And this can take time and can hinder the strength of the recovery.
But, unless one is inflating the country out of its debt load, this re-structuring of the balance sheets must take place for the recovery to become a healthy recovery. There will be pain during this time. But, living beyond ones means for fifty years creates a situation that is uncomfortable for some. Unfortunately, the people that are hurt are not generally the people that really profited from the credit inflation that caused the excesses.
Perhaps focusing on longer term financial discipline might be better for workers over time rather than concentrating on every little short-term wiggle in unemployment. Certainly, the countries that are paying more attention to longer-run issues (like China) are going to put a lot more economic pressure on those countries that only focus on the short run (like the United States and Europe). For more on this see “How China is Changing the World” http://seekingalpha.com/article/206830-how-china-is-changing-the-world.
Krugman’s New York Times column on Monday chastises those that take an alternative view: “More and more, conventional wisdom says that the responsible thing is to make the unemployed suffer.” (See “The Pain Caucus”, http://www.nytimes.com/2010/05/31/opinion/31krugman.html.)
He goes on: “What’s the greatest threat to our still-fragile economic recovery? Dangers abound, of course. But what I currently find most ominous is the spread of a destructive idea: the view that now, less than a year into a weak recovery from the worst slump since World War II, is the time for policy makers to stop helping the jobless and start inflicting pain.”
Amen, brother! Alleluia!
Right out of the creed! When you need to protect your economic doctrine, bring out unemployment and the unemployed. This goes back in history at least to Keynes and the Paris Peace Conference in 1919 when there was a fear about the spread of the Bolshevik revolution throughout Western Europe. (See my book review from October 25, 2009 of “John Maynard Keynes and International Relations”, http://seekingalpha.com/article/167893-john-maynard-keynes-and-international-relations-economic-paths-to-war-and-peace-by-donald-markwell.)
To support his argument, Krugman claims that America would be creating a situation not unlike that of Japan in the 1990s if the United States followed the “conventional wisdom” he disdains. “We are, however, looking more and more like Japan….[Recent data] suggests that we may be heading for a Japan-style lost decade, trapped in a prolonged period of high unemployment and slow growth.” (See the article by William Galston, “the Case Against Keynes (With Some Questions for Krugman, Too)” at http://www.tnr.com/blog/william-galston/75228/the-case-against-keynes-some-questions-krugman-too.)
The problem is that Krugman (and other fundamentalist Keynesians) interprets the Japanese situation—and the current situation in the United States—and the current situation in Europe) as “a rare real-world example of Keynes’s famous ‘liquidity trap’ in which monetary policy loses its effectiveness.” (See the Galston article.) The Keynesian solution to such a dilemma is to engage in “pump-priming” government expenditures that, through a cumulative multiplier effect that substantially increasing private demand, initiates a self-sustaining process of economic recovery.
The difficulty with this is that it does not take into account the huge amounts of debt that may have been accumulated through the earlier credit inflation that caused people and businesses to increase their financial leverage and risk taking. It was this credit inflation that ultimately led to the financial collapse that put the economy into the current situation. The other side of a credit inflation is a debt deflation.
The problem? People and businesses (including commercial banks) may find themselves so in debt with loan and interest payments far in excess of their own cash flows that they stop spending because they must repay or write-off large chunks of debt. They choose to become as liquid as possible because they must continue to live and finance their daily needs as much as they can through any wealth they may have accumulated. They do not become liquid because of they are afraid or unwilling to commit to the purchase of investment goods. They become liquid to survive.
Within such an environment, the Keynesian solution of pump-priming which leads to credit inflation becomes the only real response because it leads to inflation. To Krugman, Galston argues, “The root of the Japanese crisis is deflation, and the only remedy is a credible shift to a long-term inflationary policy.”
Although not stated in the “liquidity preference” arguments for such a policy, inflation reduces the debt burden because it reduces the real value of the debt. Inflation is always a way to get out-of-debt. The problem is, inflation encourages more financial leverage and more financial risk taking. This is what we in the United States have been doing for the last fifty years. And, ultimately it does not prevent the problem of a financial correction, it just postpones it.
Getting ones financial books in order is not necessarily a bad thing. It appears that Ireland is pulling out of its crisis situation after enduring “one of the worst recessions of any developed economy since the Great Depression.” (See the Bloomberg article: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a_gxU5nfACkg.)
Also, the United States in the 1990s presents an example fiscal prudence which contributed to a period of sustained economic growth. The Clinton administration pulled off a very successful policy of deficit reduction which was accompanied by the longest post-World War II period of economic expansion on record. So it can be done.
Other countries around the world are showing the fruits of fiscal discipline in the face of the economic slowdown of the past three years. Even with the turmoil in Europe, manufacturing seems to be recovering around the world, in the U. S., in the U. K., in Canada (where the Bank of Canada just raised interest rates yesterday over concerns about its robust economy), and in Australia, Brazil, China, India, and Japan.
The lingering problem connected with the buildup of debt is the “debt overhang” that remains once the peak of the credit cycle has passed. Yes, there may be liquidity problems connected with reversing out of the expanding economy into an economy that is contracting. Any reversal of direction will experience a dislocation of markets. But, the liquidity problem is a short-run phenomenon. Once the short-term problem is eradicated, the issue becomes one of getting the balance sheets of individuals, businesses (including commercial banks) back into a more conservative structure. And this can take time and can hinder the strength of the recovery.
But, unless one is inflating the country out of its debt load, this re-structuring of the balance sheets must take place for the recovery to become a healthy recovery. There will be pain during this time. But, living beyond ones means for fifty years creates a situation that is uncomfortable for some. Unfortunately, the people that are hurt are not generally the people that really profited from the credit inflation that caused the excesses.
Perhaps focusing on longer term financial discipline might be better for workers over time rather than concentrating on every little short-term wiggle in unemployment. Certainly, the countries that are paying more attention to longer-run issues (like China) are going to put a lot more economic pressure on those countries that only focus on the short run (like the United States and Europe). For more on this see “How China is Changing the World” http://seekingalpha.com/article/206830-how-china-is-changing-the-world.
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