What Economic Growth in the United States? And, in Europe?

The Congressional Budget Office (CBO) just released its forecast for economic growth and what it sees seems to differ substantially from what the Federal Reserve sees.

The CBO forecast places economic growth (real GDP growth) for the United States at 2.0 percent this year and at 1.1 percent in 2013. (http://www.nytimes.com/2012/02/01/us/politics/deficit-tops-1-trillion-but-is-falling.html?_r=1&ref=todayspaper)

The Federal Reserve just released its projections last week.  Taking the average of the ranges given, the Fed is forecasting that economic growth in 2012 will be 2.5 percent, and, for 2013 will be 3.0 percent.

Hey, these forecasts are going in opposite directions!

The one forecast, that of the CBO, emphasizes the future of the federal deficit: “The deficit will be $1.1 trillion in the current fiscal year, about $200 billion less than in 2011, and will fall sharply in the next three years as a result of tax increases and spending cuts required by existing law…”

The other forecast, that of the Federal Reserve, emphasizes the future of interest rates: short-term interest rates will remain close to zero until well into 2014.

In one sense, it seems as if the consequences of the two forecast are backward.  In order for the deficit to decline, the economy needs to be growing so that tax revenues will increase and welfare payments will decrease.  This will not happen if economic growth slows and unemployment increases…as it does in the CBO projection. (See a strong argument on this point, http://professional.wsj.com/article/SB10001424052970204740904577195352148844134.html?mod=WSJ_Opinion_LEADTop&mg=reno-secaucus-wsj.)

The Federal Reserve, on the other hand, has short-term interest rates staying extremely low despite the fact that they predict rising rates of economic growth, a condition that usually produces higher levels of interest rates.  This is because the demand for money generally increases with the rising level of incomes produced by the economic growth.

The major point is, however, that the CBO has produced a pretty dismal economic forecast. 

The CBO projection has unemployment rates rising to 8.9 percent in the last quarter of this year, up from 8.5 percent in December 2011.   Furthermore, the unemployment rate is expected to rise to 9.2 percent in the final quarter of 2013. 

This is not good!

And, what happens to the amount of under-employment if the CBO forecast takes place.  We certainly would see the under-employment rate stay in the 20 to 25 percent range.

On top of this is the real threat of recession in Europe.  The question is, how much does a European recession play into the forecasts of the Congressional Budget Office?

My big fear has been that a recession in Europe will have very negative connotations for growth in the United States.  (See my post, “Issue Number 1 for 2012: Recession in Europe,” http://seekingalpha.com/article/317268-issue-number-1-for-2012-recession-in-europe.)

Data released yesterday and presented by the Financial Times indicates that the unemployment rate for the eurozone was at 10.4 percent at the end of 2011 for the whole workforce, and was at 21.3 percent for the category “youth.”  Furthermore, the consensus real GDP growth for the eurozone is at negative 0.3 percent, not a level that is conducive to the reduction in the unemployment rate. 

The unemployment rate ranges from 22.9 percent in Spain and 19.2 percent in Greece to 5.5 percent in Germany and 4.1 percent in Austria showing the split that exists within the eurozone, itself. (See ”Eurozone Jobless Rate at Euro-era High,” http://www.ft.com/intl/cms/s/0/dca5fe48-4bf3-11e1-98dd-00144feabdc0.html#axzz1l92ForcZ, and, “Contraction Threat Clouds Euro Zone,” http://professional.wsj.com/article/SB10001424052970204740904577194442237686180.html?mod=ITP_pageone_3&mg=reno-secaucus-wsj.)

How much impact will this “European Recession” have on the economy of the United States and has it really been taken into account by the forecasters of the CBO and the Federal Reserve System?

And, given the over-extended position of consumers (http://seekingalpha.com/article/328252-where-is-the-u-s-consumer), corporations (http://seekingalpha.com/article/326412-corporate-confidence-continues-to-wane) , and banks (http://seekingalpha.com/article/320698-what-s-to-like-about-the-united-states-banking-system), where might a pickup in spending take place?

Given these facts, I tend to agree more with the economic projections of the Congressional Budget Office than I do with those of the Federal Reserve.  However, if we do achieve the growth rates of the Congressional Budget Office it would seem that the cumulative federal deficit for the next five years would be closer to the cumulative federal budget deficit of the past five years…in excess of $6 trillion, than what is now being forecast.

In essence…we are going nowhere…fast!

Where is the US Consumer?

“Rising Income is Saved, Not Spent,” reads the Wall Street Journal Tuesday morning. (http://professional.wsj.com/article/SB10001424052970204740904577192702993936344.html?mod=ITP_pageone_1&mg=reno-secaucus-wsj)

“Personal income increased 0.5% in December from November adjusted for seasonality, the largest monthly increase since March…but spending was flat over the month—actually fell when inflation is factored in.”

“The savings rate, around 5.0% for the first half of 2011, was near 4.0% for much of the second half of the year…. Economists warned that consumers would soon resume socking away cash at the expense of spending, and that appears to be playing out now.”

With unemployment still high and the housing market in the doldrums, consumers are reluctant—and in many cases unable—to increase their spending in a big way.”

The Federal Reserve’s recently released forecast projected unemployment rates remaining at high levels through 2014, declining only slightly throughout the next three years.  And, even worse, underemployment is also expected to remain high with the rate of underemployment staying near to one out of every five people of working age.  No help coming here.(

Furthermore, a large proportion of homeowners still find themselves “under water” with mortgages that exceed the market value of their houses.  This situation is not expected to improve in the near future.

Robert Shiller, the Yale economist, was just interviewed at Davos and responded to questions about home prices by saying that prices will probably continue to decline, although not at the rate they declined in recent years.  He added that even if housing prices did stop declining, there is no reason to expect that they would start to rise anytime soon.  In addition, he added, that even though housing prices were returning to something more like a “fair value” that historically, the tendency was for the market to “overshoot” the “fair value” until all the previous exuberance is wrung out of the market. (http://professional.wsj.com/article/SB10001424052970204740904577192702993936344.html?mod=ITP_pageone_1&mg=reno-secaucus-wsj)

A White House effort to lessen the impact of these homes that are “under water” seems to have failed in that the program developed by the administration has not reached enough borrowers to have much impact on the market. (http://www.ft.com/intl/cms/s/0/cf9fed00-4a89-11e1-8110-00144feabdc0.html#axzz1l2qSCMaM)

Even more chilling is the report released today by the Corporation for Enterprise Development (CFED) titled “The 2012 Assets & Opportunity Scorecard: How Financially Secure are Families?” (Go to http://cfed.org/.)   This study presents what it calls the households that are in “liquid asset poverty”.  A household is considered in liquid asset poverty if it owns a home, yet has no savings to speak of.  These people are just one significant emergency away from a real financial crisis. 

The emergency could take the form of a major car breakdown or a health problem.  Most of these people are earning a regular paycheck, CFED says, but they don’t really realize how close to the edge they are living.  Many have some other form of debt, but in an emergency would have to rely on very expensive sources of debt to try and carry them through the emergency. 

The study reports that 43 percent of the households in the United States are liquid asset poor.  This amounts to roughly 128 million households. 

Again, we seem to see the country bifurcating.  There are those households that are doing OK and are continuing to spend through these tough times.  Yet, there are a large number of people that have to watch out where every penny of their income is going.  This means that the economic recovery will not only remain week, but it will be fragile and susceptible to unexpected shocks.

Saving and deleveraging are still needed and being sought by many families, but this will just mean that the recovery will be missing any strong support from consumer spending in the near term.

And, it means that banks and other financial institutions cannot be sure of value of many of the assets on their balance sheets, both mortgages and consumer loans, but also face the fact that loan demand will also not be strong in the future.

We are still looking for where the surge in economic activity will come from.    

An Economic View from the Supply Side

As I have written before, the United States economy is recovering.  It may not be recovering as fast as some would like, but economic growth is positive.  Economic growth is not as rapid as some would like because there is still a massive debt overhang that must be eliminated, one way or another.

Furthermore, unemployment and under-employment are not dropping as fast as some would like.  The labor market is not improving with any speed because the economic policies of the last fifty years has resulted in a large amount of the United States manufacturing capacity being unused.  As physical capital is unused so is human capital.

Both of these situations took a long time to get to their present state and will take a long time to regain higher levels of economic growth, capacity utilization, and employment. 

The background for this situation can be examined from the following chart.

  This chart contains a graph of real Gross Domestic Product beginning in 1960 and ending in 2010.  I start with the year 1960 because that is the year before the United States government, both Democratic and Republican, introduced a “new” economic philosophy into its policy considerations, one that emphasized the inflation of credit throughout the economy. 

To me, the important thing about this chart is that real GDP is almost continuously rising.  Yes, there is a sizeable bump at the far right-hand side of the chart, and this is associated with the Great Recession, an apt title.  Otherwise, there are other little deviations from the upward trend, but these are relatively minor movements along the way.

This is where I take my stand with the economic growth proponents.  In the United States economy, growth is almost always positive.  The annual compound rate of growth for the period covered in the chart is 3.1 percent.  The annual compound growth rate of the United States economy, ending the calculation in 2007 (the Great Recession began in December 2007) the rate of growth rises to something around 3.25 percent.  But, growth is dependent upon the private sector, not directly on the government.    

I define credit inflation as a period in which the rate of growth of debt in the economy exceeds the rate of growth of the economy.  Over the past fifty years, the debt of the United States government has increased by more that a 7.0 percent annual compound rate of growth.  The debt of the private economy has risen in the range of 11.0 to 12.0 percent every year.  This meets my definition of credit inflation because these growth rates are far in excess of the rate of growth of the economy. During this period, the purchasing power of the dollar declined by about 85 percent.  In other words, a 1960s dollar could only buy 15 cents worth of goods and services today versus a dollar’s worth in 1960.

Side note on credit bubbles: when the annual compound rate of growth of the debt being created in a subsector of the economy exceeds the annual compound rate of growth of the economic growth of the subsector, a credit bubble can be said to exist.  The housing market bubble of the early 2000s fits this definition.

Credit inflation can have a detrimental impact on economic growth.  Credit inflation creates incentives that cause manufacturers to move away from the producing of goods and to move into the creation of finance.  Two examples of this are GE and GM: for example a couple of years ago GE was earning more than two-thirds of its profits from its finance wing.  In terms of the whole economy, there has been a huge swing over the past fifty years from the manufacturing sectors of the economy to the financial services sector of the economy.

Some of the consequences of this re-allocation of capital is that the employment of capital declined: capacity utilization is around 77 percent now relative to more than 90 percent in the 1960s.  Under-employment is over 20 percent now and was under 10 percent in the 1960s.  And, the income/wealth distribution is more skewed toward the wealthy than it was 50 years ago.

This has impacted economic growth.  For example, the annual compound rate of growth of real GDP has only been 2.5 percent over the past twenty years, down substantially from the rate of growth for the whole period.  Credit inflation, as an economic policy of the government, seems to have exactly the opposite impact on the economy that is desired by policy makers.

But the other important thing to notice in the chart is the “bumps in the road”.  In my opinion, all of these “bumps” resulted in some way from dislocations in the growth of credit instruments as a result of the monetary or fiscal policies of the United States government.  In most cases, the dislocations were relatively minor. However, as the debt load expanded and the private sector devoted more and more resources to financial services, the ability to carry the load grew greater and greater.

The debt burden cannot keep growing: it has to collapse sometime and along with it the economy.  In most cases the “bumps” were relatively minor.  I know it is never fun for anybody to be un-employed or under-employed, but in the aggregate sense, the “bumps” were not large. 

During the Great Recession and following, the “bumps” were much larger because the build-up of the debt dislocations were greater than ever.  However, since the debt burden must be worked off, it will take more time for the economy to achieve the longer run rates of growth that were achieved earlier in this fifty years of economy prosperity.  But, it will come. 

We must be aware of these dislocations and the things that must be done to re-structure the economy and get back to the economic growth performance we are looking for.  For example, we cannot ignore the state of the banking industry in this recovery. (See my post from last Friday: http://seekingalpha.com/article/295630-why-banks-aren-t-lending.)  Resolving the “bumps” just means that the previously created dislocations in finance and economics must be resolved.    

Labor Day Highlights the Need for American Restructuring

The world has changed!

Of course, entrenched interests fight the change.

An instance is the United States Postal Service:  we heard over the weekend that the Post Office faces the possibility of bankruptcy.

The high profile cause of this situation: email.

The cause that gets a lesser play is the position of the labor unions connected with the Postal Service.  The Postal Service is the nation's second-largest civilian employer, after Wal-Mart. As of 2011, it employed 574,000 personnel, divided into offices, processing centers, and actual post offices.  The employed are served by four major labor unions, the National Association of Letter Carriers being the largest. 
 
Offices have continued to be kept in existence in spite of declines in business and expenses, including wage and pension costs, have continued to grow relative to the services provided.  Now however, cuts are being proposed: proposed cuts include eliminating Saturday mail delivery, closing up to 3,700 postal locations and laying off 120,000 workers — nearly one-fifth of the agency’s work force — despite a no-layoffs clause in the unions’ contracts.  

In terms of the labor situation, Steven Greenhouse writes in the New York Times that “decades of contractual promises made to unionized workers, including no-layoff clauses, are increasing the post office’s costs. Labor represents 80 percent of the agency’s expenses, compared with 53 percent at United Parcel Service and 32 percent at FedEx, its two biggest private competitors. Postal workers also receive more generous health benefits than most other federal employees.” (http://www.nytimes.com/2011/09/05/business/in-internet-age-postal-service-struggles-to-stay-solvent-and-relevant.html?pagewanted=1&_r=1)

There are, of course, many different plans that are being floated around relating to what can be done to “save” the post office.  But these plans all point to one thing…the U. S. Postal Service must be restructured.  It cannot go on as it has been going on.

Resistance is expected: “The post office’s powerful unions are angry and alarmed about the planned layoffs. “We’re going to fight this and we’re going to fight it hard,” said Cliff Guffey, president of the American Postal Workers Union.”

This is just one high-profile example of what is going on all over America. 

The world has changed.

Entrenched interests reject the fact that they must change as well.

Let me just point out three major changes that are impacting the work force these days which have, I believe, massive implications for the future re-structuring of the United States economy.

First, the majority of labor unions no longer reside in the manufacturing sector.  Most employees that belong to labor unions work in the public sector.  The public sector, as we know, has vastly over extended itself, fiscally, in many areas of the country.  The existing economic problems connected with slow economic growth, high rates of under-employment, and a depressed real estate market have put government finances in these areas in bad straits.  Existing relationships are being re-worked as these governments try to get themselves back in control of uthe situation.

The relative growth rates in manufacturing employment dropped off beginning in the 1970s, and now growth in the public sector is seemingly dropping off.  This is a re-structuring problem.

Second, there has been a demographic shift in the workforce.  As reported in ‘The Slow Disappearance of the American Working Man,” (Bloomberg Businessweek, August 29—September 4, 2011) “The (economic) downturn has driven the share of men who have jobs lower than any time since World War II.”

“The economic downturn exacerbated forces that have long been undermining men in the workplace,” and “the impact has been greatest on moderately skilled men, especially those without a college education,” and African-American men and Hispanic men. 

This is another re-structuring problem related to the changes in technology and the changes that have taken place in education: “college graduation rates essentially stopped growing for men in the late 1970s,” whereas “women continued to pursue college degrees in greater numbers and have been more responsive to the changing economy in other ways.”

Third, the last fifty years has also seen a tremendous shift in American employment from the manufacturing sector to the financial sector.  The credit inflation created by the United States government has underwritten the finance industry and resulted not only in growing institutions but also in more and more innovation leading to the greater horizontal diversification of financial institutions.

The example of this is four of our large commercial banks: GE Capital, Goldman Sachs, Morgan Stanley, and ALLY (formerly GMAC).    GE Capital has $606 billion in assets and is bigger than all but seven U. S. banks.  It now finds itself regulated by the Federal Reserve where the Office of Thrift Supervision formerly regulated it.  But more, important is that GE Capital recently provided 40 percent of the profits of its parent company General Electric.  (Before the financial collapse, the contribution of GE Capital reached 75 percent of GE earnings.)   This shows how manufacturing has given way to finance in the United States.

The re-structuring of the American economy is going to have to take place over the next ten years or so.  This “fix” cannot be achieved through short-run solutions. 

In fact, short-run solutions will only exacerbate the situation.  This, of course, is what most of the economic policy of the last fifty years has done for the United States economy.  The credit inflation of this period has built up the financial sector of the economy relative to the manufacturing sector.  The credit inflation has also supported the growth of the public sectors as the inflation in real estate prices supported the government tax base and open capital markets allowed even small governmental units to expand their expenditures.  Finally, much of the economic policy of the government during this fifty years was aimed at putting people back into the jobs they had lost during periods of slow economic growth.  This “Keynesian” approach to the government’s economic policy had an unfortunate impact on male employment, especially those with a lesser education, because the jobs these people were put back into were jobs that were becoming less and less important in the economy.

The times have changed.  Employment practices must change to meet the needs of the modern world. 

Re-structuring is never easy and we can expect a lot of pain in the process.     

The Merger Binge and the Economy

We wondered what Microsoft was up to when it started issuing long-term debt last year, something that it had never done all the rest of the time it has been a public company. 

This money was not going to go to expand operations.  It already had tons of cash to do that!

The best bet was that Microsoft was going to go acquiring…but, what.

Now we have a partial view…Microsoft…and Steve Ballmer…is buying Skype!  The estimated cost?  More than $8 billion.

What about all the other money Microsoft raised in the bond market?  My best guess is that we will see more acquisitions in the future!

But, Microsoft is not alone in this.  Hertz is going after Dollar Thrifty and outbidding Avis.  Southwest Airlines acquired AirTran Holdings to get into the Atlanta airport, the world’s busiest. 

And the beat goes on.

AT&T is intent on acquiring T-Mobile for around $39 billion; Johnson & Johnson has a $21.5 billion deal in the works for Synthes; Duke Energy plans to merge with Progress energy, the deal totaling a little less than $14 billion; and there is the bid for NYSE Euronext for more than $11 billion.

I have been arguing for at least a year now that much of the cash being built up at many large corporations was going to contribute to a major acquisition binge…worldwide. 

And, this binge would include companies from more and more nations.  The Chinese are looking to put $200 billion into corporate acquisitions globally.

Roger Altman, Chairman of Evercore Partners, Inc., argues that the deal making will be at an all time high in 2011, surpassing the $4 trillion record total that was achieved in 2007. (http://www.bloomberg.com/news/2011-05-06/altman-sees-dealmaking-recovery-surpassing-record-4-trillion-of-2007-boom.html)

Some analysts argue that the growing stability of the economy is contributing to this.  Others attribute this movement to the strength in the stock market. 

Whereas these support the cumulative rise in the amount of M & A activity taking place, I still believe that this record-breaking rise in acquisition activity is being subsidized by the monetary policy of the Federal Reserve System. 

The first to benefit from this subsidy are those companies that came through the Great Recession with little or no debt on their balance sheets. 

The second group to benefit have been those that have been able to use leveraged loans and junk bond issues to refinance billions of dollars of debt borrowed during the credit inflation of the past decade or so. 

These companies are now buying other companies and strategically positioning themselves for the future.  And, in a real sense, the big are getting bigger…and more complex.  Industry is following the banks on this as the larger firms are getting greater market share and expanded market space. 

And, in my experience, there is only one way to really make acquisitions work.  The acquirers, after the deal is made, must become the biggest “bastards” in the world.  That is, the acquirers must become ruthless in rationalizing their purchase…otherwise…the acquisition just won’t pay off.

The effect on the economy?  In the longer-run…good…very good!  In the short run…continued pain.  Jobs must be cut, un-economic facilities must be disposed of, and, in general, spending must be reduced. 

“In AT&T’s pending deal for T-Mobile USA, the companies estimate cost savings of $40 billion over time, including expected layoffs, starting from the third year after the merger is completed.” (http://professional.wsj.com/article/SB10001424052748704810504576305363524537424.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj)

But, this gets into another point I have been trying to make for the past two to three years.  During this time I have argued that about one-in-four to one-in-five people of working age are under-employed.  Forget the unemployment rate as it is measured…there are a lot of individuals that have either left the labor market or are not fully employed but would like to be.  And, this has been a growing problem over the past half-century. 

The merger and acquisition binge is not going to help this situation…one bit!

David Brooks in his New York Times column this morning emphasis this problem. (http://www.nytimes.com/2011/05/10/opinion/10brooks.html?_r=1&hp)  Brooks reports that 80 percent of “all men in their prime working ages are not getting up and going to work…there are probably more idle men now than at any time since the Great Depression and this time the problem is mostly structural, not cyclical.”

And, the primary factor that distinguishes the unemployed?  Not sufficient educational training.  “According to the Bureau of Labor Statistics, 35 percent of those without a high school degree are out of the labor force.”  Not unemployed…but, “out of the labor force”!  And, while this number goes down the more education one has, there is still a close correlation between the number of individuals “out of the labor force” and the amount of education that an individual has.   

And, as the mergers and acquisitions take place, the trend will just worsen.  For too long a time, when unemployment arose, we have tried to put people back into the jobs they had formerly held, even though those jobs became less and less economically justified.  The expectation was that the government would stimulate the economy and people would get their old jobs back.

Now we are going through a transition in which those “old jobs” are no longer there. 

And, the monetary stimulation coming from the Federal Reserve System is now resulting in a continued reduction in the less productive jobs through the merger and acquisition banquet going on and is doing very little toward helping these people get back into the work force.

This is consistent with the argument that I have continuously made in these posts that the credit inflation created by the monetary and fiscal policy of the United States government over the past fifty years has done a very good job in splitting the labor force into two segments, the less educated and the more educated, and the society into a much more highly skewed income distribution than earlier.

The acquirers have the cash, they can still borrow at ridiculously low interest rates, and these conditions are expected to stay in place for “an extended period.”  Continue to watch all the M&A activity taking place.  I think this will be a time to remember.

The Current Performance of Commercial Banks

Commercial bank profits are OK. Commercial bank lending is practically nil.

The prognosis for the future?

If commercial bank lending does not pick up, commercial bank profits will fall.

When will commercial bank lending pick up?

Good question, but the answer is not an easy one. Also, to get an answer, it seems as if we need to go to both sides of the desk: to those that are demanding loans and to those that are supplying loans.

There seems to be four factors that are keeping loan demand from growing. First, of course, is that a lot of people and companies are still trying to climb out of the economic hole in which they have found themselves over the past three years. We still have foreclosures and bankruptcies continuing at a very rapid pace even though below record levels. We still have massive amounts of unemployment as well as underemployment. And, we still have large numbers of the American families and businesses with extremely poor credit records.

Second, there is a great amount of uncertainty about the future of business. And, confidence is not built when the Chairman of the Board of Governors of the Federal Reserve System announces before Congress…and the whole world… that the business outlook is “unusually uncertain.” If Mr. Bernanke believes this to be true, what are the people “in the trenches” expected to believe?

Third, there are a large number of companies, mostly big companies, that are sitting on a large amount of cash. These companies are not ready to commit at the present time, but they are poised to put these funds into play, either in an expansion off-shore, or in purchasing other companies. These big companies have been profitable, much like the big banks, but they are not yet ready to put these funds to a business use. As far as wanting bank loans, that will depend upon the strategies these companies want to pursue and the cheapest way to finance them.

Fourth, consumers that have the income flow or wealth continue to pay down their debt in an effort to re-balance their balance sheets. At a time like this with all the evidence around that too much financial leverage is not “the place to be”, individuals and families are not seeking credit and are even reducing the amount of credit that they do have outstanding.

From the demand side we see the reality that the people that have the income and the cash assets are not real anxious to borrow and the only ones that really want to borrow have neither the cash flow nor the cash assets to get a loan.

This gets us to the supply side. Commercial banks, in recent months, across the board, say that they have not changed their credit standards. I take them at their word. Yet, if one compares current bank lending standards with those that were in place one, two, or three years ago, the bar is set much higher than it was. This tightening of standards was to be expected as credit standards are always raised during an economic down turn. They were raised to current levels due to the severity of the 2008-2009 financial crises and to the pressures that were brought on the banks by the regulatory agencies. Although these standards will not get tougher, they will not be eased appreciably any time soon.

The commercial banks are also hit by the uncertainty of the current economic situation and by the coming imposition of new financial reform legislation. In terms of the economic situation, loan officers have to be skeptical of business projections of future cash flows. Since the economic outlook is “unusually uncertain” banks have to be extremely careful about basing the extension of money to a borrower upon “optimistic” forecasts. Even “prudent” forecasts are suspicious because of the uncertain nature of the business environment right now.

Plus, bankers, in general, and lending officers, in particular, are “debt guys”. (Please excuse the gender specificity here, “guys” refers to all bankers and lending personnel.) “Debt guys” are taught that forecasting just on cash flows is a tricky business and so it is wise, extremely wise, to require a borrower to put up collateral behind the loan. And, if cash flows projections become even more uncertain than in the past, more collateral should be required.

But, in a very uncertain economic environment, another problem rises to the surface. This problem has to do with the “value” of the collateral. In a very uncertain economic climate and uncertain secondary markets, how can you get a good estimate of what the value of “physical” capital might be? Hence, commercial banks extend their requirements for the collateral backing of loans, now requiring financial instruments, bank deposits like CDs, compensating balances, or other cash demands. Banks are getting back to the “good old days” when to qualify for a loan, a potential borrower had to prove to the bank that they did not need the loan in order for the bank to extend the money to them.

There is another uncertainty now in play. The passage of the financial regulation reform bill introduces more unknowns into the banks’ decision making. Just the concern over higher capital requirements causes the commercial banks to become more conservative in their lending practices. Furthermore, it is unclear how other rules and regulations, some of them not even written yet (the regulators have several months to write up some of the new provisions), will affect bank policies and procedures. How can commercial banks be aggressive in their lending practices it they don’t know what the “playing field” is going to look like in the future?

Finally, there are still many commercial banks that have solvency problems. As I continually quote, about one in eight commercial banks is on the list of problem banks put out by the FDIC. This list was as of March 31, 2010. Soon there will be a new list out relating to June 30, 2010. It is anticipated that the number of commercial banks on this new problem list will be greater than was the case at the earlier date.

My estimate that another two or three commercial banks out of eight still have problems pertaining to capital requirements, or, pertaining to major credit problems in the areas of consumer or commercial real estate loans. To me, this latter problem is one of the major reasons why the Federal Reserve is keeping short-term interest rates so low and will continue to do so, as Bernanke reiterated in his testimony yesterday, for “an extended period”. Market estimates for when the Federal Reserve might increase its target rate of interest now go until at least the third quarter of 2011. This says to me that there are still many, many problems in the commercial banking industry and these problems are not going to be resolved for “an extended period.”

This situation can only result in a large consolidation in the commercial banking industry in this country. Right now there are about 8,000 domestically chartered commercial banks in the United States. I remember when this number was 14,000 and this did not include an extensive Savings and Loan industry. One could see a drop by one-half or more in the number of banks in the country. And, this doesn’t even take into account the effects information technology is going to have on the banking industry in the next five to ten years.

This does not bode well for the supply of bank loans. With the changing financial regulations, the uncertain economic environment, and the changing structure of the banking industry itself, commercial banks are going to concentrate on “high quality” loans. And, if the big banks cannot find them in existing markets they will invade the local or regional markets of other banks. In fact, many banks are now talking about how the big banks are becoming more aggressive in their markets. This will not result in an increase in loan supply, but it will contribute to the consolidation in the commercial banking industry.

In short, there doesn’t seem to be much reason to expect a pickup in bank loan volume in the near future.

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?