The Problems in Housing and the Labor Markets Will Not Go Away Soon

President Obama announced a mortgage plan aimed at giving relief to homeowners that are facing problems with their mortgages.  Yet, this is just putting a finger in a hole in the dike.

The problem is that after fifty years of governmental credit inflation many homeowners are facing the reality that their homes were grossly over-valued and that they assumed too much debt to finance their “American Dream.”

One out of every four or five houses has a mortgage on the property that is greater than the market value of the house.  Many of these homes are now valued at only 75 percent or less of their mortgage value. 

Regardless of a government “solution” to this situation, either through debt relief or a renewed bout of government-induced inflation, the attitudes and expectations of homeowners have changed.  These homeowners have been “burned” and are unlikely to expose themselves to this possibility again in their lifetimes. 

Even if the market stabilizes in the near term and housing prices bottom out, many potential home buyers will be much more financially conservative in the future given the experience that they have just been gone through. 

The reluctance to buy a home will also be affected by the situation in the labor market.   And, here again there is a longer-term problem that will not be resolved in a matter of months. 

One out of every four or five people of employment age are either unemployed, employed in a part time job but would like to be employed full time, or are not seeking employment.  The percentage of working age people in the labor market has recently dropped to a level not seen for several decades. 

With conditions in the labor market so tenuous, people will not have the same resources to purchase housing as they have had in the recent past. 

But, how is this under-employment situation in the labor market going to be resolved in the short-run?

The fundamentalist preacher Paul Krugman cries out for short-run government “solutions” to put people back into the jobs that were in existence at another time.  Krugman writes, “We have become a society in which less-educated men have great difficulty finding jobs with decent wages and good benefits.”  For example, “Adjusted for inflation, entry-level wages of male high school graduates have fallen 23 percent since 1973.” (http://www.nytimes.com/2012/02/10/opinion/krugman-money-and-morals.html?ref=opinion)

Maybe, part of this problem is that the government has emphasized putting high school graduates into what have historically been entry-level jobs, jobs that are shrinking as a proportion of the jobs available due to changes in technology and needed training.  And, what about those that do not graduate from high school…they are in an even less-favorable position. 

Elsewhere in the New York Times, we read that “Rich and Poor Further Apart in Education.” (http://www.nytimes.com/2012/02/10/education/education-gap-grows-between-rich-and-poor-studies-show.html?hp) “Education was historically considered a great equalizer in American society, capable of lifting less advantaged children and improving their chances for success as adults.  But a body of recently published scholarship suggests that the achievement gap between rich and poor children is widening, a development that threatens to dilute education’s leveling effects.”

This is a gap that cannot be overcome quickly.  And, it is a gap that cannot be overcome by national tests and government spending.

  

Since the end of World War II, politicians have generally believed that they could get elected and re-elected by keeping people employed and by helping more and more people become homeowners.  This underlying emphasis has resulted in the fifty years of credit inflation the United States has experienced since the early 1960s. 

People were kept employed by short-term government economic programs that put the unemployed back into the jobs that held previously before becoming unemployed.  And, why should someone going through high school be concerned about employment when they knew that the government would continue to stimulate jobs in heavy manufacturing and industry and keep them employed. 

The government continued to promote these kinds of stimulus programs even though under-employment increased steadily over the past fifty years and the capacity utilization in manufacturing was declining over the same time period. 

The federal homeowner programs and credit inflation created in the housing sector over the same time period created a “piggy bank” for many people not only helping them to own their own home, but also to allow them the ability to borrow more and more money to binge on consumer goods.     

So, we ended up with the “less wealthy” being under-educated and hence not readily employable in the labor markets of the 21^st century and with many of these same people owning homes and over-their-heads in debt. 

  

This is a situation that does not have an easy or ready solution. 

Under-employment can only be resolved over an extended period of time.  The same holds for people with too much debt.  Short-run stimulus is not the answer.  In fact, the emphasis on short-run stimulation has created and further exacerbated the situation. 

A safety net may be necessary for many of the under-employed and overly leveraged.  In fact, the efforts to keep people in “legacy” jobs and to put families in homes to make their life better may have resulted in a whole generation of individuals being excluded from the mainstream.  They are going to need some economic support.

But, the only real solution to the labor market situation is a long run one and it begins with education and the environment that surrounds the culture of education. 

The situation in the housing market will only get better as people lower their expectations and get their balance sheets back in order.  This, too, will take a substantial amount of time because it is related to a major change in expectations.  People, in the future, just cannot expect a “free ride.”      

The Focus Should Be On Under-Employment Not Un-Employment

The president, the press, and the political pundits focus on the unemployment rate in November as it dropped to 8.6 percent of the workforce, a drop from 9.1 percent in October.

However, under-employment still remains in the 20.0 to 25.0 percent range as it has for the past several years.

Under-employment includes those people that are working part time but would like to work full-time.  This component did decline by more than 4.0 percent in November from a month earlier but was down by only about 5.0 percent year-over-year.

Under-employment also considers people that are not working but say that they would like to be.  This includes discouraged workers and those who cannot work for reasons like ill health.  The number included in this classification increased by about 6.0 percent over the last year.  Does this capture the movement from part-time employment to discouraged workers? 

These figures indicate that there are long-run factors at work in the labor market that cannot just be solved by short-run fixes or election-year accusations and verbal confrontations.

My argument is, and has been, that fifty years of credit inflation has left the United States with a substantial dislocation of economic resources, like labor, and a vast redistribution of income toward the wealthy.  These dislocations are not subject to the “quick fix”. 

The economy is recovering, but the economic recovery is not doing much…and cannot do much…to create the restructuring that is needed.  You cannot try and put an employee of the auto industry back to work in the same job he/she held for the last ten years when the industry has moved on technologically and that job no longer exists. 

Another significant indicator of this is that the share of the population in the labor force has dropped to 64.0 percent, the lowest level in decades. 

This drop in labor force share is being driven by people retiring early from the labor force.  We see this in a lead article in the New York Times this morning, “Many Workers in Public Sector Retiring Sooner.” (http://www.nytimes.com/2011/12/06/us/more-public-sector-workers-are-retiring-sooner.html?_r=1&hp)  This is a result of the budget problems being faced by state and local governments, but it is also a result of events taking place in the private sector as well.

Further supporting information comes from the data of the manufacturing sector.  Capacity utilization continues to be below the levels attained over the past fifty years. 

The latest figure for capacity utilization was 77.8 percent.  This is above the level capacity utilization reached in the depths of the Great Recession, 67.3 percent in June 2009, but it is only slightly higher than the level at the trough of the 2001 recession.  And, the trend throughout the last fifty years has been down with capacity utilization being near 90 percent in the 1960s.

Over the past fifty years in the United States, under-employment has increased dramatically and capacity utilization has declined dramatically.  Note, that this is the time period that the income distribution skewed so dramatically toward the wealthy in the United States.

The economic policies of the United States government, both Republican and Democratic, have produced this outcome over this time period.  More of the same will not be helpful. 

Economic growth and economic recovery will not be robust unless and until people come to understand that the economic policies of the government must change.  And, these economic policies must deal with the structural dislocations that have evolved over the past fifty years as well as put the economy back on a more stable foundation with less reliance on debt and credit inflation. 

Credit inflation paints a very pretty picture while it is accelerating.  But, the consequences of this inflation is anything but pretty.  Just ask the less wealthy, the under-employed, and the manufacturers that cannot use their full capacity.   

Post QE2 Federal Reserve Watch: Part 2

Excess reserves in the commercial banking system did not change much over the past quarter.  The two-week average for the banking week ending September 7, 2011 was $1, 569 billion.  At the start of August the total was $1,602 billion and at the start of June the total was $1,549 billion.  So roughly, excess reserves averaged around $1.6 billion over the past three months.

It’s kind of hard to appreciate the irony of saying excess reserves didn’t vary much over the past three months when in August 2008 the excess reserves in the whole banking system totaled only $2.0 billion. 

QE2 ended June 30.  So, we were not to expect the Federal Reserve to do too much to the banking system after this period of quantitative easing ended.  And, so far the Fed has done little or nothing.

This does not mean things were not happening in the commercial banking system. 

For example, the required reserves in the banking system rose by more than 20 percent from the banking week ending June 1 to the banking week ending September 7.  The rise was from about $76 billion to around $92 billion.  These are the reserves banks must legally keep on reserve to back up transaction and savings account balances.    

Most of the increase came in the last week of August and the first week in September when required reserves increased by more that $10 billion. 

The rise in required reserves came about due to a massive jump in the demand deposits held at commercial banks in August, which require the highest amount of reserves to be held by the banks! 

There also was a surge in savings deposits at commercial banks in August.  

The increases in demand deposits and savings deposits seemingly came about due to a large movement of funds from small savings accounts and institutional money funds. 

It was during this time that the Federal Reserve announced that it was going to keep short-term interest rates at very low levels for the next 24 months.  This announcement seems to have accelerated the movement out of short-term interest bearing assets to bank accounts…transaction accounts and savings accounts.  In a real sense the disintermediation continues. 

The point is that these movements on the part of wealth holders have influenced the money stock figures.  For example the year-over-year growth rate of the M1 money stock, the measure most affected by the shifts in money, the shifts toward demand deposits, has risen from about 12 percent at the end of May to just under 17 percent at the end of August. 

The M2 money stock measure has also risen but its growth rate remains under 50 percent of the growth rate of the M1 money stock.  Its rise has gone from about 5 percent to 8 percent over the same time frame. 

As I have pointed out for about two years now, the money stock measures appear to be growing because people are shifting out of short-term interest bearing assets because of the exceedingly low interest rates and are parking the funds in commercial banks in transaction balances and savings accounts. 

Some of this transfer is also occurring because people who are under-employed or having other financial difficulties want to keep their funds in accounts that can be accessed quickly to meet daily and weekly needs.      

The money stock growth is not occurring because the banking system in gearing up the lending machine and providing the loans needed for a more robust expansion of the economy.

I believe my interpretation of money stock growth is the correct one because this re-allocation of wealth balances from interest earning assets to transaction balances and other short-term bank assets has been taking place for two years or so and this movement has resulted in increasing growth rates for the money stock measures.  Yet, there has not been a real increase in bank lending during this time period and economic growth remains anemic with a stagnant labor market. 

Money stock growth is occurring but, one could say, for the wrong reasons.  The money stock measures are growing because people are protecting themselves and staying liquid while interest rates are so low.  This is not the behavior that drives the economy forward.  The money stock measures are not growing because of the monetary stimulus and this means that one cannot expect much economic growth from it.

The open market operations of the Federal Reserve have basically been operational over the past five weeks.  Federal Agency securities and Mortgage-backed securities continue to run off from the Fed’s portfolio and these run-offs have been replaced by US Treasury securities.  The off-set has been almost one-for-one, dollar-wise.

The interesting action on the Fed’s balance sheet has been a $34 billion increase in Reverse Repurchase Agreements with foreign official and international accounts.  Reverse repos take reserves out of the United States banking system.   In these cases, the Federal Reserve “sells” US Treasury securities under an agreement to buy them back at a later date. Over the past 14 weeks, reverse repos to foreign governments or their agencies rose by $43 billion.  One can only guess that these transactions have to do with the financial crisis that has been taking place in Europe.  More research needs to be done on this.

The net result of all this is that the Fed has done nothing overt since the end of second round of quantitative easing.  Economic activity continues to be stagnant and the under-employment situation does not improve.  Money stock measures continue to grow but for reasons not related to increases in bank lending and improving economic activity.  The question seems to be, where does the Federal Reserve go next?  Answers to this question are all over the board. 

The Economic Picture--No Steam Ahead!

The August unemployment rate was 9.1 percent.  Not much joy in Mudville.

About one in five Americans in the prime age for working range remain under-employed. 

We have the short-run problem related to economic growth and the fact that families, businesses, and governments need to get their balance sheets in order before they will really begin to spend again. (http://seekingalpha.com/article/290934-struggling-with-a-great-contraction) 

We have the long-run structural problems in the labor market related to the fact that the skills of many individuals of working age do not mesh with the jobs the economy is creating or is going to create.  For a dismal picture of this situation see the recent article in Bloomberg Businessweek (August 29—September 4, 2011) titled “The Slow Disappearance of the American Working Man.” 

And short-run growth seems to be going nowhere.  Just look at the year-over-year rate of change in industrial production.  Note that this series peaked in the second quarter of 2010.  The modest decline in this growth rate has now been going down-hill for more than 12 months.

Of course, the performance of industrial production is also captured in the year-over-year growth rate of real Gross Domestic Product.  Here the peak growth rate was achieved in the third quarter of 2010.  The growth rate has declined since.

If the economy fails to grow by 3.0 percent or more, jobs will not be added at a rate that will lower the unemployment rate.  And, growth at this rate will certainly not resolve the long run problem related to those that are holding part-time positions that would like to have full-time jobs and those people that have left the work force. 

Furthermore, this scenario is not one that is favorable to people making much headway in reducing the burden of their debts.  Thus, the “debt overhang” seems to be a part of the continuing saga of our economic malaise.  The environment for getting out of debt does not exist.

Given this picture, the questions that arise pertain to the concern that America may face a decade like Japan has faced or a decade like that in America in the 1930s.  Maybe this is the “payback” for the period of credit inflation we have experienced over the past fifty years.  Maybe the only way out of this situation, which is not a short-run solution, is to focus on the fundamentals, focus on the structural problems created over the past fifty years.

The Federal Reserve, so far, has acted so as to prevent another “shock” to the economy like the one they introduced in the 1937-38 period.  In this earlier period the Fed caused banks to become even more restrictive in their lending operations than they had been and this precipitated a second depression for the 1930s.  This time the Fed has flooded the banking system with liquidity and seems to be in no hurry to remove anything that appears excessive in terms of bank reserves even though bank lending remains modest, at best. (http://seekingalpha.com/article/290416-quantitative-easing-theory-need-not-apply)   

The short-run conflict that is going on right now is between the efforts of the Federal Reserve to stimulate bank lending and the financial system, and the efforts of families, businesses, and governments to reduce their debt loads.  At the present time, the latter interests seem to be winning.

The longer run question relates to whether or not the government stops focusing just on short-run solutions to the problems of the economy and begins to focus on the longer-term structural problems that exist.  The difficulty here is that it took a long time to get where we are now and it can be expected that it will take us a long time to get things back in order. 

The real dilemma is that we don’t create more problems for the future by implementing short-run solutions to our problems that will just exacerbate our longer-run problems.  In the long run we may all be dead, but we now seem to be dealing with the long-run problems left to us by earlier generations of policy makers that just focused on short-run solutions without any regard for the long run!

Winning Strategies

Good teams find ways to win even when the calls go against them, even when the weather is bad, and even when their opponents change their strategy. 

Bad calls are a part of sports…and business…and politics.  You have to go on.  It is a part of the game.  Yes, the ref missed the call, but you still have to play out the rest of the game.  Sure, Standard & Poor’s may have not handled the ratings adjustment and timing in the best way possible, but the Obama administration knew that the government’s bond rating might be changed and it also knew that the United States had fiscal problems, political problems, and economic problems. 

The announcement on Friday evening was not a surprise.  Yet, the administration chose to claim that Standard & Poor’s was “incompetent and not credible.”

To some this puts the United States right up there with Greece…and Portugal…and Spain…and Italy.  The blame rests elsewhere.  This is what losing teams do.

The weather, the external environment, is a part of games…and business…and politics.  Yet, your opponent, others, has to face the same external environment that you do.  The snow or wind or rain made playing rough, but the game continues.  Sure, the economic conditions being faced by the United States are difficult, but the Obama administration has been facing them for two and a half years, as have many other countries, and blame cannot continually be placed upon the Bush(43) administration or the rest of the world. 

Again, losing teams put the blame on somebody or something else, like speculators, like rating agencies, like previous Presidents.  And, then they keep on doing just what they have been doing in the past.

Opponents change their strategies during games, or, they may change personnel.  Given the refereeing, given the weather, given the strategy you are pursuing, your opponents may alter the way they do things in order to take advantage of your strategy or your personnel or the weather.  Yes, the Republicans won the mid-term elections, sure the Tea Party advocates came on very strong, and sure the economy did not respond the way that the Obama administration expected, but that is not a reason to blame these factors as a reason why the Obama team didn’t succeed. 

President Obama relied on the same strategy and game plan established at the start of his presidency.  Every issue was addressed by a speech after which the construction of a plan, whether for health care, financial reform, or debt control, was turned over to Congress.  The opponents of President Obama changed how they played the game and largely succeeded in their efforts because the Obama team played the game exactly as they had in the past.      

Losing teams always seem to blame other factors, like their opponents changing strategies for their failures. 

It is obvious that there is great concern in the world over the financial affairs of governments in the United States and Europe.  Yet, these governments continue to claim that others are imposing the problems upon them.  And, as this attitude continues, we all are worse off for it.  This is the way losers play the game. 

The conditions are what they are.  The people in power need to make adjustments to their game plans…they cannot continue to follow the same strategies they have been pursuing in the past.  When is it going to become obvious to these people that what they are doing is not working.  When are they going to realize that the past is the past and that maybe they need to listen to new voices?   Politicians are supposed to be pragmatic…so let’s seem some of that pragmatism.

Where should they start?   

I believe that the United States government needs to change its economic objective.  For more than fifty years, the primary economic objective has been to achieve high levels of employment…a low unemployment rate.  Under this objective, the percentage of people working in labor force has dropped to an historic low of about 55 percent and the underemployment rate has risen to about 20 percent of those of employment age.  Furthermore, pursuing this policy objective has resulted in an income/wealth distribution skewed more toward the rich than ever. 

To continue to maintain this policy as the number one priority of the United States government is like a football team continuing to run the same play over and over again even though the opponent has stacked the defense to stop that very play.

To me, the primary objective of United States economic policy should be the maintenance of a strong dollar.  Although every presidential administration for the past fifty years has supported a “strong dollar”, the policy of credit inflation followed by both Republicans and Democrats to achieve high levels of employment for the past fifty years has achieved exactly the opposite end.  First, the United States dollar was taken off the gold standard on August 15, 1971 and its value was allowed to float.  Next, the credit inflation policies followed by these Republican and Democratic administrations have resulted in a decline in the dollar in world markets of about 40 percent since 1971.

The game plan of credit inflation to achieve low levels of unemployment has not succeeded and the standing of the United States in the world has suffered for it.  That game plan needs to be changed. 

A strong dollar is the foundation for a strong economy because the emphasis is placed upon the competitiveness and innovative capabilities of the businesses and workforce of the economy.  The government must be concerned with education and training, with the ability of companies to innovate and change, and with incentives for people to start and grow companies.  High levels of employment and labor participation are achieved in this way. 

Putting all the emphasis on credit inflation to ensure high levels of employment works against the things mentioned in the previous paragraph.  Credit inflation works to put people back in their old jobs rather than encourage innovation and training to raise productivity and change.  Credit inflation puts emphasis on financial leverage and financial innovation and leads to the financial sectors of the economy becoming more important than the manufacturing sectors.  And, credit inflation results in the income/wealth distribution becoming more skewed toward the wealthy. 

If the basic philosophy of the Obama administration continues to be one based on the further application of credit inflation to the economy it will have fundamental problems going forward.  One, economic growth will continue to stagnate.  Two, the administration will face greater and greater opposition, first, from its opponents because they will see that nothing has changed in the game plan and that the game plan is not succeeding; and second, because its supporters will become more and more dissatisfied with its performance.  Three, potential outside opponents, like China, Russia, Brazil, and so forth, will prepare much more aggressive game plans against the United States because they can smell the weakness.  Note the responses of China, Russia, and others, to the Standard & Poor’s downgrade. 

Winning teams focus on building strong organizations with the best personnel for the times and with the best game plans for the game they are playing.  They adjust with the conditions.  They find ways to win.  And, they do not make excuses.  

What Can or Cannot Be Done About Economic Growth?

Over the past fifty years, the United States economy, as measured by real gross domestic product, has grown at a compound rate of growth of 3.1 per cent. 

Yes, there have been cycles in which economic growth substantially declined or expanded and in which unemployment rose and unemployment fell.

But, over this time period, the trend rate of economic growth remained relatively constant. 

Maybe we can’t do much about achieving greater trend economic growth in the United States.  Other countries are growing more rapidly over time than the United States but we used to talk about the convergence of growth rates.  Emerging or developing economies grew faster than the more developed countries, but as these countries matured their economic growth rates would converge to that of the more developed countries.

In this view there is not much that a “mature” country can do in order to achieve higher secular rates of growth.  Maybe the United States is “stuck” with a growth rate slightly in excess of three percent.

Another statistic that has caught my attention is the so-called under-employment rate.  Since the 1960s, this rate has grown dramatically to the point where one out of every four or one out of every five Americans of employment age (depending upon how you measure this condition) are either unemployed, employed part-time, or has dropped out of the labor force and is not looking for a job.

Of, course, the labor market has changed substantially.  For example, the participation rate in the work force has grown since the 1960s as more and more women have entered the work force, but even this number has dropped modestly.

These statistics came to mind this morning as I read (for the second day in a row) a very important article on the front page of the New York Times.  The article is “Companies Spend on Equipment, Not Workers.” (http://www.nytimes.com/2011/06/10/business/10capital.html?_r=1&hp=&adxnnl=1&adxnnlx=1307710996-gxrbDaAG3hw1i6zHqy/zcw)  “Workers are getting more expensive while equipment is getting heaper, and the combination is encouraging companies to spend on machines rather than people.”

But, this is not the whole story.  As one business owner is quoted in the article, “’People don’t seem to come in with the right skill sets to work in modern manufacturing,’ Mr. Mishek said, complaining that job applicants were often deficient in computer, mathematics, science and accounting skills. ‘It seems as if technology has evolved faster than people.’”

Another factor creating this divergence beyond just the evolution of technology, I believe, is the fact that the federal government has been spending lots and lots of dollars over the past fifty years to put people back into the jobs they lost either over the business cycle or as foreign competition grew.  Government spending to “keep the economy growing” or to protect US industries was good for the labor unions because it kept their base in tack, and it was good for the politicians because it kept the labor unions happy and kept the employees employed and happy.

But, it did nothing for the skills of the employment age people and it provided a promise to many joining the labor force that similar jobs would be available to them in the future and that their employability would be protected by this governmental policy.

Earlier this year, some test results of school age children around the world were released.  There was only one category that American students were first in the world in…”self-esteem.”  In almost everything else, the American student scored in the middle of the pack.  However, they believed they were the best.

Seems like we have a growing mis-match in the United States economy about what people expect about future employment opportunities and how young people are being educated to be prepared to work in the world of the twenty-first century. 

Stimulating the economy to put people back to work in the same jobs they lost is going to resolve only one problem…getting the politicians who proposed the stimulus re-elected.  As we have found out, this may be a “short-run solution” but it does not resolve the problem over time.  The attitudes in the society toward education must change and this is only a “long-term solution” that is not easily marketed in elections.

The same thing applies to “re-distribution” programs.  Housing and home ownership have been a major component of the economic policies devised by the federal government over the past fifty years.  Again, the justification for attempting to achieve these objectives…getting sitting politicians re-elected!

And, like the current disarray in the labor market, where is the housing market these days?

There are some things that can be achieved by economic policies and some things that cannot.  Over the past fifty years, the United States government has tried to force solutions on the United States economy that cannot be achieved. 

The effort to achieve higher rates of employment and home ownership over the last fifty years has resulted in a credit inflation that has produced the consequences we are now experiencing.  One of the reasons why this approach was taken was that there was not sufficient historical data or information available to provide insight into the problems and difficulties that such policies could produce.  This is one reason why Kenneth Rogoff and Carmen Reinhart conducted research over eight centuries to examine the “financial folly” that could lead to the justification for policies such as the ones that have been followed since the early ‘sixties.

One of the problems that come out of such “folly”, however, as Rogoff and Reinhart point out in their important book “This Time is Different,” is that a nation does not get out of such irresponsible behavior overnight.  

That is, a country cannot just “stimulate” itself out of the hole it has dug for itself. 

There are some things that a government cannot do with respect to generating more rapid economic growth.  Efforts to over-achieve in this area just result in longer-term misery.  Sometimes the prudent behavior is to stop digging the hole deeper.   

Debt Ultimately Leaves You With No Good Options

The economies of Europe are hurting, unemployment is too high, and the social nets are under attack.  The economy of the United States is hurting, unemployment is too high, and the social net is under attack.

Options for the governments in each area are decreasing and despair is growing. 

This is exactly what piling on the debt eventually does to you.

I sympathize with the unemployed.  I sympathize with the under-employed.  I sympathize with the labor unions…public sector and private sector…that are losing members and popular support.  I wish there were more for everyone.

Taking on debt, in the beginning, looks like it frees one up…provides opportunities to do more things…own more things…live a better life. 

Eventually, debt does exactly the opposite…limiting your options…constraining your life style…and exerting pressures that are unwelcome.

I sound like a preacher from the early part of the twentieth century…don’t I?  This is exactly what they used to say. 

Except this is just what we are seeing. 

Taking on debt in the early stages of financial leveraging does allow you to do some things that you cannot do without debt.  And, in these early stages, more debt can seemingly “buy” you out of difficulties. 

As we have seen, more debt then becomes the solution to the problems created by debt.  And, it works for a time.

The thing that people don’t see in continually using debt as a panacea for their problems is that the more and more debt they add to their balance sheets, the fewer and fewer options they have. 

Finally, the obligations created by the debt result in a reduction in the options leaving the debtor with very few choices…and, with most of the choices undesirable ones.

So, the government of Greece is faced with selling assets, and tightening up its budget even further, reducing government employment, and cutting social services. 

Portugal is now under the knife although it believed for a long time that it would escape the “cure”.

And, who are becoming the hard-nosed critics that are pushing these governments to take on more radical solutions?

Spain…and Italy…and Belgium….

Why?  Well, because these latter countries are now feeling the potential for the “contagion” to spread in the European continent. 

Spain, who seemed to be getting its house in order, observed a massive shift in voting on Sunday as the long ruling socialist party was basically removed from office.  There is great fear that the accounting in regional governments has been understating the debt of the country and this will have to be recognized and dealt with by the incoming governments.  Whoops!

Italy has a national debt equal to 120 percent of its gross domestic product and is experiencing sufficient economic dislocations that its future was called into question by a bond rating agency.

Belgium is now also coming up on the radar screens of the investment community.  The interest spread on 10-year Belgium debt over 10-year German debt jumped to a near term high on Monday.  Belgium, too, is looking anxiously at what Greece…and Portugal…do to avoid becoming one of the falling dominoes.

Yet there are still calls for these countries to increase their spending and create more debt to solve the employment and social services problems for the countries experiencing such suffering.

Foremost among those calling for more spending and more debt is the fundamentalist preacher Paul Krugman.  To him more debt seems to be the solution to any problem an economy faces. 

Yes, people are hurting, but, as he seeks to achieve a reduction in the “official” unemployment rate, some of us see the increase in the under-employment of our workforce throughout the past fifty years, the period of credit inflation, as the consequence of those, like Krugman, who profess the gospel of governmental deficit spending as the way to put people back to work in their legacy jobs.

Krugman criticizes those concerned with the massive debt levels achieved by  European governments…and by the United States government…and claims that those worrying about these debt levels are like some that are claiming that the end of the world is near.

Yet, Krugman, himself, sounds like a profit of doom, when he claims that the world as we know it will end if governments don’t increase spending and create more debt!

The problem we now face is one in which there seems to be very few choices left for us.  The amount of debt that people and nations have created is acting like a noose around our neck that is getting ever tighter.  We can do as Krugman suggests, and goose up stimulus spending some more creating more debt, but, as we have seen, the outcome of this would be to provide us with even fewer choices in the future.  The noose will just get tighter.

Eventually, the options will run out, leaving us no choices.

It seems to me that we must deal with the choices that are now available to us, even though they may not be very pleasant ones, and act in a way that will allow us more and better choices in the future.  If reducing the debt outstanding at this stage is the only way we to increase our options, then it seems as if this is the way we must go. 

Given the limited choices that are available to us at this time…I would hate to see our options become even more constricted.         

Does Getting Out of Debt Mean that People Should Start Spending More?

From the Wall Street Journal this morning:

“U.S. families—by defaulting on their loans and scrimping on expenses—shouldered a smaller debt burden in 2010 than at any point in the previous six years, putting them in position to start spending more.

Total U.S. household debt, including mortgages and credit cards, fell for the second straight year in 2010 to $13.4 trillion, the Federal Reserve reported Thursday. That came to 116% of disposable income, down from a peak debt burden of 130% in 2007, and the lowest level since the fourth quarter of 2004.” (See “Families Slice Debt to Lowest in 6 Years,” http://professional.wsj.com/article/SB10001424052748704823004576192602754071800.html?mod=WSJPRO_hps_LEFTWhatsNews.)

The logic in this is that people reduce debt so that they can spend more. I think that is called a “non sequitur”.

If people (and businesses) get more and more in debt over a fifty year period (as they have since 1960) and this contributes to the worst recession since the Great Depression the objective of these people (and businesses) getting out of debt is so that they can get more in debt once again?

I thought that if people (and businesses) got themselves so leveraged up and so “over-extended” that they found themselves in serious financial trouble and were faced with foreclosure on their real estate and personal (or business) bankruptcy that what they would try and do is bring their debt more in line with their incomes so that they could manage their debt.

I thought that maybe people (and businesses) would become more prudent and try and manage their debt in a way that would allow them more “peace of mind” not having to scramble to make principal or interest payments every month.

And we read that there are 11 million people who find themselves owing more on their mortgages than their home is worth on the market.

And we read that about one out of every four individuals of working age is under-employed.

And, we read that the income distribution is skewed toward the high income end worse than it has ever been in the history of the United States.

And, we read that America is bifurcating more and more based on education and race.

And, we read that many state and local governments can’t meet their pension commitments and can’t balance their budgets so that they are cutting jobs, cutting pensions, and cutting education.

Some people are spending. Some people are using credit again. Some people are buying very nice homes. Some people are paying for very expensive educations.

But, this spending and credit extension is not across the board.

The inflation over the past fifty years created the ideal environment for debt creation. The inflation was not large enough to create a panic. From time-to-time, the inflation was not enough to really see.

Yet, from 1960 to the present time, the purchasing power of the dollar has fallen by 85%. The dollar that could buy a dollar’s worth of goods in 1960 can only buy about fifteen cents worth of goods now.

This was the perfect scenario for the creation of credit, for financial innovation, and for the growth of the finance industry.

This could not have been a better environment for the consumer culture to thrive where people could feed their insatiable appetites for goods and think that things were great.

And, now a substantial part of our economy is mired in this debt and struggling hard to get their heads above water. They don’t need to pile on more debt…they need some stability and consistency to their lives.

Yet, many are pushing to get the “credit machine” going again. The federal government is setting the standard (as it has over the past fifty years) by living way beyond its means and threatening to increase its debt by $15 trillion or more over the next ten years.

The Federal Reserve has pumped almost $1.4 trillion in excess reserves into the banking system in order to get the banks’ lending again.

We want families to be “in position to start spending more” as the Wall Street Journal article stated.

A credit inflation is just what is needed.

Each time we restart the “credit inflation” button again, more and more people seem to be in a position in which they are excluded from its benefits. They are under-employed, substantially in debt, and excluded from benefitting from further increases in prices.

This means each time the “credit inflation” button is pushed again, only a smaller proportion of the population can participate in subsequent expansion.

Maybe this is why it is taking us so long to get the economy “moving again.”

History has shown that this “show” cannot go on forever. The difficulty is in knowing just when the “show” is over.

The government is trying to start the music playing again. And, those that can are supposed to begin dancing. But, maybe this time only the financial industry will be dancing (http://seekingalpha.com/article/255748-will-the-financial-industry-dance-alone).

How the Crisis Catapulted Us Into the Future

“How the Crisis Catapulted Us Into the Future,” is the title of Martin Wolf’s opinion piece in the Financial Times this morning. Wolf, in the article, ruminates on what he experienced last week at the World Economic Forum held at Davos and how this all fits into the world we are now living in.

Wolf concludes: “The crisis has not proved a great turning point, so far. But we cannot conclude that it is of small significance. It has brought some transformation, much acceleration of previous trends and, above all, great uncertainty. That uncertainty was present all along. But now we know.” (http://www.ft.com/cms/s/0/5fc7e840-2e45-11e0-8733-00144feabdc0.html#axzz1Chh2pOYC)

The usual items are mentioned. First, the “turnarounds” such as the tightening of financial regulation, the de-leveraging that still continues, the lessening of “global’ imbalances”, and the vulnerability of the Eurozone’s “excessive accumulations of private and public sector leverage.” Then there are the “accelerations” such as the new focus on sovereign fiscal affairs, the “accelerated shift in the global balance of economic power,” the changes in relative attitudes in the west and in the east, and the uncertainties related to how the future is going to work out.

There is another change that has taken place over the past three and one-half years that Wolf doesn’t allude to but is one that has also accelerated during the crisis and will play an even more important role in the future. A consequence of the financial crisis has been the rapid advancement in the use of information technology in the world and the effect this advancement has had in changing the way we all do business and how we govern and how we all live.

First, the headlines in newspapers all over the world tell us of the events taking place in Tunisia and Egypt, and in Jordan and Syria, and elsewhere. Could these events, would these events have taken place if information had not spread about conditions in different parts of the world and if communications had not been as complete as they are. In Egypt the Internet was closed down, but that didn’t stop information from traveling.

Analysts have argued that two factors seemed to be catalysts for the uprisings that have taken place: food prices and unemployment. In terms of the former, information spread that food prices were an international concern and impacting countries with autocratic governments the worst. Unrest was experienced in other countries as more and more people reacted to governments that were a part of the problem and not a part of the solution.

In addition, people had more and more information that countries other than the developed countries were experiencing economic expansion. China and India and Brazil, among others were creating a future and putting people, educated people, to work. This was not happening in Tunisia or Egypt, Jordan or Syria or in some of the other countries experiencing unrest.

Information and the spread of information is something governments are going to have to take more and more into consideration in the future. But, this does not just extend to social issues.

Governments are finding it harder and harder to hide things. One of the fallouts of the crisis in the Eurozone is that governments like Greece were hiding things so that its financial condition was not really apparent to its people and to people in the investment community. Spain is now experiencing some of this within its regional governments. This is causing Spain real headaches in attempting to stem the impending financial crisis it faces.

But, people in the United States cannot be too smug in this area. More and more we are finding out how state and local governments “hide things” in managing their finances especially in the accounting for pension fund liabilities.

On top of these revelations, there was the release of large amounts of inside information connected with the organization called WikiLeaks. This, apparently, has had some impact on middle eastern events as well as disclosures relating to military and diplomatic relationships. We were reminded once again of this release of this “secret” information in the article in the New York Times Magazine, “The Boy Who Kicked The Hornet’s Nest” which appeared over the weekend. (http://www.nytimes.com/2011/01/30/magazine/30Wikileaks-t.html?adxnnl=1&ref=magazine&adxnnlx=1296651604-/6As33QJtY/sr5n+tM0J5w)

Information spreads and, although it may be contained in the short run, over the longer run its spread cannot be stopped. This is a major problem for governments.

The WikiLeaks adventure also spilled over into the business sector as several firms or banks were threatened with disclosures. But, the information “leakage” problem extends far beyond just WikiLeaks. Today, in Mr. Wolf’s paper, the Financial Times, there was a detailed piece on “industrial espionage” titled “Data Out of the Door.”( http://www.ft.com/cms/s/0/ba6c82c0-2e44-11e0-8733-00144feabdc0.html#axzz1Chh2pOYC)

“Cyber-spying has fast become a specific threat for many companies. ‘Industrial cyber-espionage is one of the biggest problems that all nations are facing,’ says Melissa Hathaway, a former US intelligence official and the leader of a digital security review set up by President Barack Obama.

The scale of hacking to gain corporate information has gone so far, she says, that the Securities and Exchange Commission…might soon need to require companies to assess routinely for the benefit of shareholders how well they are protecting themselves from electronic attacks.”

On the other side of the ledger, this fact also says a lot about what companies can and should
reveal to the investment community. People can get more and more company information these days and it is very important for a business to accept this fact and address the issue of how open and transparent it must be to earn the trust and confidence of the investing community.

Nothing can be worse for a company to be ‘”caught out” and have to admit it was hiding information from the public that should have been released.

Modern information technology is impacting business in another way raising all sorts of different questions. How closely can finance be regulated when finance, which is nothing more than information, can be transmitted around the world in seconds…or less? How can financial transactions be understood when financial information can be “sliced and diced” in any way it can conceivably be re-constructed? How fast can transactions take place? How fast should transactions be able to take place? How secure are all these transactions? How have “the Quants” changed their business practices since the melt down of August 2007? What other ways can the “physical” be transformed into just information?

Rahm Emanuel, formerly President Obama’s Chief of Staff, once stated that one should “never waste a crisis.” I believe that many people and organizations, especially people and organizations within the financial industry, acted this way during the crisis. As a consequence, the world is a very different place now than it was three and a half years ago.

The problem going forward is that many people and businesses are looking forward to what they can do in the future while many governments and other institutions, like religious groups, are only looking to regain the past. This divergence only adds to the uncertainty that Mr. Wolf observes in the world today.