The Progress of the Economic Recovery in the United States

The United States economy is growing.  However, the United States economy is not growing very fast and the growth does not appear to be very deep.  

January figures for Industrial Production were released today and about all one can say about the numbers is that the rate of growth is positive but modest.  And, the rate of growth seems to be declining. 

Year-over-year, industrial production grew at a 3.4 percent annual rate in January 2012. 

However, this is down from a 3.9 per cent, year-over-year, rate of growth in the fourth quarter of 2011 and down from a 6.2 percent, year-over-year, rate of growth in the fourth quarter of 2010.  In the fourth quarter of 2009 the economy actually declined by 5.5 percent, year-over-year. 

The numbers for industrial production are not inconsistent with the pattern of growth, year-over-year, of real Gross Domestic Product.  In the fourth quarter of 2011, the year-over-year rate of increase in real GDP was 1.6 per cent.  In the fourth quarter of 2010, the similar measure stood at 3.1 percent.  For the fourth quarter of 2009, like the figure for industrial production, the economy actually declined by 0.5 per cent.

Looking at the numbers in this way does not give one the upbeat feeling one can often get from just looking at the month-to-month change in the numbers.

Furthermore, information on the capacity utilization of industry (also released today) and the under-employment of working age people still indicates that there is a massive problem in our use of physical capital and of human capital. 

Capacity utilization in manufacturing stands at 78.5 percent in January.  That is, more than 20.0 percent of our industrial capacity is standing idle!  The important thing to me here is that the capacity utilization in the United States has been on a downward path since the 1960s.  Please check the chart below. 

Reading the chart from the left to the right shows a dramatic downward trend with each subsequent peak in capacity utilization being lower than the one previous to it. 

The question that remains to be answered is whether or not the trend will be continued with the “peak” in capacity utilization we are going to reach this time around.

The United States has a growing mis-match in the industrial capacity it has built and the industrial capacity that is useful.  This mis-match must be worked off…there is not an over night solution to this problem.

The same situation exists in the labor markets.  The under-utilization of working age people has grown since the 1960s.  In the 1960s about one in eleven or twelve people in the United States were under-employed.  The measure of under-employment now stands somewhere between one in four or one in five people that are of working age. 

The United States has a major problem.  Jobs and industrial capacity are not matched with the present makeup of our human and physical capital.  These under-employed persons and this under-utilized plant and equipment are not going to be matched up any time soon.  Thus, under-employment of labor and under-utilization of industrial capital are going to be around for a long time.  And, the rates of economic growth we are experiencing will not do much to help the situation.

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.   

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.    

Why This Economic Expansion is Going Nowhere

This economic expansion is now in its twenty-fourth month.  It is one of the weakest expansions on record.  And, it seems to be going nowhere.

One reason for this is that there is just too much debt still outstanding in the economy.  The economy is experiencing a debt deflation where more and more people and businesses feel over-burdened with the debt loads they are carrying on their balance sheets.

The government, especially the Federal Reserve, is trying to counter this by pushing hard on the credit inflation button to extend the fifty years or so of credit inflation we have already experienced.  The problem with this is that each new round of credit inflation puts more and more people and businesses into unsustainable positions so that expansions rely on a smaller and smaller proportion of the economy to drive further economic growth. (http://seekingalpha.com/article/279283-credit-inflation-or-debt-deflation)

 Debt takes time to work off or work out.  The bigger the debt-load the longer and harder it is for the people and businesses to climb out of their holes.  Repeated cycles of credit inflation not only end up with more people digging holes, it also contributes to some existing holes becoming deeper. 

Hence with every cycle recoveries become harder to achieve and the subsequent economic growth becomes less and less robust.

Another reason why economic growth is having trouble picking up momentum is because of the dislocations that exist within the economy.  Credit inflation causes many distortions beyond what it does to the balance sheets of people and businesses.

Most analysts concentrate on the unemployment rate.  Right now this figure rests just over 9.0 percent.  Analysts focus on this variable as the crucial one for the upcoming 2012 election. 

To me, a more important measure of the dislocation of human resources in the economy is the amount of under-employment we are experiencing.  This number includes those individuals that have left the workforce or are employed but are not fully employed.

The under-employment rate in the United States right now runs about 20.0 percent.  About one out of every five Americans is under-employed. 

This number was under 10.0 percent in the 1960s and has trended up ever since. 

The reason:  the number one goal of the economic policy of the United States government was to achieve high rates of employment…low rates of unemployment.  The best way to do this when unemployment arose was to stimulate the economy through the monetary and fiscal policies of the United States government to put people back to work in the jobs they have previously been laid off from.  This, of course, resulted in more and more of the human capital in the country being underutilized…a capacity utilization problem.

Adding to this was the shift in employment in the country with relatively more and more of the new jobs opening up being in finance and financial services and less and less in manufacturing.  Many “potential” workers find themselves limited in terms of opportunity either through geographic location or educational training.  Both of these results came from the governments attempt to achieve high levels of employment through credit inflation.

Finally, there is the problem of capacity utilization of physical capital.  As one can see in the accompanying chart, capacity utilization in American industry was in the 87.0 to 90.0 percent range in the 1960s.  As the proportion of human capital being used in this country trended downward from the1960s to the present, capacity utilization in manufacturing has also trended downward.  

One can observe very clearly in this chart the cycles of capacity utilization associated with each recession during this time period.  Also, one can not that with every cycle in capacity utilization that the “new” peak achieved is lower than the peak reached during the previous cycle…with the exception of the 1995-1997 experience.

Right now, United States manufacturing seems to be “peaking” out just below 77.0% of capacity, down from a previous peak of about 82.0 percent of capacity.  It has been stuck at this level for at least seven months now, through June.

My argument is that just as credit inflation is responsible for the growing under-employment in the United States work force, credit inflation is also responsible for the growing under-employment of the physical capital of the United States.  Credit inflation distorts business decisions and leads to a capital stock that is less and less productive over time.

So, here are three reasons why I place a low probability on the United States economy achieving a more robust economic recovery: the debt load on people and businesses; the dislocation existing in the labor market leading to high rates of under-employment; and the dislocation existing in the use of physical capital in the United States leading to low rates of capacity utilization. 

Note that credit inflation can only be a short run panacea for these problems.  Credit inflation leads to greater debt buildup adding to the unsustainability of the debt load being carried by people and businesses.  Credit inflation works to put people back into the jobs they recently lost but as the society changes, the old jobs go away.  And, credit inflation affects the productivity of the country’s physical capital making the existing capital stock less and less usable.  There are no good answers here.

Why Debt Is Going To Continue To Be A Problem In The United States

Officials at the Federal Reserve and in many other leadership positions around the world believe that liquidity is the solution to our current woes. And, if the amount of liquidity that is in the anking and financial markets is not enough to resolve our problems then more liquidity is certainly the answer.

This is behind QE2, and this is behind most of the effort to resolve the sovereign debt crisis in Europe.

What does liquidity allow you to do? It allows you to sell assets into the marketplace.

However, selling assets into the marketplace does not solve your problems if the price at which you sell the assets is substantially below the accounting value of the assets on your balance sheet. In such cases, having liquid markets in which to sell assets may allow you to more than wipe out your equity and leave you unable to pay off your debts.

There are two ways to counter this problem. The first is to inflate prices so that the real value of the debt declines which reduces the amount of leverage you have on your books. The second is to create income and wealth so that equity increases relative to the debt outstanding thereby reducing leverage.

The people advocating the injection of more liquidity into the financial system hope to spur bank lending and thereby stimulate economic growth. Those that are concerned with the creation of more and more liquidity argue that this first group of people really just want to create inflation and reduce the real value of the debt.

The problem I see unfolding is that the economy is expanding and will continue to expand in 2011, but it will not expand in such a way as to stimulate sufficient income growth and wealth creation so as to lower the debt loan many people are bearing. As a consequence, the further liquefying of the banking and financial markets will just benefit those who are not too highly leveraged…generally the financially better off in society…and continue to depress those who are highly leveraged.

In terms of economic growth, the economy is expanding. However, by historical standards, the year-over-year rate of growth of real Gross Domestic Product is substantially below the general recovery pattern. In the year-over-year rates of growth in 2010 were 2.4%, 3.0%, and 3.4% in the first, second and third quarters, respectively. Historically, at this stage of the recovery, the growth rates are usually much greater.

The problems come when we observe some very basic facts with respect to economic performance. First, although Industrial Production has recovered from the lows reached during the recession it has not come close to reaching the peak it attained before the recession set in. Second, the capacity utilization of our manufacturing has recovered, yet it still lies well below its previous peak (which is the lowest peak achieved since the statistical series was begun in the 1960s). Finally, even though unemployment dropped last month, under-employment continues to be extremely high as I estimate that one out of every four or one out of every five individuals of employment age are either unemployed, working part time but would like to work full time, or have dropped out of the work force. This phenomena is captured in the data on the Civilian Participation rate. Note, that this rate is substantially below the level it was before the Great Recession began in December 2007 and is also even further below the level reached before the 2001 recession. Under-employment in the United States has been growing, almost steadily, since the latter part of the 1960s.

Even though corporate profits are rising dramatically, even though many large corporations are acquiring other corporations at a very rapid pace, even though commodity prices are going through the ceiling, even though the big banks are doing very well, thank you, there seems to be a real structural problem in the United States. Liquidity is helping a lot of people but it is not the people we are talking about in this

Questions for a Monday Morning

Beginning in 1961 with the inauguration of President John F. Kennedy, the United States government has basically operated from a “Keynesian” economic philosophy. The economists that Kennedy brought into his administration were avowedly Keynesian and the Kennedy tax cuts that followed were developed from a Keynesian model.

This has been a bi-partisan effort and Republicans are as guilty as anyone in terms of the emphasis upon stimulative government budgets. President Richard M. Nixon confessed in the early 1970s that “we are all Keynesians, now!”

Government economic policy was written into legislation beginning with the The Employment Act, Act of Feb. 20, 1946 which was followed by the Humphrey-Hawkins Employment Act, the Full Employment and Balanced Growth Act, enacted in October 1978. Congress enacted laws that required the government to produce economic growth policies that were aimed at high levels of employment.

A growing economy and high levels of employment became a necessary goal of any presidential candidate running for election (“Get the economy growing again,” and “It’s the economy, stupid!”) or for re-election.

And, what was the result?

Since 1960 through 2009 the United States economy has grown at an average annual compound rate of growth of around 3.2%. Economists in the 1960s calculated that full-employment growth in the economy was about 3.2% and so economic policy was targeting a potential for growth in the United States economy of 3.2%.

If, after 50 years, these economists were to look back they might be astounded that the economy grew roughly at what they presumed to be the rate at which the economy could potentially grow during that time period.

Yet, not all is well with the world.

These economists could argue that fiscal policy really worked. The gross federal debt grew at an average annual rate of more than 9% during this 50 year period. Fiscal policy must have worked?

Financial innovation in the United States government was astounding during this period. As Niall Ferguson has claimed in several of his history books that governments have always been the number one innovator in finance historically. The United States government certainly proved this to be true over the last 50 years.

Certainly, credit inflation was the name of the game during this time period as the private sector came to emulate the government sector in terms of creating financial innovation and financial leverage became the necessary means of competition for firms to gain an edge in financial performance.

On the way to the bank, however, certain other things happened…and these raise some serious questions.

During all of this time period, in the United States industrial sector, capacity utilization went from over 90% of capacity to about 75% of capacity. If growth was proceeding at 3.2% a year, how come our industrial base has been used less and less over this period?
Also, the big concern in terms of unemployment was that we reach and sustain a 4% unemployment rate. Yet the unemployment rate has progressively increased and the under-employment rate, hardly different from the unemployment rate in the 1960s, is now above 20%. Why hasn’t the economic stimulus put more people to work?

Housing, which used to be the backbone of the private sector is now primarily the realm of the federal government. Who owns most of the mortgages in the country?

In the 1960s there were over 14,000 commercial banks in the United States. Now, there are less than 8,000 and, in my view, we are going to 4,000 in the next several years.

We had a vibrant sector of thrift institutions in the 1960s. By the end of the 1980s the thrift industry was almost gone. By the end of 2011, the thrift industry will be gone. This was the result of sound fiscal policies?

Income inequality has risen dramatically over the last 50 years. We have found out that the wealthy or the financially savvy can protect themselves during times of inflation and credit inflation. The blue collar worker, the less financially sophisticated, the middle class cannot protect themselves nearly as well during times when hedging or speculation becomes the way to financial wealth. Weren’t the Keynesian policies supposed to help the less well off by keeping them employed?

The “piggy bank” that the middle class and finally the less-well-off were supposed to exploit and protect themselves against inflation and lead them into a better financial future eventually busted. Housing was the “piggy bank” that many were supposed to ride to retirement leisure. But, falling house prices and foreclosures are turning the dream of many into nightmares? Couldn’t credit inflation keep this ball in the air?

There are many other question going around right now. The concern is the validity of the economic model that has been the foundation of our economic policies over the past 50 years. It appears as if we got the economic growth. What happened to all the other benefits we were supposed to receive once we achieved this economic growth?

Where Economic Success is Going to Come From

One piece of economic information that I have focused on over the past 18 months has been the Federal Reserve’s figures on capacity utilization of the industrial sector of the United States.

The story that can be read from this information is that capacity utilization in the United States has fallen from the middle of the 1960s to the present time. In 1967 when the data series was started, capacity utilization was about 90%. Over the past fifty years, every cyclical peak of capacity utilization has been lower than the previous one. In the 1990s, capacity utilization reached a peak of around 85% while in the middle 2000s the peak dropped to 82%.

Currently, although capacity utilization has risen above its recent cyclical trough of about 68%, it is still languishing around 74%. One should note that as cyclical peaks during this period have been at lower and lower values, cyclical bottoms have also been at lower and lower values.

The conclusion one can draw from this is that United States industry does not seem to be “tooled-up” for the right output.

If the United States is going through a major secular restructuring both economically and financially, as some of us believe that it is, then United States industry will be restructured so as to shed some of this excess capacity.

There are many indications that such restructuring is taking place and will continue to take place over the next few years. This, of course, will mean that the economy will not recover real quickly which will mean that it will take just that much longer to resolve the “under-employment” problem.

The evidence of this restructuring can be observed in places like the front page article in the New York Times, “Industries Find Surging Profits in Deeper Cuts”: See http://www.nytimes.com/2010/07/26/business/economy/26earnings.html?_r=1&hp. The gist of the article is that companies are producing very good profits, not through revenue growth, but through the reductions in their cost structure, predominately through cuts in labor costs.

Of course, the real “economies of scale” in this effort are found in the larger companies. Smaller companies can reduce labor costs but they don’t have anywhere near the impact that large companies achieve when they go through a major restructuring.

Rod Lache, of Deutsche Bank: “These companies cracked the code of a successful turnaround. They’re shrinking the business to a size that’s defendable and growing off a lower base.”

Over the past fifty years industry did not downsize in this way because success seemed to come from “hoarding” labor and getting the company positioned for the next surge in sales revenue. This attitude was re-enforced by the federal government that underwrote the “nest surge” in consumer spending through fiscal stimulus programs created through deficit spending and the expansion of the money stock.

The “artificial” underwriting of economic growth by federal government largesse can only go so far. Throughout this period, the question that always lurked in the background concerned the burden of the debt being created, both private and public debt, and the economic mismatch that was being created between where the country should be technologically and where it was both in terms of physical and human capital. The growth in labor under-employment and the decline in capacity utilization over this time pointed to the fact that at some time an economic and financial restructuring would have to take place.

And how are these companies that are doing so well using their profits? They are building up their cash reserves. Jamie Dimon at JPMorgan Chase has indicated that it is not time to pay these profits out in dividends. There are just too many uncertainties present in today’s economy…and there are just too many other possible ways to use the funds in the future. Many other CEOs agree with this assessment.

The New York Times article contains a chart that shows the relationship between “Corporate Cash as a Share of Corporate Assets.” The most recent data show this relationship to be 6.1%. Guess what? One has to go back to the middle of the 1960s to find this figure at such a high level. Through most of the last fifty years the share of cash ran between 3% and 5%. This shift is huge and is taking place primarily in the larger, better positioned companies.

This same thing is happening in the commercial banking arena. The larger, more successful banks are piling up cash reserves. The smaller banks are not the ones with the profits or with the cash resources.

What does all this mean?

It means that the next few years will see a massive restructuring of industry, in manufacturing, financial services, and in other services. Reconsolidation will be in vogue, not expansion. The cash will be used for mergers and acquisitions, for rationalization of industry, for capacity reduction, and for control.

The one caution about this is that these companies cannot get too far ahead of the financial markets for investors will punish those that seem to be “jumping-the-gun”. In the Wall Street Journal we observe the warning, “Markets Say No to Expansionist Companies”: See http://professional.wsj.com/article/SB10001424052748704719104575389172070900184.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj. The economy, in the near term, does not look strong. Profit performance is not seen as coming from increasing revenues, but from continued cost containment or cost reduction. Companies that appear to be moving too quickly in this environment are getting hurt by investors that believe cash should be conserved for use on another day at a different time.

Financial markets seem to want prudence now and not outright aggressive behavior.

Yet, people are getting prepared for the time when action is called for. But, the action will not be toward expansion, but toward containment. In the Financial Times we read of the return of “merger arbitrage funds”: See http://www.ft.com/cms/s/0/d74a2fa6-980c-11df-b218-00144feab49a.html. These funds attempt to profit from the spread between the price of a merger target after a deal is announced and the closing price at the completion of the deal. The funds “smell” something in the wind and they want to be ready when the time is right.

Gerard Griffin of GLG Partners’ event-driven team is quoted as saying: “Companies have built up large cash balances and the economy is not looking particularly strong, so earning growth will have to come through synergies.”

That is, consolidation will have to take place within industries reducing industry capacity and thereby increasing capacity utilization. For the time being, however, this rationalization of industry will reduce the number of jobs that are available and will also result in changing the nature of who is employed in these more technologically advanced and productive firms.

The evidence is growing that a massive restructuring of industry is taking place. This restructuring will not speed up either economic growth or the reduction of unemployment or under-employment in the near term, only over the longer term. But, the types of things managements and companies are doing are similar to what has happened at other times. However, these restructuring events are captured in the economic writings of Joseph Schumpeter, and not in the economic writings of John Maynard Keynes.

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?

Jobs and Skills: the Current Mismatch

For at least 18 months, I have been arguing that the United States economy is going through a transition period that is more than just a cyclical slowdown and recovery. My argument has been that the economy is going through a period of restructuring that will take an extended amount of time to work out all the changes that are necessary.

As a consequence, “blunt-edge” efforts to stimulate jobs by means of the fiscal policy of the federal government will not achieve a great deal of success.

The reason for this in many cases is that the fiscal stimulus of the past 50 years has caused companies to keep aging physical capital in use and has resulted in these companies hiring people to perform jobs related to “legacy” technology.

The evidence I have provided for this is the increasing amount of unused capacity in the manufacturing realm and the growth in the number of employable Americans that are under-employed. To be under-employed, one is either unemployed, not fully employed and looking for full-time work, or discouraged and not seeking a job.

I have argued that this is not unlike the 1930s when the United States economy was going through a transition period in which jobs and employment were shifting from rural and agricultural areas to cities and industrial areas. The restructuring that took place accelerated during World War II and did not really calm down until the 1950s and 1960s.

Two reports came out toward the end of last week that support my claim of an economy that is in the process of restructuring. The first was an article by Motoko Rich that appeared in the New York Times on Friday July 2, with the title “Jobs Go Begging as Gap is Exposed in Worker Skills.” (http://www.nytimes.com/2010/07/02/business/economy/02manufacturing.html?_r=1&scp=2&sq=motoko%20rich&st=cse) Rich writes that “Plenty of people are applying for the jobs. The problem, the companies say, is a mismatch between the kind of skilled workers needed and the ranks of the unemployed.” The subheading to the article reads that “Shifts in Manufacturing are Leaving Many as Unemployable.”

The second report came from the Labor Department on Friday, July 3. Although the unemployment rate declined in May to 9.5 % from 9.7% in April, this was because the labor force shrank as more people left the labor force than were added to payrolls: the labor force shrunk by 0.3% while the number of individuals employed dropped by only 0.2% (due to the loss in jobs connected with the collection of Census data).

The official statistics report that the “underemployment” rate has been in the 17% range for the past year or so. I estimate that, currently, about one out of every four or five individuals that are in the employable age group are under-employed. The reason is that there is a tremendous mis-match between what employers need to be competitive in the future and the pool of skills and experience that are available in the labor market. Products are being made differently now than they were several years ago and this trend will continue. The current downturn has provided additional justification for manufacturers to make the changes that they need to make.

Why do they need this added justification?

Well, over the past 50 years, every time there was a recession (and even in periods when there was not a recession), the federal government provided fiscal stimulus to get people “back-to-work.” Back-to-work, however, meant putting people back into jobs that they were in before the workers were laid off. This is what the government wanted to happen.

However, putting people back to work in “legacy” jobs did not contribute to modernization and improved productivity. It did increase employment and reduce unemployment which is what the federal government wanted to achieve.

Now, businesses can use the excuse of the extreme downturn in the economy to justify the changes in who is hired to meet the reality of changes in training, skill levels, and experience that have occurred. And, this transition will not be completed overnight.

We see the same thing in the use of physical capital in the United States. Since the 1960s, the capacity utilization of manufacturers has declined steadily. As with the increase in the underemployed, the employment of the physical capital in the United States has fallen over time.

In January 1965, American manufacturers were working at 89.4% of capacity. The next peak in manufacturing usage (capacity utilization is very cyclical) came in February 1973 at 88.8% of capacity. The following peaks were: December 1978 at 86.6% of capacity; January 1989 at 85.2% of capacity; December 1997 at 84.7% of capacity; and April 2007 at 81.7% of capacity.

Note that the troughs of the cycles in capacity utilization also fell since the 1960s. In December 1982, manufacturers in the United States worked at 70.9% of capacity and in June 2009, they worked at 68.2%. Currently, manufacturers are working at 74.1% of capacity.

In essence, businesses in the United States have been utilizing less and less human and physical capital over the past 50 years relative to the amounts of these productive factors that have been available. And, the policy makers just don’t seem to get it.

From Rich, in the article cited above, “Christina D. Romer, chairwoman of the Council of Economic Advisers, said the skills shortages reported by employers stem largely from a long-term structural shift in manufacturing, which should not be confused with the recent downturn. ‘I do think that manufacturing can come back to what it was before the recession,’ she said.” So, manufacturing will return to the new, lower level of capacity utilization that was achieved at its previous peak level, roughly 82% of capacity. And, this is good?

My guess is that capacity utilization will hit, maybe, 80% at the next peak. We are still talking about 20% of the manufacturing capital of the United States being underemployed, right in line with the 20% to 25% of employable labor in the United States being underemployed.

The fiscal stimulus proposed by “fundamentalist” Keynesian economists will not do the job. Additional, “blunt-edge” governmental expenditures may alleviate some of the current worker distress, but at the cost of postponing the adjustments that need to be made to restructure the economy, the restructuring that is now going on.

The problem with the “fundamentalist” Keynesian view is that it is constructed from a short term perspective. The basic attitude is that which is attributed to Keynes: “In the long run we are all dead.” This approach leads to a focus on only “current” problems. What is not explicitly stated is that we will deal with the longer-term problems when they become current problems.

The difficulty with this: the longer-term problems may require a different “medicine” than did the short-run problems.

Well, one could argue that the longer-term problems have become current. The short-term solution of forcing many companies to continue to employ people in “legacy” jobs and to continue to use “legacy” plant and equipment has resulted in higher and higher rates of worker under-employment and lower and lower rates of manufacturing capacity utilization.

Just more of the same does not seem to be an adequate answer.

The Fed is "Pushing on a String"?

During economic times like these, economists say that the Federal Reserve is “pushing on a string”. That is, the central bank has pumped a large amount of reserves into the banking system, yet banks are not lending, and the money stock is not growing.

Excess reserves in the banking system total more than $1.0 billion. Bank loans on a year-over-year basis show a negative growth rate. And, the M2 measure of the money stock, year-over-year, is growing at a 1.6% annual rate.

The Fed’s actions are not getting transferred through the banking system to the real economy!

As a consequence, economic growth does not seem to be accelerating at the speed economists and governmental policy makers would like.

Yet, if one compares the Great Recession which we have just passed through with the second worst recession in the post-World War II period the recovery does not really look that bad.

What seems to be different is the rate of growth at which the economy was growing in 1978, between 5% and 7%, and the speed it was growing before 2008, around 3%. In addition, the economy rose out of the 1981-1982 recession accelerating into the 8% range. No one seems to be predicting that the United States economy will move into this latter range in the near future. Recovery is occurring, it is just not very robust.

Fed Chairman, Ben Bernanke, testifying before the House Budget Committee yesterday spoke of the economy growing at a 3.5% rate “in the months ahead.” Economists surveyed by the Wall Street Journal expect the economy to grow about 3% in the second half of 2010 and continue that pace into 2011. (See http://online.wsj.com/article/SB20001424052748703890904575296403144025366.html#mod=todays_us_front_section.)
No one seems to believe that economic growth in 2010-2011 will match the recovery achieved in 1983-1984. The difference? Banks aren’t lending. Underemployment seems to be hanging at post-World War II highs, near 20%, and industry is operating at a capacity near post-World War II lows. On this see my post, http://seekingalpha.com/article/207148-breaking-down-the-u-s-economic-recovery. The economy was expanding before the Great Recession, but substantially below the post-World War II average of about 3.4%, year-over-year.

Real growth in the period 2005 to 2010.

The American economy has been showing some substantial dislocations and these are expected to persist as the recovery continues! These dislocations are not going to be corrected with short-term fiscal stimulus packages. And, so the economy will just scrape along.

Along with the factors already mentioned as reasons for why the economy has grown so slowly in the 2000s and why it might be expected to continue to grow slowly is the perception that the economy is bifurcating. That is, one side of America seems to be doing very well and another side is not doing so well at all. This may be due to the restructuring of the United States economy and the slow transition that is occurring getting us there.

For example, big banks seem to be doing very well, thank you, while banks smaller than the 25 largest banks seem to be struggling. (See http://seekingalpha.com/article/209229-federal-reserve-exit-watch-part-11.) Foreclosures remain high and are expected to remain high as unemployment (and underemployment) remains high. Personal and small business bankruptcies have not dropped off. Legacy industries are still in the process of restructuring and are only modestly turning around while younger industries are growing very nicely. The economy of the early 2000s is different from that of the 1990s and before and we cannot go back. And, government shouldn’t force us to go back.

This restructuring is taking place in balance sheets as well as in the structure of the economy. People and businesses that have built up relatively large debt-burdens are restructuring their balance sheets. Consequently, debt liquidation is exceeding debt creation within the financial system and this is resulting in a contraction of bank loans. This is also contributing to the slow growth in money stock measures. This is why it seems as if the Federal Reserve is pushing on a string in terms of stimulating credit expansion.

Economic recovery is occurring, but it seems as if it will be modest and uneven throughout the economy. It also appears as if the economy is transitioning into something else, the Information Economy and not the Industrial Economy, and this will take time and patience. And, maybe we don’t want the banks to expand their lending too rapidly…given the $1.0 trillion in excess reserves in the banking system. Maybe.

Let's Look at the United States rather than Europe for a change

Durable goods orders are up 2.9% in April. New home sales rose last month. More and more statistical releases point to a continuing recovery. More and more it appears as if the Great Recession did end in July 2009 and we are, consequently, in the tenth month of the economic upturn.

However, it still doesn’t quite feel like much of an upturn. But, economic pundits contend that there is very little chance for a “double-dip” recession even with the financial turmoil rocking Europe. One analyst argued that with the European disorder the probability of having a “double-dip” recession has risen, but from about 5% a month earlier to around 20% now. In other words, he believed that it is highly unlikely that we will have a “double-dipper.”

My concern is still focused upon the long-term fact that there is so much un-used capacity in the United States. The efforts to stimulate the economy, as a consequence, represent efforts to put people back into “legacy” jobs (the jobs from which they were released) that will continue to thwart the competitiveness of the United States in world markets and put back to work “out-of-date” plant, machinery, and labor.

If we look at capacity utilization in the United States, we see that we are using more capacity now than we did in July 2009. For April the figure was below 73.7%. However, we are still substantially below the previous peak in capacity utilization, which came in at about 81.5% in 2006. And, the previous peak before that was below the previous high before that, 85% in 1997, which was lower than the previous peak and so forth for the whole post-World War II period.

Furthermore, industrial production remains depressed from the level it attained in early 2008 and also in 2000. Both series are making progress, but we are still running way below levels that were previously attained and although the “catch up” seems to be robust, the question remains as to whether or not these measures will exceed earlier highs in the near future.

Adding to this concern is the fact that the labor situation remains weak. Unemployment in April stayed just under 10%, but the number I am very concerned about is the total amount of workers that are under-employed. I am concerned, not only with those that are out-of-work, but those that are not fully employed but want to be fully employed, the discouraged who have left the workforce, and the people that have taken lower positions, positions that they can fill but are fully qualified to perform in other more challenging jobs. My estimate of these under-employed persons runs around 25%, about 1 out of every four people who could be considered to be in the labor force.

The fact that these factors are running so low relative to “capacity” employment raises concerns about the United States achieving its “potential” any time soon. To examine this possibility we look at a comparison between the estimates of the Congressional Budget Office of potential real Gross Domestic Product and the level that real Gross Domestic Product was actually attained. Not only was the United States economy producing at a level of output only 94% of potential, the rates of growth of actual real GDP seem to lie below the rate at which the CBO is estimating that potential real GDP should grow.

The economy of the United States is recovering, but one can understand why many people really do not seem to be experiencing it. Nothing in the previous stimulus plan, or in the one being developed, or in the current stance of monetary policy, gets the United States back on track. Different types of policies are needed to renew the productive capacity of the United States so that the U. S. can become fully competitive again and fully use its resources…both human and physical. Unfortunately no one seems to be working on these kinds of policies because they rely so heavily on the private sector. Also, these policies take too long to achieve results; politicians have a much shorter employment cycle.

Economic Recovery?

The front page of the New York Times reads, “Why So Glum? Numbers Point to a Recovery.” (http://www.nytimes.com/2010/04/09/business/09norris.html?hp) The economic recovery is at hand, yet, to many, even to many economists, something seems to be missing.

Unemployment remains high, but it is a lagging indicator. Consumer debt remains high and home foreclosures and personal bankruptcies continue to stay near record levels, but these tend to be lagging indicators. State and Local governments are on the edge, apparently faced with becoming the “next Greece.” (For example, this morning see “Los Angeles Faces Threat of Insolvency”, http://online.wsj.com/article/SB20001424052702304830104575172250422355156.html#mod=todays_us_page_one, and “Next ‘Big Crisis’ Is Unfolding in Muni-Bond Market”, http://www.bloomberg.com/apps/news?pid=20601039&sid=aKj_LXH6zUrw.) But, these problems are related to the condition of the consumer and hence will not recover until the consumer recovers. Commercial banks are not lending, small businesses are not getting bank loans, and there are still concerns about the value of bank assets and the impending loan problems.

Floyd Norris, in his New York Times article, speaks about slow economic recoveries and attempts to put the current situation within the context of other post-World War II recessions. Within this context, he argues, the prospects for the current recovery are not that bad. When the economy is turning around, current data tend to be revised as more information becomes available and the recoveries, historically, appear to be “less slow” than they were during the time they were actually being experienced.

I believe that Norris is correct in his interpretation of where the United States economy is at the present time and how the data we are now receiving compares with the data relating to previous
recoveries.

What this misses, as I have tried to present over the past six-to-nine months, is that there are other factors at play in the economic developments of the past fifty years and this has created a situation that is not favorable to a strong economic performance in upcoming years…unless some things change.

One of those changes that are necessary relates to the inflationary bias of our government’s monetary and fiscal policies. As I have mentioned many, many times before, inflation is not helpful over the longer run and, in fact, over the longer run tend to hurt the very people the inflationary bias is aimed to help. The fact that the purchasing power of a dollar has declined by over 80% in the last fifty years has left the American economy is a very weak position. Long-term inflation has had an impact on the economy.

For one, inflation is supposed to help existing manufacturing industries. Yet, we have seen that over the past fifty years, the capacity utilization of United States industry has continuously declined with each peak reached in a subsequent period of economic recovery lying below the level of the previous peak. (See my post “The Trouble with Recovery,” http://seekingalpha.com/article/192713-the-trouble-with-recovery.)

Inflation is supposed to help labor, yet the level of the under-employed has risen almost constantly during the last fifty years. As capacity utilization has declined, the “mainstream” laborer has found him- or her-self less and less trained to do something outside “mainstream” industry. Hence, the growing number of those that don’t “fit” into the twenty-first century industrial structure. It will be very difficult to put these people back-to-work on a full time basis.

The economy of the past fifty years has also relied on the strength of construction, especially the construction of houses. This area has received special attention in that the government has created many, many financially innovative ways to support this industry which has led to an inflation in real estate prices that has out-stripped those in other areas of the economy.

A consequence of this has been that most personal saving over the past fifty years was tied up in the value of a person’s home. People saved by investing in a home and then watching the value of the house continue to appreciate. This appreciation of home prices also allowed their owners the opportunity to borrow against the increased value of the house to maintain higher and higher living standards. Now much of this “wealth” has been destroyed.

And, the inflationary bias has led to a hurricane of financial innovation. The creation of debt and financial innovation thrive in an inflationary environment. The last fifty years has been a treasure-trove for those in the financial industry and the financial innovation that has resulted exceeds that of any period in the history of human-kind. The economy may seem unbalanced with the growth of the finance industries relative to the manufacturing industries, but that is what you get when you have fifty years of consumer and asset price inflation.

The theoretical underpinnings of the policies that have resulted in the inflationary bias of the last fifty years were built on two primary assumptions. The first is that the labor force must be kept employed in order to avoid revolutionary unrest. The second assumption is that foreign exchange rates would be fixed in value. (See my book review: http://seekingalpha.com/article/167893-john-maynard-keynes-and-international-relations-economic-paths-to-war-and-peace-by-donald-markwell.)

The model derived from these assumptions is “short-run” in nature. (Remember Keynes is quoted as saying “In the long run we are all dead.”) Policy making within this paradigm, therefore, focuses upon achieving short-run goals even if the long run consequences, as presented above, are detrimental to the people that are, hopefully being helped. Since the world is a series of short-runs, the problems resulting from previous “short-run solutions” will be offset at a later date. As we have seen, this does not happen.

In addition, since 1971 most of the world has been operating within a regime of floating foreign exchange rates. A country cannot isolate itself from other countries, in terms of the fiscal and monetary policies it follows, without repercussions. In the case of the United States, we have seen during this period of inflationary bias the value of the United States dollar has declined. The two periods in which this was not the case were those of the late 1970s-early 1980s, when Paul Volcker was the Chairman of the Board of Governors of the Federal Reserve System, and the 1990s, when Robert Rubin was an influential member of the Clinton Administration. Overall, however, the value of the United States dollar has declined during this period and is currently substantially lower, relative to other major currencies, than it was in the 1970s.

The policy focus of the United States government must change. To me, Paul Volcker had it right when he argued that “a nation’s exchange rate is the single most important price in its economy.” Consequently, he argued that a government cannot ignore large swings in its exchange rate. A country’s exchange rate reflects how international markets interpret the inflationary stance of the monetary and fiscal policy of a government. In the future, more emphasis must be placed upon this price in making policy decisions for the United States no longer dominates the world the way it did in the past.

Second, the policy focus of the United States government must move away from employment in legacy industries. A recent research paper by Dane Stangler and Robert Litan, “Where Will the Jobs Come From?”, published by the Kauffman Foundation, emphasizes that “nearly all” of the jobs created in the United States from 1980-2005 were created in firms less than five years old. By focusing on legacy industries in determining its economic policy, the federal government is just fostering an environment in which under-employment is going to continue to grow. This is not healthy for the future of the American economy, especially as emerging nations around the world are focusing on the future and not the past.

The Problems of Recovery

Comparisons abound between the Great Depression of the 1930s and the Great Recession of the 2000s. So far, we seem to have avoided the depths that were reached in the earlier experience, but we still have to consider whether or not the breadth of the two might be similar. That is, almost everyone one forecasting the recovery of the United States economy in the 2010s seems to be expecting that it will be a long, slow process.

The comparison I would like to consider in this post is the possibility that both of these periods represent a time in which the United States economy was going through a substantial structural change. Many people that have studied the 1930s period argue that the economy that existed in the United States in the 1950s was substantially different from the one that existed in the 1920s. Huge shifts took place in both manufacturing and agriculture throughout the 1930s and these shifts were just accelerated in the 1940s, a period of world war. The underlying cause of this change: technology had changed and the American economy had to adjust to become a modern nation. However, the mismanagement of the financial crisis in the 1930s just exacerbated the depth of the decline.

The argument can be made that major structural changes had to take place in the United States economy as it entered the 21st century. Changes of the magnitude of the present adjustment did not take place during the shorter, less severe recessions of the post-World War II period because the buildup of technological change takes time in order to build up a sufficient backlog of the new technology to really be disruptive. By the end of the 1990s, the structural change connected with the move from a society based upon manufacturing to an information society was ready to occur.

This buildup was not really a sudden one. It has been occurring throughout the last fifty years or so. I believe that the decline in the figures on capacity utilization for the United States captures this change very well.

Note in the accompanying chart that capacity utilization continues to decline throughout the whole period since the late 1960s. Obviously, cycles in this measure took place that were related to the various recessions occurring during the time span, but each new peak in capacity utilization never exceeds the peak it had reached in the previous cycle.

This, I believe, captures the changing nature of the United States economy and the movement from the foundational base of the Manufacturing Age to the growing impact of information technology and the Information Age. The conclusion that can be drawn from this is that the United States economy is not going back to where it was. But, this will take time.

Let me just point out three important factors that are playing a huge role in this change: evolving technologies, changing structure of the labor market, and the rise of the emerging nations.

First, the core of American commerce is not going to be manufacturing as we have known it. The future belongs to information technology, biotechnology, and knowledge. For the government to attempt to “force” workers back into jobs they held in the manufacturing world is just going to postpone the changes that WILL take place and threatens the stability of the society by re-establishing the inflationary environment of the last fifty years.

Second, the age of the labor union is past: non-public sector labor unions are legacy. There was a time when labor unions were needed to temper the pressures and demands of the industrial age of the large corporation who needed large numbers of physical laborers. These unions now compose less than half the union population in America yet have an over-sized impact on the politics of the country. In the next fifty years, the importance of the labor union is going to decline, economically and politically, as the United States moves from the manufacturing base that has dominated the last fifty years into the Information Age described in the previous paragraph.

Third, the United States, although it will remain the number one economic and military power in the world, is going to see its relative position in the world decline. The reason is that major emerging nations are beginning to feel their power and exert it. The immediate group of nations that come to mind are the BRICs. But, there are others. China, as we well know, is starting to exert its influence throughout the world. We see Brazil directly challenge America in the World Trade Organization concerning tariffs and subsidies. (See “Tax Move by Brazil Risks US Trade War”: http://www.ft.com/cms/s/0/dbf4284c-2afa-11df-886b-00144feabdc0.html.) And, more of this is to come! This is going to provide its own pressure for the economic structure of the United States to change.

These adjustments are going to take time. There will be substantial pain for those of working age who are not trained or educated for the new era. I believe that even the number of underemployed, 16%-17% of the work force, under-estimates the structural problem that exists. Thus, the estimate of 11 million new jobs that are now needed in the economy to get us back to where we were before the Great Recession began also under-states the problem.

Investment-wise, just as in the 1950s, the whole structure of opportunities available is changing from the earlier age. But, one needs to consider the new format of the economy that is evolving out of the manufacturing age in developing ones portfolio strategy. Similar to the 1930s, the 2000s are producing a modernization of the United States that will alter the world as it has been known and will produce a world that we can’t even hardly imagine yet.