The dismal March jobs report, printing at less than half of expectations, raise additional questions about the strength of the current recovery. While its well known the current recovery is weak, its less well-known that this is the weakest recovery since at least the end of WWII. That’s a deeply troubling notion, given the historic levels of fiscal and monetary stimulus that have been applied to the US economy since late 2008. It should raise questions about the effectiveness – and even the wisdom – of US fiscal and monetary policy.
We reviewed quarterly GDP, using chained 2005 dollars, from the end of WWII to December 2012, the last quarter for which statistics are available. Then, we segregated recessions (measured using the traditional standard of two consecutive quarters of negative growth, rather than the more subjective NBER standards) to determine all the economic expansions from 1947Q4 to 2012Q4. Then, we determined the average rate of growth in each of the quarters and the maximum quarterly growth during each expansion and charted the results in Figure 1.Click the caret in the upper left and manipulate the power bars or click here to see a larger version of the chart.
The current expansion is the weakest of all post-war expansions, both in terms of the average quarterly growth during the expansion and the maximum growth in any single quarter.
While the Dow and the S&P have enjoyed a full (nominal) recovery of their pre-recession lows, Main Street – and partcularly small businesses – have had far less success. Non-transport manufacturing, as we discussed here, has been flat lined since at least January of 2012.
What, then, is the purpose of the Fed’s monetary policy and the Obama Administration’s fiscal policy? It would seem that an average GDP growth slightly below 2% is hardly worth the costly expansion of the Fed balance sheet or the trillions of “investment” we’ve spent on stimulus.
The policy objective of the Fed and the Administration is to counteract the deflationary effect of the debt overhang that arose when the housing and stock markets collapsed in 2008. Without the additional liquidity of the Fed or the spending of the government, there would be a liquidity trap.; that is, with further economic contraction arising from the anticipation of lower prices and an increase in debtor’s relative levels of nominal debt.
A liquidity trap can be devastating in an economy with a huge debt overhang, where workers and businesses earn less but are still liable for debt incurred prior to the onset of the deflationary spiral. Demand plunges as consumers anticipate of lower costs in the future. Disposable income, after debt service, decreases and highly leveraged enterprises – including banks – fall into bankruptcy. The latter is the greater threat.
In the Depression of 1920-21, following the inflation and demand of Word War I, prices collapsed by some 30%. Unemployment soared from 4% to 12% and the measure of national goods and services fell a staggering 17%. (See Figure 2.)
But unlike more recent countercyclical fiscal and monetary policy – where governmental intervention, spending, and loose money is Keynesian de rigeur – President Warren Harding met the downturn by embracing the deflationary spiral, cutting government spending almost in half and reducing the nation debt by one-third. Tax rates were reduced across the board. The Federal Reserve, too, decided to stand pat, making no major change in monetary policy.
The result of this “non-intervention”, and the dutiful repayment of much of the national debt, was that the economy started to recover by the end of the Summer of 1921. Prices had fallen far and fast, as had wages, but employment picked up rapidly because the costs of production had also fallen, thereby stimulating demand. At the newly adjusted deflated level of the economy, the recession was arrested and growth restored, almost holistically. There were, of course, undoubtedly bankruptcies and hardships. Creditors were forced to write-down or write-off debt, but they soon recovered in the “Roaring Twenties”, the expansion that commenced in 1921 that lasted for more than another eight years.
By contrast, Japan’s labor unions, political establishment and businesses – the class who stood to lose the most from inventory write-downs and the repayment of debt worth relatively far more than when it was borrowed – cooperated to maintain price levels during the 1920-21 crisis. They were, of course, aided by Japan’s financial sector of banks and insurance companies, that would have suffered the prospect of humongous loan write-downs and write-offs (or even insolvency) had prices been permitted to achieve their natural market levels. As a result, Japan suffered recession and inflation throughout most of the 1920’s, until the natural course of deflation caught up with the economy. Banks and businesses failed in 1927 and the effects of the Great Depression soon followed.Click the caret in the upper left and manipulate the power bars or click here to see a larger version of the chart.
Clearly, the circumstances of 1920-21 are different from the downturn that took effect in 2008. The “buy now, pay later” consumer culture that commenced in the late 1950’s and 1960’s was not commonplace in 1920, so consumer debt in 2008 was considerably higher as a percentage of personal income. Governmental debt, just 35% of GDP in 1920 (and decreasing under President Harding), was over 60% of GDP in 2007, at the beginning of the downturn, and rocketing upwards to reverse the downturn so that it is more than 100% of US GDP today. Moreover, a number of the large banks and insurance companies in 2008 were, literally, “too big to fail” because their failure would lead the entire financial system to seize up and commerce to have effectively stopped had government and the Fed not intervened to stop the financial system from callapsing. Effectively, policymakers in 2008 and 2009 were trapped by existing debt loads and the size of America’s “mega-banks”; they had little choice but to attempt to hold back the deflation and wave of defaults that would otherwise have occurred. They were also trapped, as it were, by their single-minded ideology – Keynesian Economics – that pervades economic thinking among Washington policymakers.
We already know how this policy “solution” plays out, though. Again, Japan is illustrative.
Japan’s economy has been stagnant following the burst of their real-estate bubble nearly 30 years ago. Keynesian prescriptions have served only to (somewhat) forestall a Japanese deflation, not to stop it. But genuine growth in Japan’s economy has been elusive, given their debt overhang and an aging national demographic. Japan chose not to cut back on spending; indeed, Japan has put tens of billions into often redundant and unnecessary infrastructure and government jobs.
The effort to reverse the organic trend of deflation – preserving business and banks, the course Japan took in the 1920’s – has caused Japan’s debt to soar to 200% of GDP. After 30 years of tried — and failed — fiscal and monetary policies Japan’s Prime Minister Abe has moved Japanese economic policy in another direction, one that will likely eventually be adopted by American policymakers: slow-motion de facto default. Abe and his minions at the Bank of Japan – with the consent and approval of the G-20 nations – have embarked on a massive course of monetary easing that will devalue the yen. Thus, Japan’s default won’t be in the technical sense of a debtor refusing to pay. Instead, Japan’s debt will be by devalued as a percentage of the national economy through inflation.
Of coure, its not necessarily a foregone conclusion that the Federal Reserve will follow Japan’s lead and move toward an inflationary fiscal policy to assuage deflationary pressures and engaging in slow-motion de facto default by reducing the real value of the national debt to more manageable amounts. But a staff study issued under the imprimatur of the New York Fed – on Good Friday, where it would earn little press attention – suggesting that inflation is the best stimulus for the economy when the Fed can no longer lower interest rates (the so-called “zero bound”) – can’t help but make one suspicious. The authors write:
“In fact… we will see that the benefit of inflation
becomes bigger rather than smaller as inflation becomes more and more anticipated. This result turns
Volcker’s argument on its head at the zero bound. It is the main result of the paper.
Of course, the paper came with the usual Fed disclaimer that it was intended for discussion only, that it was the opinion of the authors only and not a representation of Fed policy, etc. So, there’s no cause for suspicion that the Fed might gin up the presses and print the US out of its debt by causing an inflationary spiral.
Pay no attention to those men behind the curtain.