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Interest Rates

The failure to control credit and the decision to leave financing to the markets and their manipulators is the great failure. It is the genesis of the great financial crisis, and its legacy is the huge burden of debt that now crushes prospects for an orthodox recovery. The invisibility of financing and financing structures – as we’ve noted before – is what made the orthodox forecasters blind to the biggest economic event of the generation. And the unwillingness to deal with the misallocation of credit in a ruthless and rational way is what prevents policy-makers from putting the crisis behind us and real recovery in front. Instead we limp from crisis to crisis, always choosing to burden the future with more debt, always choosing to socialize the losses of the powerful and privatize the suffering of the powerless.

(click on the chart for a larger image in a new window)

Source: Federal Reserve (click on the chart for a larger image in a new window)

Today on the Forecast, we look at interest rates. We are forecasting interest rates to continue to trend downward. But we do not put much stock in the importance of interest rates to the real economy or see monetary policy as playing a positive role in recovery.

For several reasons:

1. Credit availability is not described by how low interest rates are. Particularly in the mortgage market, where banks once so happily lent to anyone and were even willing to lend the down payment. Banks will not now finance anyone who needs financing. They resist refinancing even the best risks, in fact, so as to keep the old higher interest mortgages paying. Not too different from squeezing credit card holders. But the point is, mortgages may be at four percent, but you can’t get one if you need it.

2. Low rates delight the market players who can finance their stacks of chips cheaply. This means speculation, and it means higher prices in commodities like oil and food and basic materials. This means higher and volatile prices for consumers than would be the case in a supply-demand market. Which means decreased consumer confidence and reduced private demand.

3. It is not ultimately the supply of credit that is the problem, it is the demand for credit.

4. Real interest rates for assets may actually be high when nominal rates are low. Deflation in the prices for investment goods means a zero nominal rate is actually positive. Two bullets on this:

  • It doesn’t seem that long ago that markets were efficient, by the accounts of the fundamentalists, and incorporated new information with seamless efficiency. Outguessing the market was futile according to Eugene Fama and the Chicago School, and better to be passive. Now it seems that investors are stupid and their information is deluded when they take the two percent ten-year Treasuries. They need to be coaxed by the enlightened fund managers. Well, maybe investors are not so stupid. Housing as a surrogate for investment goods? Prices are dropping. A hundred dollars in a ten-year at two percent yields five percent versus a house that drops three percent in value….
  • Consumer price inflation is not relevant to calculating real interest rates. As we’ve said, if it were any more than commodity speculation, inflation in wages and incomes would be rising, too.

5. It is a lot easier to stall an economy with hikes in interest rates than it is to restart it by lowering rates. This is, again, because demand comes first. It is the demand for products and thus investment goods driven by the prospect of profit that causes people to invest. It is not the supply price of inputs.

You can see this on today’s chart. We’ve mapped GDP on the right axis with an inverted scale. So it should be going in the same direction as interest rates. And it does in many of the negative cases. The well-worn plot has been: The Fed sees inflation in its tea leaves, myopically searches for its only button, the big red EASY button, and punches it. The economy stalls. Our chart goes back only to 1991, but the pattern is similar since the Fed became the independent authority over monetary policy in 1951.

In our chart, the bust as well as the latest greatest recession both were triggered in part by the inability to lay off the interest rate button. Parenthetically, in both cases, rising energy prices were accomplices, and in fact, it was the real … ah … short-sightedness of the Fed in not seeing that its inflation fears were rooted in the price of oil that compounded the blunder of raising rates.

There is more in our chart. First, we see that one recovery was actually helped by lower interest rates. That was the recovery of 1992. The Budget Deal raised taxes and the Three Amigos – Greenspan, Summers and Rubin – brought rates down. Millions of homeowners refinanced, producing billions in new demand. Interest rates went back up in 1994, but GDP stayed strong – Plus Four was the norm through the 90’s.

And – yes – low oil prices. Don’t forget the Gulf War oil prices helped trigger the 1991 recession and then, not exclusively through the brilliance of Bill Clinton, oil prices came down to the $15 per barrel range throughout most of his presidency. That’s one-five. Fifteen. Dollars a barrel.

And further on. yes, in 2009 GDP bounced back up – or down in our inverted scale – as an apparent response to interest rates. But was it the rate of interest? No. It was the federal stimulus and the massive give-aways to the financial sector.

What else do you see?

Interest rates in the boom of the 1990s were substantially higher – five to eight percent for Treasury ten-years, seven to nine percent for triple A bonds and 30-year mortgages. They are now stretching toward two for ten-year notes and four for mortgages and triple A paper.

But you see the pogo stick at the Fed. Six percent effective federal funds rate PLUS in ’91. Three percent in ’92. Six percent in ’94, followed by a little bit of stability in the five to six range, before going up to six point five in 1999 to trigger the recession of 2001 and then diving from six and a half to one and three-quarters in 2001, finally settling in at one percent on into 2004 as a way of throwing gasoline on the housing bubble. Then? Bernanke to five plus in 2006 and Wile E. Coyote down to the zero of today.

And you see the bars for QE I and QE II. These quantitative easings were happy news for stock markets, but for the real economy, not so much. Yes, the intended interest rates did come down, though not really in sync with the QE’s, but no, the push on housing and other investment has not been observed.

Below is a chart from the Federal Reserve describing the QE’s in terms of the Fed’s balance sheet. You see the pig of direct loans to banks that was gulped in September ’08, subsequently passed in favor of the cow that is the mortgage backed securities. Which at one point were intended to be resold, but which now are apparently a permanent feature of the balance sheet, since the only buyer of MBS’s is the government. And while retaining the cow, the Fed added the long-term treasuries beginning in the fall of ’10, to no great effect on anything except financial markets.

And you see our forecast at the end, an extension of the trends because there is no reason for optimism on either the recovery front or the monetary policy front.

GDP and Net Real GDP

GDP – gross domestic product – is economic activity. At present – looking at it from the demand side – that economic activity, GDP, in the US is underwritten by massive government activity.

We hear dissonant messages from the same mouths that (1) the economy is in recovery and (2) government spending is out of control. Both cannot be true. As we’ve shown in previous podcasts and posts, it takes only Algebra, Kalecki’s and Minsky’s Algebra, to demonstrate that the profits of corporations in the absence of investment are logically linked to these deficits.

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So, GDP less government deficits should show us the underlying strength of a private economy. We call this metric Net Real GDP. Remarkably, or perhaps not, this calculation portrays an economy that looks very much like the economy portrayed by unemployment, real investment and median incomes.

And this has been true for decades. In the Bush II era of the early 2000s, and in spite of the immense private debt build-up, jobs languished and with them Net Real GDP. The supposed strength of the economy during the post 2001 recession was due in large part to very large budget deficits. Prior to that, the relative strength of the economy under Clinton is mirrored in the strength of Net Real GDP, and prior to that, in the Reagan-Bush I years, massive government borrowing supported the top line Real GDP number.

Of course, previous to Reagan, public borrowing was quite a bit more restrained. We paid for public services then. More under Democrats than Republicans, but more under both than under the Reagan trickle down policies. Since Reagan it has become the norm to demand services, but to be insulted when asked to pay for them.

And interesting here is to note that private debt has exploded in the past two decades, particularly since 2000, but this private deficit spending has not affected GDP to the same degree as public deficit spending. This is not visible in any of our charts, but

I suppose we should note here that the only metric that IS up is profits. Kind of sad for those who claimed – and still claim – that profitable companies spur wage growth and economic vitality. Seems to be one of the hypotheses that will survive all evidence to the contrary. Can it be called a hypothesis, if it is not vulnerable to being disproven by evidence? More of an article of faith, I would say.

This profits lead to prosperity seems to be one of the hypotheses that will survive all evidence to the contrary. Those profits, we find, were obtained by Draconian austerity by the corporations on their workforces, by Fed-sponsored interest rates that make corporate debt service as light as it could possibly be, and by demand supported not from the private sector BUT FROM FEDERAL DEFICIT SPENDING.

The charts are up, featuring our accounting for past forecasts in the We Told You So dotted lines. They look pretty good. Please note these are authentic forecasts, issued 9-12 months in advance at least. These are not adjusted for data at the end of the quarter they are forecasting. Compare us with anybody else.

Going forward we’re going to project another divot in the road. We’ve already made much of our call for negative Real GDP in the second half of this year. A call issued in January, not in the second half of the year. These are Depression numbers.

Parenthetically, we do think corporate profits will contract along with deficits.

Why would it be different? The demand side says that contracting government, households burdened with debt, and a corporate sector run for the benefit of its managers mean there is no upside.

There is no shortage of those who disagree. But insofar as I can detect, there is no explanation for an imminent recovery. There is the premise that the amazing austerity across the globe will starve returns out of the productive capacity of the economy – most notably labor – that are needed to ratify existing financial claims. But how that leads to economic recovery is not explained. Even that theory is wrong. Those claims can be ratified only to the extent that we employ that capacity.


To review.

Long-time listeners to our podcast will appreciate that our call for negative growth in the second half of 2011 was made in the first days of 2011, not at the end of Q3. Now, just as last month the turning in the sky was from recovery to no recovery, it is now from recovery to recession. This was epitomized by Laksman Achutan of Economic Cycle Research Institute when he rushed to press in the last days of September to announce, yes, recession, either now or in the 4th quarter. But Demand Side listeners had the same information back when it would have made a difference to planning. That was a forecast. Saying it is happening now is not a forecast.

And we can’t go very far without a comment on Europe. As the same January forecast made clear, and even into last year, we said – following Nouriel Roubini and others – that there was no option but default for Greece. We added that this was essentially a cost of the financial crisis and would not be a problem except that it exposed the banks. That is, policy makers would be willing for Greece to undergo whatever austerity they could impose, but asking the banks to take a hit on the other side of the contract for bonds? There would be hysteria. Now there is hysteria.

We are in 1932, 2008 was 1929. Now as then, we didn’t fix the problem but kicked the can down the road. Now we’ve run out of road. The kicking of the can has let us imagine we are going somewhere. But we needed to fix the road and the bridge, not comfort ourselves or our elites.

Forecast: Commodities

This week is forecast lite.


Demand Side is an economic forecaster, not a market predictor. In terms of investment advice, we don’t. The markets are a herd or behavioral field. They react to what they perceive the economy to be doing. That perception today is the perception of a herd of cattle in a lightning storm.

And today we are forecasting markets. We are not forecasting demand and supply for individual commodities based on global production. Because all that is washed out by the market dynamics. Commodities are trading in close correlation with other financial assets. Financial assets? Commodities are goods, right? Not when the traders need a profit. Your food and fuel is their bread and butter.

The market is being driven not by demand for the product, but by demand for financial returns. Speculation. There is immense liquidity sloshing around in the system. There is massive paper wealth looking for a place to be. This is part of the dynamics of commodities. As the real economy failed over the past dozen years, that money has moved more and more into liquid financial assets and away from real productive assets. No real investment in the private economy, particularly with the housing crash. There is a glut of productive capacity (see Forecast: Capacity Utilization) brought on by focus on the private consumer economy at the expense of the public goods economy.

In any event, this massive amount of capital needs a home. It can go into cash. But at its base cash is just a government bond with no interest on it. “Federal Reserve Note.” It has gone into stocks, bonds and commodities and derivatives of these. Commodities are perceived to be a liquid asset that will maintain its value. This is in spite of all evidence to the contrary.

The commodities bubble of 2011, which is now collapsing, was a core predictor of the new leg down in the economy. We used it in January, saying it would be the trigger. And so it has proven out. So far, 2011 is a repeat of 2008, only on a weaker economy, with far less appetite for the stimulus of 2008-09, and thus much more likelihood of serious further suffering. We didn’t fix the banks the first time. All the old troubles are still with us. We kicked the can down the road instead of fixing the bridge.

L. Randall Wray at Economonitor has this discussion of the coming commodities nuclear winter. His blog continues in three parts. Including analysis of how index trading has contributed.

Shall we do Copper?

Shall we do Gold?

Gold is interesting as a commodity, because it has no real industrial use. Other precious metals do. Gold is simply a bet. Some see it as inflation hedge. Some see it as a hedge against instability. But it is a bet that people will continue to buy gold. The new ETF’s for gold have undoubtedly raised the price by allowing purchase of gold without holding it in your house. If you have one, look closely, it may be a virtual fund which operates on the “value” of gold, rather than actually owning gold.

So recently when commodity prices went south, gold should have gone north. it didn’t. We have a very loose understanding, but it came a little tighter when someone revealed that traders take positions in gold as a liquid value that can be tapped to cover other positions. This is what we think happened to gold. As stocks and bond yields came down, investors covered their losses by liquidating gold. Much to the consternation of the world. Or at least to the financial speculators. We understand the buying of gold to hold in India and China dried up when the price went over $1,700. They may be coming back now.

What about oil?

Here is the poster child for all commodities. You can see the up-to-the minute action on the right side panel on the transcript. The bubble is bursting, hopping down now to under $79 a barrel West Texas and under $103 in the much more relevant Brent Crude.

Oil and commodities are bouncing around in complete correlation with the rest of the markets. A correlation incidentally that is closer than at any time since the maps of correlation became detailed.

But speculation as the cause. Senator Bernie Sanders let the cat out of the bag in August by leaking data from the CFTC, Commodities Futures Trading Commission, which clearly shows that financial traders have positions in oil futures which dwarf those of any legitimate hedger. And as we showed last year, it is the futures market – not the spot market – where real oil prices are set. Apologies to Paul Krugman.

We’ve been 9-12 months ahead of consensus forecasters on the commodities bubble. Our surprise this time is the trend down is in bunny hops, clearly visible in the charts but which have yet to be explained in any terms that make sense. Our view is again, a trading strategy designed to limit losses in the Big Houses.



Backing the Fed and monetary policy is like watching your horse come in last in every race and still putting money on it in the Derby.


It is often claimed that the Federal Reserve has a dual mandate. Indeed, there is such a thing in law. The Humphrey-Hawkins Full Employment Act of 1978 established full employment and price stability, along with requiring the Fed’s Chair to report to Congress and a list of other things designed to bring the Fed back into concern with the real economy.

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But as soon as the ink was dry, the Fed was back at work, not promoting full employment, nor price stability. Then, as soon as Carter’s presidency turned into Reagan’s, the Full Employment Act became a footnote. What survived was basically the mandatory appearances before Congress by the Chairman.

The Fed sees its single mandate neither as price stability nor full employment, but protection and encouragement of the banking sector. There is little room for debate on the point. The Fed is a captured regulator. Its concern with inflation is not concern for inflation, but concern for the returns on fixed rate investments.

Ben Bernanke was brought on board largely because of appreciation for his work on the Great Depression, which he analyzed forty years after the fact as primarily the result of not protecting the banks. The past four years of aggressive monetary policy, massive guarantees to bank credit, wholesale purchases of shoddy mortgage-backed securities and other direct if secret support to banks and quasi-banks, ahs been a test of Bernanke’s hypothesis. The result four years on? Hypothesis rejected. Bailing out the banks, holding their managements and creditors harmless, shifting trillions upward in the wealth scale, has not prevented the Second Depression.

We didn’t mean to get off on this, but the manifest failure of monetary policy illustrates the manifest ineptness of the Fed and its governors.

Maestro Magoo, Alan Greenspan also protected banks and markets to the exclusion of full employment, never shrinking from massive liquidity injections when things were rocky for markets. “The Greenspan Put” became the aggressive stock pickers ace in the hole. Greenspan would never let markets fall. But they did fall, late in the 1990s, and soon after we got Greenspan’s Put Two, 1% interest rates for years to jinn up a housing bubble. Previous to Greenspan, the now-venerated Paul Volcker made his reputation by sacrificing millions of jobs on the altar of low inflation. Volcker’s hypothesis, actually Milton Friedman’s hypothesis, was also untested: “Inflation is always and everywhere a monetary phenomenon.” Turns out, didn’t matter how you squeezed the money supply, inflation continued until you shut down the economy.

And on back to the Treasury Accord of 1951. Excess interest payments as a result of Fed favoritism to the banking sector and rentiers were, by the accounts of Leon Keyserling, the economist who led the transition from War to Peace under Truman, were tremendous even prior to 1980.

So when you hear, “the Fed targets inflation,” realize the Fed and its version of monetary policy are chosen not because they control anything, but because they serve the purposes of the financial sector.

So we should expect them to have a good idea about inflation. Right? No they don’t. That’s apparent by the wide diversion of opinion on their own self-selected Board.

Inflation and unemployment are the two horns of their dilemma. That is indisputable the way it is characterized. Raise rates to fight inflation. Lower rates to boost the economy and fight unemployment. Do I hear anybody who disagrees that this is how they work it? Basically a roomful of people operating a toggle switch? No.

It hasn’t worked, it won’t work, it can’t work.

Three years after the collapse of inflation with the collapse of the last commodities bubble, the central bankers are still running out their inflation horse. There is conflict at the fed, sadly, not about what to do about deflation or unemployment, but about how not to do anything more aggressive because of high inflation. As if…

And inflation, we assure you, is the subject of today’s forecast.

Unemployment is the cancer in a diseased economy. Inflation is body temperature. Or blood pressure. The two are not alternatives. One is a disease. The other is an indicator. To manage an economy to stabilize inflation without regard to what is going on with the patient is like forcing the blood pressure down or up to a medium level whether the patient is vigorously exercising or comatose.

What is inflation? First:

Is there inflation? No. There is no inflation. There is deflation. House prices are deflating, labor prices are deflating, investment goods prices are deflating.

But core CPI is on the uptick. Headline CPIO is going up.

Inflation is properly defined as a rise in the general price level. Core CPI, Headline CPI, PPI are the aggregate of many prices. So 95% of prices could be going down and one could be going up, dramatically, and the official measures would record an increase in inflation, CPI, or PPI.

Which is what we have. Here is Chad Moutray, chief economist at the National Association of Manufacturers, when he lets the cat out of the bag at a recent presentation at the National Economists Club.

Yes, the rise in producer prices is due exclusively to a rise in industrial commodity prices, we suggest as a result of financial market speculation.

Bottom line, we don’t have a rise in the general price level.

Here are our predictions anyway, for core inflation, all items, health care and energy components. Making sure you understand our point, that these are the indicators of prices of different sectors, they are not general inflation. Putting them together and adding them up does not necessarily approximate inflation.

(click on above image for expanded view in another screen)

Now our rendition here captures some of the volatility of prices that escape year-over-year comparisons. Ours is a 6-month moving average rendered at the mid-point. At least you can see why high-frequency inflation hawks get disturbed when you look at this. There is steepness you don’t see. You can imagine one of the hysteria hawks losing sleep over that.

But more interesting and instructive to us is the energy component driving the core and all items. Energy quickly becomes embedded in the all-items headline number, but look at core. Core, as we’ve noted, being a measure that eliminates energy and food – that is commodities – ends up measuring labor input. And here you see one of our – actually following from Warwick University professor Andrew Oswald’s – key observations. Everything in the world is made of energy and labor. If prices are going to remain steady, when the price of one of these components goes up, the other must go down. Energy up, returns to labor down. Looking closely, you can see, even the past ten years – Oh, expand the first chart by clicking on it – that just such a relationship is shown. Energy prices up, all items up, core down. If we lagged it right, you could see it even more clearly.

Now we don’t expect a recovery in labor – core – this time, because we are in a deflationary cycle. When energy prices go down this time, as always led and defined by oil, or as they fluctuate lower over time as you see in our forecast, labor prices will not go up. The deflationary cycle.

Where is the deflation?

It is in asset prices. House prices, financial asset prices, investment goods, capital goods, whatever you want to call it, that’s where the deflation is. We divide them between financial assets and investment goods. Where is my forecast for the index of those? There is no index for asset price deflation. Maybe the stock market. House price indicators. But the rest is locked behind obtuseness. Ask the owner of a downtown office tower how it’s going for the price of his investment good. He won’t say it’s inflating, and he’ll likely say the next owner will be the bank.

This deflation is critical. It kills construction. It stops the investment sector that is the engine of growth. Getting some life back in investments is the only way out of the continuing Depression. As we’ve said, though, there is no life in private investments and these investments will have to be made in public goods.

And as we said, this asset price deflation – or the inflation in previous decades to asset prices – is invisible to the inflation hawks and the Great Moderators. House price inflation was running at ten and twenty percent when Alan Greenspan had his interest rates locked in at one percent. What would have happened had he simply incorporated that inflation number into the CPI. Likely he wouldn’t have been so concerned then about deflation. Might have even raised rates enough to forestall the great financial crisis. Well, no, probably not. Greenspan was in the business of engineering whatever economic activity he could find.

But wait, you say, there has been inflation.

No. There has been commodity speculation. Not investment. Goods are not investments, they are the products of investments. Playing computer games to milk the futures or options markets may make money for the trading house, but it may come up craps, too. Has anybody else noticed the bunny hops in the commodities indexes since the peak of the most recent bubble?

I’ll put that up online.

Tracks of the carnivore in the snow, I say.

This commodity bubble was the trigger for the most recent downturn. We correctly cited that in January, and even back in November 2010. The trigger because it sucks demand out of the economy in a sharp way. In this case, like punching an old man, because the economy is sick and frail. It has grown sick and frail from decades of supply side nonsense and public goods atrophy. Will it blow up? This commodities bubble.

Here From L.Randall Wray

Now, to be sure, the whole thing is going to blow up, in what Frank Veneroso calls a commodities nuclear winter. As prices rise, consumption of the commodities falls (as we are already observing) both through substitution and through conservation. At the same time, additional supplies come on line. Real world suppliers feel the imperative to slash prices to have some actual real world sales. They cannot forever live in never-never land with rising prices and collapsing sales.

There are many shoes that will drop, bringing back the Global Financial Crisis with a vengeance. Commodities crash, default by a Euro periphery nation, failure of a Euro bank, or the closure of Bank of America or Citi. All of these are likely events, less than one standard deviation from the mean; probably all of them will happen within the next year.

No matter what the triggering event is, that commodities nuclear winter will happen.
Nuclear winter. So why is our forecast, even as low as it is, not lower? Because it’s lower than anybody else’s already. Not that watching forecasters is a good idea, but we have leverage on the downside. We have core inflation below zero for an extended period. We have headline dipping below. We have energy prices fluctuating widely – notice they are marked to the right axis, which is basically three times the scale of the left axis where everything else is graphed, and they are still the biggest waves on the screen.

Secondly, it is asset price deflation and unemployment that will reflect the road down, the bottom sloped downward. Commodity prices coming down will put people out of business, perhaps, but there will be an increase in disposable incomes reciprocal to that of the decrease on the way up. Maybe we’ll come up with an asset price index some night.


Now, before we let you go today, we want to bring your attention to a transition we are making from one platform to another. For the near future, you can find us at both and The latter reflects our attempt to get more exposure, capitalizing on being right for the past four years. Relatively right, I suppose. The demand side perspective needs to get into the thought train of more people and find its way into policy.

You can help us by re-upping your review on iTunes. Thank you very much for all those nice words over the past years. We see that some of the things you most liked we’ve gotten away from. But time is limited. We learn a lot from it every time we sit down.

You can also follow us on Twitter, for whatever good that will do. I’ll try to get that straightened out. Link to the posts. Get the Email version. Give us your feedback in the comments or at the address Making money is low on the priority list here. Any ads you see are not endorsed by us. We will probably opt out of the ads soon, but since we can’t see them from our terminal, they don’t really bother us.

We were inspired to go more mainstream, to take advantage of accuracy, just last month. It was the first week in August when we saw in the sky the great turning of economists and pundits, like a flock of birds turning in one motion. Previously the recovery, now the no recovery. It was a beautiful thing.

Here on the ground we, like many of you, saw there has been no recovery. The current non-policy of genuflecting to the powerful hasn’t worked, it won’t work, it can’t work. For anybody.

Ah well, at least they’re going in the right direction now. Too bad they’re still so far above the real world. You know, it’s not brilliance that makes the demand side work when all that hypothetical and market fundamentalism doesn’t. Look at what we’ve got today. When people trot out in their two thousand dollar suits and talk about how important it is to have investor confidence, and that’s bought on the backs of austerity and suffering. When bailing out governments is important only when they can’t pay their bankers. When the Washington Consensus, a program with no successes, is the order of the day. That’s the “confidence” that they are in charge of governments. It seems to me.

Capacity Utilization

Capacity Utilization, trending down for 45 years and going to record lows, is our projection. First a note on “Leadership.”

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We’re looking for leadership these days, I’m told by the newly anxious. Leadership is what you call for when things are going wrong and people need to step up and do the right thing. We have been calling for leadership for the past three and a half years.

I suppose what the right thing is depends on who you are. When you ask for leadership, you want people to do what you want them to do, not what anybody else who is calling for leadership wants them to do. And here’s another take, right off the top of Bloomberg.

TOM KEENE: Greg Anderson starts us off from Citigroup FX. Greg, good morning.

GREG ANDERSON: Hi, how are you? Good morning.

TOM KEENE: Very good. Well you have in your very fine print in your statement on the dollar.It says here there are few alternatives to the U.S. dollar. There are also few alternatives to a coordinated response to European crisis. This is the Market simply telling the political leaders and financial elites what to do, isn’t it?

GREG ANDERSON: Ah. It is. And they don’t necessarily like to be told what to do. But yeah, the Markets will force the hands of politicians in reducing debt burdens and in resolving Europe’s situation one way or another. I would say, look, it lets you know that policy makers are gearing up for the potential of major volatility like we saw in 2008, and they’re sort of proactively going back to 2008 type measures.

The 2008 measures they are talking about is TARP. Bail out the banks. Yes, folks, we’re back. The issue is not liquidity, so what the central bankers did early last week is as much the precursor to bad things as it was in the dark days of the subprime crisis. It is solvency, not liquidity. The banks want another bailout. “We lost a hand, no fair, we’ve used up our chips. If you want us to keep playing, you’d better give us another stack.”

It’s not Greece. As we’ve said since late last year. The default that is on the minds of the markets is the banks. It is Soc Gen, Deutche Bank, and yes, Citigroup. Greece is, on the great scale of things, even smaller to Europe than the subprime sector was to the U.S. On whose minds? Who is worried about default in the great mega-banks of Europe. It is the megabanks of the U.S. U.S. banks have withdrawn their short-term funding, and the long-term bets of their European brothers (or competitors) combined with the credit default swaps that link them all together have made banks too fragile to survive and to interconnected not to bail out.

Wall Street is worried. They sent their emissary Tim Geithner to the finance ministers meeting in Poland at the end of the week. Tim got a chilly reception. The Europeans don’t want to hear about it. They have a problem to solve, and it is the problem Wall Street, the world’s Wall Street, and Lombard Street made.

Are we going to bail them out again? Angela Merkel is is on the political hot seat. Germans still think it’s the Greeks. Maybe they’ll never figure it out. The best thing for the Euro would be if Germany left it. Then there could be a rational revaluation. German capitalists would never let it happen. They are the major beneficiaries of the weak euro. They don’t even have to peg it like the Chinese do to the dollar.

Pretty soon Barack Obama will be sitting in Merkel’s seat. Not only are the banks connected to the European mess, those in the U.S. are still holding a lot of the bad mortgages, with more coming as former customers demand their money back on shoddy securities unloaded during the 2008 crisis. Will Obama really ask for another bailout? Where will the leadership be? Carrying the flag for …. You ask. Wall Street, the banks, or a real economy that needs a rational financial sector, not a casino.

Now the forecast.

It is capacity utilization. (click on image for larger view)

Of course, industrial capacity will be used less as the economy flags, according to the Demand Side projections, even though no more capacity is being built. It’s part of the debt-deflation cycle. The point with capacity utilization is that it’s been grading down for forty years, and this illustrates a primary mistake made by the orthodox economists in charge of the current muddle.

That point is made clearly by Steve Keen in the paper of the week. At Real World Economics Review, it’s

Economic growth, asset markets and the credit accelerator (link on the transcript) (

Keen says

“Firstly, and contrary to the neoclassical model, a capitalist economy is characterized by excess supply at virtually all times. There is normally excess labor and excess productive capacity, even during booms. This is not per se a bad thing, but merely an inherent characteristic of capitalism – and it is one of the reasons that capitalist economies generate a much higher rate of innovation than did socialist economies. The main constraint facing capitalist economies is therefore not supply, but demand.”

And that is what you see in the capacity utilization numbers.

Since the total index was begun in 1967, the trend has been down. You can see it on the transcript. Prior to 1967 there was no total index, but there was a manufacturing index of capacity utilization. That index has tracked the total index fairly closely since, although manufacturing utilization has sunk a bit from the total index as time has worn on. In any event, we append the earlier series so as to get a reading back to 1948.

As you can see by the trendlines, prior to 1967 the trend was up. This reflects the privileged place America found itself in after the Second World War. During the war the industrial capacity of Europe and Japan was decimated. This left a virtual monopoly for American industry, which benefitted further from the Marshall Plan and the rebuilding of Europe. Once other capitalists came on line, that monopoly eroded. Footnote: It also marks the heyday of American unionism, which split the take with the capitalists in the monopoly economy.

But today is long past 1967, and the point is, unused capacity in the private sector has been growing for decades. Excess productive capacity means investment has been redundant. Particularly since a lot of productive capacity has moved overseas, where Chinese and Germans are making things and shipping them into the American market.

Not to say there isn’t a need for productive capacity, but it is just not in the satiated consumer economy, the private economy dominated by consumerism. So returns to capital came down and investors went looking for yield in the financial sector and in a housing bubble.

Yes, we have need. This is the ultimate frustration. No more frustrating, I suppose, than when the one of the supply side talking heads complains about government deficits in one breath and then in the next says, “But I just came back from (fill in the blank of Asian or European country) and when I came back, it was obvious that the U.S. is falling behind in infrastructure. We are approaching Third World status.” Often they add, “The budget will have to come out of entitlement spending.” How that follows from the European example, I’m not sure, but it often does.

Yes, we have need. But need is not demand unless, as Keen says, it comes with money.

Secondly, all demand is monetary, and there are two sources of money: incomes, and the change in debt. The second factor is ignored by classical economics, but is vital to understanding a capitalist economy. Aggregate demand is therefore equal to Aggregate Supply plus the change in debt.

and he goes on to explain how a capitalist economy buys not only new goods and services, but also bids up the value of existing assets.

But we have a mixed economy, a capitaliist private sector and a public sector charged with providing the structure and groundwork for capitalism and the public goods and social insurance capitalism by itself will never provide. Monetary demand can come from an agency able to borrow at near zero or tax from its privileged citzens and spend on useful, even vital – though not consumer – goods and services.

Let’s take an example. Transportation infrastructure. The U.S. depends on a tremendous fleet of trucks utilizing the public highways. Other nations have built up their rail systems, which are lower maintenance and lower cost per mile. Our system requires lots of fossil fuels, a semi wears at the road surface at the rate of 16,000 tiimes that of a passenger car, and the privately operated railroads ship bulk commodities like grain and coal or intermodal containers. It is parallel to the health care industry, where the profitable portion of the operation is segregated for the private corporations to maximize, and the remainder is shunted onto the public sector.

So, forecast, trending down, below the trendline, not in a gradual line, but in the dives and surges typical of this index. The 2008 dive was to a historic low, and we expect to see another record low by 2014. Capacity utilization in the form of private industrial capacity will, in fact, be lowered, not raised by tax incentives for private investment. We don’t need it any more than we needed McMansions. Capacity in the form of public infrastructure, education, and preparation for climate change is not on the horizon.

You figure it out.

Median Household Income

Median Household Income. While we’re on the subject of income, we’ll show that income disparity, particularly the rise of the super-rich, is a signal of decay, instability and potential collapse. That signal has been flashing red for several years.

but first a note on the Jobs Bill.

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As we predicted last week, the President’s jobs speech is more likely to revive his political fortunes than the economy. And as we were afraid, it is heavy on the tax breaks. These will not produce jobs, as we said last week, yet they cost a bundle. Now I’m not going to turn down a 3 percent raise from the payroll tax reduction, but I will be saving it, paying down debt and continuing to buy a latte every once in awhile. No net job growth if I am at all the common person. That half will be saved, used to pay down debt, or support jobs already in place. The employer portion will disappear into the employer’s balance sheet. Hiring is made on the basis of demand, not tax breaks. The economy operates … say it with me … from the demand side. If there is increased demand of 1 or 2 or even 3 percent from the employee half and that causes you as a businessperson to hire somebody, then you are not suffering in this economy. We got support from Bruce Bartlett on this point this week.

The modest … no, the tiny, miniscule … support to states and infrastructure is the part that might do something, but it is a day late and a dollar short.

Still, it demonstrates that reality IS seeping into DC. The downward trajectory of the economy must have caught somebody’s eye. A day late. Even IF this so-called jobs bill were passed tomorrow, it is hard to see how it could prevent the layoff of the 280,000 teachers as advertised. Didn’t school start last week? Total infrastructure spending, pitiful, not even the amount needed to get back up to speed.

The most politically astute thing the Republicans could do is pass the entire thing as-is, showing they are bi-partison and willing to compromise, not obstructionist, and watch it not work. Of course, that won’t happen because they are playing to the brown shirts.

Could you do better with the $450 billion?

How about the first installment of $250 billion in infrastructure spending for surface transportation and energy transmission, per year, for twenty years. The first installment of $100 billion per year for at least three for states and localities to hire. And the first tranche of $100 billion in direct hiring for a CCC-, WPA-style program to give anyone who wants a job some work doing what needs to be done. In addition, a plan that did not see the light of day in Obama’s speech, but which former president Clinton proposed in a recent Newsweek article. Retrofitting buildings for energy efficiency. These projects can pay for themselves in five to seven years by reducing energy consumption. All that is needed is the accounting architecture to segregate the energy savings. If we made it 6-8 years, we could offer a pretty good interest rate for private financing. Are you telling me there wouldn’t be takers? One million jobs, says Clinton.

Counting it up, the Demand Side plan, 6-9 million jobs. The Obama Day Late Plan, 750,000 jobs. Cost. Demand Side $450 billion plus guarantees and support to the energy retrofitting. Year one. Obama’s plan. The same, except ours creates 6-9 million taxpayers. His, to be generous, three-quarters of one one million.

We’ll even pay for it. Uncap payroll taxes, add in to the 6-9 million new taxpayers contributions, plus the jobs multiplier in the realm of 1.6-2.0. Increase the gas tax five cents a year. Done. That is the hole we have to fill.

The best of the week:

Paper of the Week: Michael Hudson, Real World Economics Review, Issue 55, The use and abuse of mathematical economics (

Podcast of the week: Lewis Latham interview David Graeber on his book, Debt: The first 5,000 years

Median Income

The next in line for indicators we are going to forecast is median income. As a metric for the economy median household income has its problems, but they are not necessarily crippling. We’ll touch on them in a moment. The primary strength of median household income is its direct connection with the well-being and strength of the economy. A vital middle class is both the symptom of current health and the condition for improvement and development in an advanced capitalist economy.

Census Bureau

Real median household income in the United States in 2010 was $49,445, a 2.3 percent decline from the 2009 median…. Since 2007, the year before the most recent recession, real median household income has declined 6.4 percent and is 7.1 percent below the median household income peak that occurred prior to the 2001 recession in 1999.

Demand Side sees real efficiencies in an interrelated society of not too disparate incomes, the lowest adjusted being no more than one-third of the highest. We’re talking economic efficiences. The book Spirit Level: Why Greater Equality Makes Societies Stronger by Richard Wilkinson and Kate Pickett details the empirical evidence of societal well-being, from obesity to incarceration rates and so on, and finds more equal societies always perform better. They may be dismissed by the crass as “normative,” not positive indicators, but saying they are not important is equally normative. And even from a crass GDP economic outcomes perspective, and confining ourselves just to the U.S., we see that when the society has been more equal, the economy has growth faster, with more stability. If you think economic outcomes are limited to how much money you make, we suggest a career in drug dealing or strong-armed robbery.

So the first drawback to median household income is that the data comes out with a lag. We’re giving you 2010 data today and it came out, what, Tuesday? September. It is produced by the Census Bureau, not the Bureau of Economic Analysis or the Bureau of Labor Statistics. The BLS has wage statistics, and they are useful in getting to the concept we want, which is How well is the broad center doing? And is there a broad center?

As a high wage worker loses her job and falls to the bottom, the measure ticks down a fraction to record the worker having been pushed off the ship and now occupying a lifeboat, some of which are getting very overloaded.

One problem, since “income” includes taxes and other stuff, “disposable income” looks better. We don’t use it because we think taxes buy real goods like schools and police. But even so, while disposable income subtracts taxes, it does not subtract costs like health care or debt payments or mandatory utilities and fuel that ARE large subtractions from the English meaning of disposable.

Median household income tracks average hourly compensation – itself inflated by high health care costs – and other measures of the financial well-being of households. In so doing it both describes and predicts the trajectory of the economy much better than GDP, even per capita GDP. It’s the difference between looking through a tinted window and looking through the same one with a magnifying glass. If you’re interested in the view, much better to put away the distortions. If you want to check out the surface of the window, use the lens. Or something like that. GDP can signal a bunch of things that are not healthy.

Our forecast is, then, for a serious and continual deterioration of median household income over the next six years, falling to a level below that of the first data point available from the Census Bureau, which is in 1980. In our view, by 2017, households will be in worse shape than they were at the low in 1983. Wiping out thirty years of gains in six years.

We would characterize these projected losses as optimistic absent significant policy changes not now in prospect. We include in the transcript a graph displaying historical data and our projections. These are not the jaw-dropping dramatic you might think, because median household income growth has been anemic for years. This is a problem 30 years in the making. The transcript also displays a chart from Atkinson, Piketty and Saez showing median household income basically stagnating since 1980. That same chart offers a comparison to GDP per capita.

You would expect perhaps that GDP per capita and median household income have some correlation, but that would be wrong. Income growth over the period has gone to the rich, and notably the super-rich, it has drawn up the average aka per capita, as displayed in charts borrowed from Uwe Reinhardt and his Economix column at the New York Times. Income growth for the top one percent has been surging for decades. The top one percent captured 58% of income growth since 1976 and 65% since 2002.

This new upward pulse in income disparity and its absolute level are key indicators of impending crisis. It clearly foreshadowed the 2008 meltdown, and since the policy response since then has been socialism for the rich, basically cover their losses, and cut loose the middle class, that disparity is only increasing AFTER the crisis.

Another chart from Atkinson et al makes the point that the super-rich top 1% made off with nearly 25% of total income in 2008, the same figure as in 1928.

(click on image for larger view)

Interesting here is that it is not just the rich, but the super-rich who are leading us into the new plutonomy. While the four percent directly below the top percentile HAVE done better, it is more by comparison to the ninety-five percent who have done worse than in absolute terms. Even the next highest five percent, not so good.

So does the collapse indicated by the income disparities and our personal experience have a silver lining? Or maybe it won’t collapse completely. Maybe bread and circuses combined with the Fed’s promotion of ever-higher credit and governmental socialism for the rich will morph into a national socialism for the rich. Well, that is collapse, of democracy anyway.

Forecast? The outlook for median household income is bleak.


A full employment economy is the only healthy economy. Last week we visited the current employment depression via our forecast for headline and U-6 unemployment rates. This week, we’ll look at employment growth itself and what can and cannot work in getting jobs for a healthy economy. Plus the forecast. Grim forecast.

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We’re going to propose that in this day of high household debt and real asset deflation that the income multiplier be revised to a jobs multiplier. It is the number of jobs added, not the number of dollars that grows an economy as a function of our interdependence with each other.

And we’ll look at the special meaning of construction and government jobs. How do the loss of construction and government jobs means bad things for the total economy as measured by its most appropriate measure – employment?

The multiplier. What is it? Why has it broken down?

R.F. Kahn and John Maynard Keynes developed the concept of the Investment multiplier, which later came to be understood as the government spending multiplier. Keynes’ famous example from the General Theory, in its original and correct form:

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines which are then filled up to the surface with town rubbish, and leave it private enterprise on well tried principals of laissez-faire to dig the notes up again(the right to do so being obtained, of course, by tendering for leases of the note-bearing territory),there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is.

New investment exogenously introduced generates a multiple of the original investment, as companies organize and hire for the new event. This concept has been warped and adopted by conservatives to suggest that tax cuts always and everywhere stimulate economic activity. Rather than trying to tease out the sense of that, just realize that tax cuts that are not paid for, that is, government borrowing, may or may not stimulate the economy depending on the financial situation of the recipients. But borrowing by the government that is investment in even idle ventures such as in Keynes’ example will stimulate the economy, because it WILL create jobs and new spending in the private sector.

Simply look at the current experiment that we are running. The ARRA, also known as the Obama stimulus has one component that matched Keynes’ example. That was infrastructure spending. It had another that might be called a negative version, which was support to states to prevent layoffs of teachers, police and fire personnel. The ARRA spending on these two activities marks a line that the actual experience of the economy follows.

The chart in a recent piece by Paul Krugman displays government spending absent the transfer payments to the unemployed and others. It is dropping off a cliff as the ARRA expires.

“When the recession officially ended, spending was rising at an annual rate of around $60 billion; now it’s declining at an annual rate of $60 billion. That difference is around 1 percent of GDP, and maybe 1.5 percent once you take the multiplier into account. That makes the turn toward austerity a major factor in our growth slowdown.” Says Krugman. He adds, “Still, I guess the beatings will continue until morale improves.”

Borrowing from the future to make useful investments in our physical or social capital is productive on its face, and to our point here, when done in conditions of underemployment it produces a multiple of the investment by way of induced economic activity. New workers spend their incomes and thus increase the number of jobs in the consumer goods sector, which themselves prompt more jobs.

This is not necessarily true of tax cuts. Sorry, John Boenher. The profile of spending of a job-holder is quite different than the profile of spending out of marginal increase in monthly income of somebody already employed or already retired. Notice in our current experiment the absence of impact of the 2% payroll tax reduction, and particularly of the extension of the Bush tax cuts. Enormous expenditures, tiny impact. Maybe pays down debt, maybe buys a consumer discretionary made in China. The argument that this new consumption will induce big new hiring and investment is very weak, particularly when confronted with the evidence. It is particularly unclear how it can induce new investment in the context of the huge capacity now standing idle.

And how would we know if the jobs multiplier works?

Let’s use the construction sector as a proxy for investment goods workers to illustrate our point. We’ve dialed up several charts here. We have one from Calculated Risk showing the position of losses and gains in construction with respect to official recession calls. Pretty starkly predictive. Dropping before and through recessions, rising through recoveries. Another we produced shows the relation of construction jobs to total non-farm employment. Now construction is a relatively minor part of the whole jobs picture, but it does represent these investment impacts. Construction is almost by definition investment.

(click on image to get to the right and sad side)

Can we use government employment similarly? Yes. At least according to Demand Side. Since government employees are not involved in producing consumer goods, except on the margin, but are producing social capital – security in the case of police, safety in the case of fire departments, education in the case of teachers, social order in the case of courts, and so on. Even market structure in the case of regulators, and we’ve seen the impact of breakdowns in market structure in the absence of regulation.

I think we’ve all heard the claim that only the private sector produces jobs. I have anyway. And I’m left with nothing to say. What is your response when somebody says it only rains at night. Such an observation cannot come from experience or logic or even rationality. So, Where do you begin with your response?

The multiplier for state and local government spending is very high. Republican economic adviser Mark Zandi paid a heavy price for simply pointing this out. Zandi, an advisor to Republican presidential candidate John McCain, constructed a ranking of multipliers early last year in a defense of the ARRA, American Recovery and Reinvestment Act, the Obama Stimulus, for short. State and local spending came in over 1.5. While tax cuts to individuals came in around 1.0. It was down into the .30 range for some corporate tax breaks. At .30 every dollar of spending induces 30 cents of activity, a loss of 70 cents. Needless to say, perhaps, the reaction from the business constituency was large and nasty and swift. Zandi makes very few public pronouncements these days.

High household debt and asset price deflation mean the income multiplier is very low for tax cuts, but the jobs multiplier is unaffected. Government jobs, far from being a drag on such an economy, are actually quite potent as stimulus. Roads and teachers multiply jobs far faster than extra trips to the mall. The inverse is true, too, as we are about to see. Cutting government spending decreases jobs at a high rate. The multiplier works in the negative direction.

Let’s go through our graphs and see what the forecast is.

Chart 1 illustrates the relationship between construction jobs and total jobs, the same relationship that is displayed in CR’s chart with respect to recessions. In particular, please see … well, you can’t avoid seeing … the huge unprecedented drop in construction employment in the past three years. More than 2 million, 25% of construction workers, versus a drop of 7 million in total employment, say 5% of the employed. Total employment has leveled off a bit, and this, we believe, illustrates that construction workers are collecting unemployment and continuing to support the consumer sectors while they don’t work. But beware. The only reason the drop in construction workers was not greater was the support from the public sector in the ARRA. That support is petering out. As Paul Krugman calls it, we are entering the “austerity economy.”

Chart 2 illustrates the relationship with construction plus government workers. Here there is little predictive value. Government employment depends on tax revenues. These can lag recession and recovery. Most government employment is at the local level – roughly two-thirds — and local governments have had to cut teachers, fire and police to balance budgets being slammed by lower tax revenues, in many cases property tax revenues. Barely one-tenth of government employment is federal. Notice the total employment line leveling off while the combination of government and construction employment continues a steep decline.

Chart 3 is the first look at the forecast. Here you see a leveling off in construction employment in a manner not visible in the annual data. And you see our forecast extending that leveling off on a much more gradual slope than witnessed in the 2008-2010 period. Total employment declines somewhat more quickly, but again, not at the same steep rate as 2008-2010. Still, it is a decline and not the extension of the feeble improvements of the past eighteen months that most forecasters predict.

Chart 4 looks at the combined construction plus government workers, a rough and ready combination of jobs with the biggest multipliers. Here you see steepness. The decline in government workers is projected by us to continue apace. This decline is going to be the biggest drag on total employment, both in absolute terms and in its multiplier effect. We have the potential short-term shocks of 100,000 postal workers getting laid off and a potential bug from teacher layoffs that may have escaped by way of the seasonal adjustment to previous counts.

Why does total employment not drop in our forecast at the same rate or even steeper? Again the total reflects the support to the consumption sector by way of government transfers, in unemployment, social security, food stamps, and other safety net spending. Precisely the kind of spending that makes deficits unavoidable, even as government is cut.

Following our charts is one from the Center on Budget and Policy Priorities, displaying three years of state and local job loss. It is accelerating, and now is hitting 345,000 per year. The majority of the losses in the last year have been in education. Cutting teachers at a record rate.


So the forecast is for down. It is not the crash we saw with the Great Financial Crisis, because debt-driven demand is not going to drop by 20 percent of GDP and investment in the real economy won’t go away overnight, since it has already gone away. But government jobs are going to wither in the climate of austerity, in the madness of austerity.

Employment will grow again when it is truly targeted. We have plenty to do and plenty of idle people and capacity which can be trained up to do it. The deficit is over a trillion dollars. If a third of that amount went to direct employment or infrastructure replacement repair and construction, there would be no employment problem and no economic malaise. Profit would quickly return to drive private sector investment. Yes, there would be inflation, but that would be the major cost of getting going. And inflation has the benefit in countering high debt levels. .

Not using the idle capacity in labor and other productive resources when the climate crisis is looming over us is the ultimate tragic irony.

You will notice our forecast contains no adjustment for the much-anticipated jobs speech by the president tomorrow. We do not expect substance. The president may recover his political fortunes, but we doubt there will be real movement in the economy.