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Employment growth and the real rate of unemployment are not only key economic indicators. They are the measure of the economy. All the other numbers, including GDP growth and the other indices, are secondary. Labor is the primary capacity that must be used to its maximum. A full employment economy is the only healthy economy.

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This is intuitively understood. People do not believe that the GDP upticks and stock market growth mean health. They know from looking out the window that things are not good. The statistic that most matches their mood is the unemployment rate. And now that statistic indicates that the bleeding continues, the malaise worsens, that the dead weight drags down demand.

The chart we include from Calculated Risk displays the huge crater of the depression in employment in which we now find ourselves, now on 42 months. This chasm swallows all other post-war recessions combined. Unemployment here is the weakness and fragility that resonates with the feelings of the real person in the real economy. The only reason other recessions are visually close to the current line in CR’s chart is because the data is in percentage terms – the unemployment RATE, right? – and in the years directly after the war, the civilian labor force was much smaller as a percentage of the population. Taking absolute jobs numbers, we’ve already swallowed up more than all those recessions combined.
(click on chart for wider image)

On the Real World Economics Review blog recently, it was asked what are the best forward-looking economic indicators. The responses came some from heavy hitters like Michael Hudson and Dean Baker, but they were equivocal. The same indicator can mean many things. But our answer was not so equivocal. Employment growth, which we’ll look at next week, unemployment rates and per capita income. These are not only the appropriate measures of economic health in the present, they are forward-looking too. They are the heart and lungs of the economy, the muscle mass. The intestines have to work, too, and so we need the financial sector or an equivalent. But when commentators say we’re looking at a long period of high unemployment and then things will be all right, it’s like saying we’re going to get somewhere without an engine or wheels on the car, just because we’ve made sure to have enough gasoline.

I should note that we also included Steve Keen’s private debt to GDP ratio and the credit accelerator as good forward-looking metrics, and they are. They capture changes in demand arising from the debt cycle. But employment and income are the base from which debt-driven changes rise or fall.

Our forecast for unemployment today and employment growth next week is pretty much our forecast for the economy. Which is continued weakness and deterioration, with opportunities for spikes related to technical issues and various crises in the financial sector.

Our backcast is similarly depressing. Unemployment has blossomed since the turn of the millennium, masked a bit by changes in the calculation methods. Raw numbers: Since the year 2000 we’ve added 25 million to the working AGE population and 2 million to the working population. Two million jobs for 25 million people.

The madness of austerity means unemployment trends upward as workers continue to be squeezed out of jobs. The continuing fragility of private financial institutions along with household debt burdens could mean unemployment spikes. You will see the chart describing the forecast. The trend line has no bounce to it. It just mechanically rises in this era of self-imposed stagnation. Even the spikes are relatively uninteresting hills compared to the mountain of unemployment they rise from.

Demand Side had some things to learn about unemployment in 2008 and 2009. Our forecast failed to anticipate the drop in the participation rate that happens in severe contractions. We said 12 percent headline unemployment was baked in. Headline unemployment rose to 10.1 percent in October 2009 before dropping back into the 9 percent range. Only some, not even half, of the gap between our estimate and the actual numbers was due to the drop in the participation rate – people going back to school, dropping out until they could get to to social security age, taking disability, taking part-time jobs and moving back in with the parents, robbing the society of its vitality and its ability to develop.

Much of the deficiency in the headline unemployment metric is captured in the U-6 measure of unemployment. Sometimes called the “all-in” measure. It is meant to count those who would take a full-time job if they could get one. This more closely corresponds to the numbers used in the other Great Depression. Read that as those who need a real job. Again, in 2008-09 we said U-6 would top out at 20 percent. It reached 17.4, again in October 2009. It briefly dropped below 16 percent, and is now on the rise again.

Looking again at the chart we presented in early 2009. We proudly placed our forecast directly next to the actual numbers, and you can see the lines are parallel and very close. That was to highlight that our forecast in the first year and a half of the Great Recession had been right on the mark. Then we split into the baseline, the optimistic and the pessimistic forecasts. The difference was what we counted on as the policy response. As we watched and saw no fundamental policy shift, we came to look more and more to the pessimistic line, which is that 12 percent and 20 percent. The baseline and optimistic were sadly too optimistic by a lot. But at least we got the real numbers in between. And you could argue we got the direction right. If you want to compare us with anybody.

But that brings into view our major mistake in 2008-09. We assumed the prospect of 10 percent unemployment and the clear failure of the private financial sector would bring about a conversion to the old religion of public works and full employment and strict structuring of the financial sector, and this would come primarily at the expense of the capitalists who had cost us so dearly.

Naïve is the kind word, I suppose.

We assumed there would be a rational policy response from the federal government, particularly when the new president proclaimed himself to be, first of all, pragmatic. We took that to mean he would be a second coming of FDR, who reached for what worked. The new president’s pragmatism, however, was actually code for compromise with entrenched interests. It was practical – pragmatic – not in the economic sense, but in the political sense. Even there it has failed, since the absence of real results is going to weigh heavily on the re-election balloon. More than the political pragmatism can fill it with campaign donations. Who knows?

But, as we said, it was a mistake to assume policy response in the appropriate direction and scale.

A favorite of the analysts we force ourselves to listen to is the term “stall speed.” Another favorite is “hard slog.” “Hard slog” is meant to define high unemployment and stagnant household demand for several years until debts are paid down, households de-leverage. “Stall speed” means there’s not enough growth to prevent decline.

The “hard slog” is not going to happen, since it defines a crisis in employment and incomes that is going to work its way up and out into the sectors that have more influence on the political system than households. We’ll have deterioration or recovery, not equilibrium. The engines of monetary policy have been revving at full throttle for 40 months. They’re providing a nice breeze if you’re sitting in the lanai with the financial sector, but they are not moving the economy anywhere.

You will see with the charts online that we’ve taken these numbers out two years – two and a half, really – to the end of 2013. We presume there will be a policy response, but we’re not going to mark it on the charts. We’ll wait to see what it is, and we’ll reserve the right to make adjustments should anything meaningful be enacted.

We expect spikes into the 10.5 range, but the baseline is a trend to 9.5 percent by year’s end, 10.1 percent by the end of 2012, and stabilizing slightly higher than that. U-6, likewise, trending upward at a somewhat steeper rate. 16.7 percent at the end of 2011, 17.9 percent at the end of 2012, flattening somewhat but still rising to 18.6 at the end of 2013.

It’s a fairly easy call, really. Made much easier by the official policy in governments domestic and foreign which can only be termed the Madness of Austerity.

Too many people say we cannot afford to hire people. What we cannot afford is idle labor. The three years of unnecessary stagnation we’ve endured since the financial sector crashed the economy is corrosive to the fundamentals of our economy and society.

The 2009 forecast for unemployment



New productivity numbers came out from the Bureau of Labor Statistics earlier this month and befuddlement set in among economists. Productivity has swung around, as in gone negative.

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Peter Radford, a wonderful economist who blogs at Radford Free Press and Real World Economics Review, put it succinctly on August 9.

This morning’s data are far from rosy: productivity declined 0.3% in second quarter, while it was revised to a decline of 0.6% in the first quarter from what had originally been reported as a 1.8% gain. This is not good. This makes two successive quarters of decline which we hadn’t seen since 2008. Moreover, productivity has crawled up a mere 0.8% over the past twelve months, which is another bad performance and a sign of things being out of kilter deep within the economy.

When productivity spiked during the economic collapse and the wholesale loss of jobs, economists and everybody else knew exactly what was going on. Employers were cutting and existing workers were in a fever to keep their jobs. The conveyor belt was moving faster. Well, unemployment is still high and productivity is now declining.

Radford continues with an effort at unravelling the Gordian knot. Tyler Cowen, a not as good economist,from George Mason completely whiffed on the subject in his interview with Jeff Sommer on the Weekend Business podcast. BLS includes with its statistics a breakout of the mysterious “multi-factor productivity,” which is code for “We assume capital improves productivity, so anything else is everything else. And we can’t say it quite so baldly, so we’ll give it a technical sounding name. Multi-factor productivity.”

Instead, as did Alexander, it is necessary only to slice through the knot. Which we did in early 2010 when we published under the title: “Multi-Factor Productivity Solved

For some reason, we used a rule of 7 back then, but now we use the Rule of 8.” Eight minus the unemployment rate equals the rate of productivity increase. A nearly perfect correlation.

Why this relationship was not discovered prior to us is likely the simple fact that nobody went looking for it. Oh, AND it is masked by the fact that contemporaneous numbers do not show this simple relationship, and often diverge from it wildly. But as you can see on the blog, the trendline for the unemployment rate has a sinuous mirror image in the trendline for the rate of productivity increase. So in the medium and long terms, described by these trendlines, if you can estimate the unemployment rate, you can estimate the rate of productivity growth or decline.

And we did go looking for it. We suspected that low unemployment would make managers manage and workers find efficiencies. We also follow Adam Smith to the extent we see efficiencies in the specialization of labor, which obviously has a better chance with more workers, as the more skilled may be shifted to the more essential tasks.

Adding tools, as is encouraged by the concessionary tax breaks for investment these days, can help, or it can simply be a bad idea. Better to add tools when unemployment is low and let your workers incorporate them as appropriate.

Again, we have shown in a simple graph that productivity is a mirror image of the unemployment rate. The higher the unemployment rate, the lower productivity. The lower the unemployment rate, the higher productivity. Keep it down out there. I can hear you yelling. No. It is not in the contemporaneous statistics, when very often the numbers go in exactly the opposite direction.

BUT, if you simply graph the trendlines, as we did, you will see what we saw, a perfect mirror. We provided the mathematical equation: 8 – U = P. No second derivatives. Not even a coefficient.

You will notice that the graph published in 2010 is of a slightly different shape. That earlier chart depended on statistics for all businesses. In order to get to the most current data, we had to use non-farm businesses.

A footnote. The productivity of government workers is not considered by the BLS or anybody else, because their output is assumed to be their input. Here, Cowen has a good idea when he notes that purported productivity increases in the health care field are inappropriate because they do not consider health outcomes. It is not rational to say that a health care system which produces poorer outcomes than the rest of the industrialized world,at twice the price and with half again as many people, or more, has any real connection with high productivity, no matter how much it makes for the corporate owners.

So, the forecast for productivity growth? Bouncing along below the bottom, averaging negative one to negative two for the next year. That follows from our projection of the unemployment rate at nine or ten or higher. But we’re not forecasting unemployment today. That’s next week.

Does it mean bad things for industry? No more than the collapse in demand for products. Nor the threatened slashing of government deficits. Workers, insofar as their wages and salaries are connected to productivity, will continue to see their incomes erode.


Now reminding you of the general shape of our forecast for the year, bouncing along the bottom with downside risks from the European debt crisis and from domestic commercial real estate slash local and regional banks. Negative growth in the second half of the year. This forecast issued back in January. Another financial crisis was a nontrivial possibility.

We’re seeing those risks play out in Europe, with the necessary restructuring of sovereign debt being delayed and the big banks sweating out that inevitable outcome for the damage it will do. Solvency in these banks depends on avoiding the inevitable. The European Union, the political umbrella for Europe is not constituted in a way that can solve the problem. The European Central Bank, the principal institution of the eurozone, is constitutionally the same as Bundesbank, with its only mandate to hammer inflation or the shadows of inflation or the hints of shadows of inflation. The current crisis is unexpected only because it was so easy to see coming and we wonder why nothing was done.

Domestically, with the petering out of the stimulus has come the petering out of the growth. Government stimulus will turn negative in a big way with cutbacks in state and local employment about to surge. Huge federal deficits and historically unprecedented zero percent interest rates for now on three years have created a puppet theater recovery which everybody bought into until recently. Our view is that there has been no recovery and another leg down is now in progress.

Simon Johnson on the state of banks; plus the hysterical matrons of the market

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Downside risks in our baseline forecast, which we repeated in January, included a new and messier financial sector meltdown. Hard to imagine even today, you say, with the huge cash balances at the banks, now $1.4 trillion. That is ten percent of GDP. You forget that many of the assets on their balance sheets are valued at mark-to-make-believe. Combine this with the new leg down now unfolding. It’s not pretty. And add to this the fact that the trading houses are exposed to the stock market more than anybody else, having abandoned investment in favor of speculation, including in commodities. I can hear Ben Bernanke saying it now, “Nobody saw this coming.”

Where is Baffled Ben? That comes next week.

Beginning next week, Demand Side will concentrate exclusively on forecasting and forecasts. We believe we have the record and awareness of who has been right and who has been wrong. In spite of its being free, it will be the best look forward, short-, medium- and long-term.

Today we bring in Simon Johnson and Nouriel Roubini to take a look at monetary policy and leadership in the current financial mess.

We begin with Simon Johnson, former chief economist at the IMF, and the voice that is most clear and most accurate about what needs to be done and what doesn’t

Johnson writes in a recent post.

In the wake of recent equity market declines, the clamor for bailouts of various kinds grows ever louder around the world. Influential voices call for “leadership” from the US and Western Europe, and for policymakers in those countries to “get ahead of the curve”. This is all code for a simple and familiar plea: Do something that will protect investors, particularly creditors who have lent a lot of money to banks and countries that now appear to be in serious difficulty.

But providing another round of unconditional creditor bailouts in this situation would be a mistake. What we need is a combination of transparent losses where bad loans were made, combined with a ring fencing approach that protects sound governments and firms. There is no sign yet that policymakers are willing to make that distinction clear.

The situation around the world is undeniably bad. … Europe is most definitely “On the Brink” of a serious economic crisis that could involve widespread defaults or significant inflation or both. At the same time, Bank of America shares this week fell to their lowest in 2 years; with other large banks under pressure, there is a legitimate fear of rerunning the parts of the financial crisis of 2008-09.

The Financial Stability Oversight Council’s recently released first annual report does not provide particularly up-to-date numbers, but most of the global warning lights that they discuss in Chapter 7 must now be flashing red. As recently as 2008-09, there were three kinds of government support available to the US and European economies when such systemic financial trouble hit. But all three traditional forms of bailout are now much harder to pull off.

First, over the past 30 years interest rate cuts and other forms of expansionary monetary policy became standard practice in the face of potential financial market disruption – this is the original meaning of the “Greenspan put”. But short-term interest rates are already very low in the United States. The European Central Bank (ECB) has room to cut rates – but both the ECB and the Federal Reserve fear that inflation may soon return. Unlike fall 2008, they are reluctant to respond to the latest round of stock market declines with a dramatic easing of monetary policy.

Second, after the initial monetary policy response in fall 2008, it was fiscal policy that took the lead in preventing global economic freefall – with significant attempts to provide countercyclical stimulus in the US, much of Western Europe, and China.

Now the eurozone faces a series of fiscal crises … Further stimulus is out of the question – the issue in Europe is who will do what kind of austerity and how fast.

The fiscal crisis in the US is more imagined than real. The S&P downgrade of long-term US government debt sparked a massive sell-off – but not in government debt. Investors around the world vote with their feet; they see US government assets as one of the safest available assets. Still, further fiscal stimulus is most definitely not on the political table in Washington.

And even Chinese fiscal policy shows signs of tightening – as the authorities try to prevent any overheating that could accelerate inflation.

Third, in 2008-09, monetary and fiscal policies were complemented by government capital injections directly into US and European banks. But these became harder to do under the Dodd-Frank financial reform legislation – unless there is a large-scale systemic approach, which would be very hard to get through this Congress.

The worst financial sector problems are in Europe. But the recent banking stress tests there were completely unrealistic as they did not include default events that now appear inevitable. To run one set of misleading stress tests (in 2010) might be considered excusable, to do this twice during the same crisis is unconscionable. There is no coherent financial sector policy within the eurozone.

What are the policy options now? The people in charge of European and US policy would clearly prefer to do nothing or postpone dealing with the underlying issues. This is a bad idea as it puts markets in charge – and these markets are panicked.

The core to any feasible strategy must be bank capital. … without sufficient capital large banks and other financial institutions are prone to failure – this is what spreads failure and panic far and wide . The Basel III framework, negotiated just last year, is crumbling before our eyes; the failure to ensure sufficient capital is at the heart of the European meltdown – and why the pressure on US banks is mounting.

The Europeans have to decide, once and for all, which sovereigns will restructure their debts and which will be protected – to an unlimited degree – by the European Central Bank. A full-scale bank recapitalization program is required, along with management changes at almost all major European financial institutions.

If the Europeans fail to get a grip on their economic situation, the FDIC will be pressed to use its Dodd-Frank resolution powers to take over and manage the unwinding of a major financial institution. In that scenario, creditors are supposed to face losses that are transparent and clearly understood; the theory is that this will stabilize market expectations.


The Dodd-Frank reform process decided not to break up global megabanks, but rather to handle them under the FDIC’s resolution framework. We’re about to find out if this was a good idea – or if we are just on the brink of more unconditional bailouts.”

That from Simon Johnson

Next week we’ll begin focusing on the forecast. With help from Nouriel Roubini and a post entitled, Mission Impossible: Stop Another Recession. Our baseline is and has been, bouncing along the bottom with significant downside risks from European debt and fallout in the U.S. banking sector from commercial real estate. We predicted and still predict negative growth in the second half of this year. In the absence of policy options, we’re looking at 1932.

The hysterical matrons of the market are about to start shrieking. Hold onto your hats.

James K. Galbraith says, “Show me the deficit”

Stop Panicking About Our Long-Term Deficit Problem. We Don’t Have One.

James K. Galbraith
New Republic
August 9, 2011

Standard & Poor’s did not downgrade the U.S. political system. It did not downgrade the stock market. It downgraded United States Treasury bonds and bills—and did so after Congress had removed whatever tiny chance existed of even a small delay in payments. So it’s instructive that, on the next market day, investors moved massively out of stocks, and into the safety of U.S. Treasury bonds and bills. Rarely has stupidity been so quickly and massively shown up.

Some commentators read the downgrade as a rebuke to the Tea Party, but, in fact, S&P was making good on its threat to act if the deficit deal resolving that drama did not reach the arbitrary threshold of $4 trillion over ten years. It wasn’t the Tea Party’s Kool-Aid they were drinking, but that of the deficit hysterics.

And yet, S&P’s statement (math error and all) was of a piece with mainstream budget projections from CBO and other official sources. These projections all assume steady growth, low inflation, and falling unemployment (in which case, one may ask, what’s the problem exactly?). Yet they also predict much higher interest rates. In these projections, it is mainly the vicious magic of compound interest—debt compounded on top of debt in computer models—that generates the explosive debt dynamic which rationalized the downgrade.

These projections are so bizarre and so inconsistent that they survive only through the willful refusal of those who use them to actually look at them. With low inflation, why on earth would the Federal Reserve jack up interest rates? If it did, mortgages would go even more massively into default, stocks and bonds and real estate would again crash, so the growth rate could never be achieved. Not to mention the fact that actual economic growth rates have been below-track for two years, so that the short-term assumption that a sustainable recovery is underway is obviously and plainly wrong.

None of this matters to the president, nor to majorities in Congress, nor to the pundit brigades. All have embraced the “long-term deficits” which appear in the projections as though they were foreordained history, sufficient to compel action now that will effectively cut Medicare, Medicaid, and Social Security, and curtail federal government investment, regulation, administration, and services to levels not seen since the 1950s.

Exactly what that threat is remains elusive. Foggy rhetoric about “burdens” that will “fall on our children and grandchildren” sets the tone of discussion. The concept of “sustainability” is often invoked, rarely defined, never criticized; things are deemed unsustainable by political consensus, backed by a chorus of repetition from the IMF, headline-seeking academics, think-tankers, and, of course, the ratings agencies.

But there isn’t, in fact, a “long-term deficit problem.” So long as interest rates stay below the growth rate, as they are, debt-to-GDP levels eventually stabilize and even decline. The notion that there is a big problem is pure propaganda based on a pseudo-debate, pitting two viewpoints that nevertheless converge on the practical issue.

On one side are those who profess to abhor all deficits, arguing that the productive private sector will rise up to offset all government cuts. This is an appealing 18th century viewpoint found in Adam Smith, a throwback to the days of peasants and petty craftsmen preyed upon by lords, kings, and tax collectors. The only problem is that things have changed since The Wealth of Nations was published in 1776.

The other force is the political liberals who were desperate to get a short-term stimulus package through Congress two years ago and who were therefore prepared to concede the case for “long-term deficit reduction.” What that case is—crowding out? Inflation? High long-term interest rates?—they rarely, if ever, say, because none of those things is remotely plausible given the 9 percent unemployment, debt-deflation, and rock-bottom long-term interest rates we see now. But having made the concession, mainly for political and rhetorical balance, they are trapped. Paul Krugman is a key example; as recently as August 6, he wrote on his blog:

America does have a long-run fiscal problem, driven by the combination of rising health costs, an aging population, and the unwillingness to raise taxes to pay for the programs we already have. If we don’t come to grips with that problem, bad things will happen.

Notice two things here: First, Krugman doesn’t say what the “bad things” are. Second, he does not mention the interest rate and never discusses what happens to the debt/GDP ratio if rates stay put. (Answer: It stabilizes eventually and nothing else happens, as I have shown in a paper linked here.) And thus he lends his great weight to the pressure that will build, later this year, for the cuts in Social Security, Medicare, and Medicaid that were deferred in August—and which Krugman surely opposes.

The perverse character of the debt deal will now force the Pentagon into the fray on behalf of cutbacks in Social Security, Medicare, and Medicaid. This is true even though the Pentagon sequesters that would occur if Congress does not pass the recommendations of the new “supercommittee” are arguably phony. It seems obvious that both the Republicans and the White House understood this dynamic very well, which is why the defense-spending-cut rabbit came out of the debt-deal hat at the last minute. As usual, the progressives who momentarily thought this was a win for Democrats were duped.

So what is to be done? This is not a moment to describe policies that would, for example, create jobs, build infrastructure, or deal with energy or climate change. Nothing like that can happen now until ideas change. And the first change must be to challenge and reject all the nonsense about long-term budget deficits, national bankruptcy or insolvency, and even “fiscal responsibility” that we are hearing. The entire object of this propaganda campaign is to cripple government—including regulation and the courts—and to roll back Social Security, Medicare, and Medicaid. The defense of those successful, effective—and yes, sustainable—programs just became far more difficult, and perhaps impossible. But it needs to be carried on to the last ditch.

James K. Galbraith is author of The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too.

Echo Chamber abandons “Recovery”

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With head-snapping speed, the echo chamber abandoned recovery last week. Yes, the much-ballyhooed recovery engineered by the three amigos Baffled Ben Bernanke, Gofer Tim Geithner, and Tiny, Timid and Temporary Larry Summers, with their trillions in support to the banking sector and not one dime to households. That recovery. What? Didn’t happen. In the area roped off for recovery deniers, Demand Side has been lonely. Now there are plenty of people around. The echo chamber is ringing with recovery deniers, and frankly it’s uncomfortable. We used to have a nice little table here, Keen, Stiglitz, Roubini, Shiller. Now you have to stand in line for the bathroom. Of course, they’re not looking at us. No. But they’re sitting on the couch and checking out the fridge.

After Q2, the forecasters began moonwalking back their predictions of 4%. Now it’s a scramble, no grace to it. An incredible pile of bull has been simply abandoned, ignored, forgotten. Actually, there’s a little bit clinging to their shoes and messing up our carpet.

You will remember, Demand Side was the outlier, a minority of not one, but not more than a dozen, for our baseline forecast of bouncing along the bottom, with downside risks and negative growth in the second half. Aggregate demand is the driver of the economy and aggregate demand is fading – from cuts to states and municipalities, growing real debt burdens on households, and the paralysis of government to invest. This scheme is still not the mainline, by any stretch. The current mainstream is kind of a cross between the Fed’s favorite, “It was worse than we thought,” and the ever-popular “flock of black swans.” There is no absence of interest in flogging the whipping boy of government, either.

Rather than debate, today, we’re going to take some prerogative from being right and restate the position. Then we’re going to look at other canards from the echo chamber. Simple facts of conventional wisdom that will sooner or later be rescinded without a backward glance.

The consumer economy is dead. It is buried under a mountain of private debt. The only way out is to socialize investment, as Keynes said, putting people back to work doing things that need to be done. Essential, not optional, are writing down this private debt (either directly or by inflation) and reconstituting public goods and services that are currently the object of a thousand cuts. That is government – teachers, police, firefighters, and a new millennium of infrastructure. We have an incredible challenge to meet in climate change and we have the spare capacity available to put to work.

This is not going to happen, we are afraid, because the current economic institutional framework is basically that the corporate control regime runs the governments, central banks, and dominates business economics with its market fundamentalism. Three years ago, when a complete collapse of the economy was prevented only by massive government intervention, it was difficult to imagine how the financial sector and corporate elite could survive. Now the institutions which created the last bust are back in charge: ratings agencies, central banks, IMF, and the fundamentally insolvent financial sector. It is difficult to imagine how they are going to be dislodged before a new and deeper collapse occurs.

So, our listeners are likely members of the choir on this and we won’t go into detail here. The principle lesson from this new validation by the echo chamber is that your analysis should ignore them. That view has absolutely no correlation with eventual outcomes. Most of their effort goes into explaining why what they said would happen did not happen because of a new extraneous factor and anyway if you look at it more closely, actually they didn’t really say what we thought they said. Besides which nobody else saw it coming either.

So. What else is reverberating in the echo chamber that is worth rejecting?

Ah. The S&P downgrade of U.S. debt is a big deal. Not so. As you will see tomorrow with the rush into U.S. debt. The ratings agencies are like Inspector Clouseau who was repeatedly baffled and caught off guard and could only get the drop on Cato by sucker punching him. The real red flag here is that the same ignorant voices that were in charge during the last financial debacle – S&P here – still get a hearing.

Another favorite which gets reverberation on the Left side of the echo chamber is that an expansion of the payroll tax reduction will create jobs. This has history. Tax cuts in the Bush stimulus of 2008 and the Obama stimulus of 2009 and the 2% reduction currently in place all ended up in paying down debt, not increasing employment. Increase employment by hiring people. The multiplier out of new jobs will be three times that out of another $50 in the average monthly paycheck. What is two percent of annual payroll taxes? A minimum, I would guess, of $100 billion. You could hire three million Americans at decent wages for that. And they would immediately start paying payroll taxes. That’s two percent off the unemployment rate. You are not going to get two percent off the unemployment rate by beating around the bush.

What else? Here’s one. Tax increases will kill jobs. Here again the confusion derives from the sound bouncing off both political walls. Not all tax increases are jobs-killers. Just as not all tax cuts increase jobs. A carbon tax, for example, would do much less damage to the pump price than has oil price speculation. The price quoted on one web site said gasoline went from $2.10 to $3.40 in just the past year. Tax revenues could produce funding for jobs, not rents to resource extractors. Tax increases on the rich don’t cut spending because the rich spend out of accumulated wealth, not income. A Tobin tax on financial transactions only captures some of the losses inherent in speculation. Eliminating the cap on payroll taxes creates a flat tax instead of a patently regressive tax and at the same time gives people confidence in their social security, so they will not hoard against uncertainty. Capping the mortgage interest deduction at $500,000 and one home will push money into productive uses, not in indulgences for the already opulent.

What else?

Our favorite call and response was that the crash in the markets had nothing really to do with the debt ceiling circus and the outcome extorted by the Tea Party. That was just a distraction. To be fair, we said something similar, that the public was fascinated by a schoolyard shouting match and was ignoring the oncoming bus. But to say that the austerity extracted in the debt ceiling debate had no effect is not very convincing. After all, the markets crashed the very next day.

In fact, some of those losses may have come from investors who share our view, that millions of jobs will be lost as a result of no balanced approach. Cutting off government investment as a means of cutting the deficit works only hypothetically, only on a spreadsheet constrained by bad assumptions. Investment by government is the road out. Cutting it is blowing the road up. Since we are kicking the can down this very road, that really doesn’t make any sense in anybody’s metaphor.

We are going to have deficits. They will happen either because we restart the economy with much-needed public investment or because we crash the economy by the madness of austerity.

Next year, we’re going to look like Greece. Remember, the Greek people swallowed Austerity One. When it didn’t produce stability, but rather a major downturn in their economy, they protested that probably more of the same would produce more of the same.

So, echo chamber says, Austerity is good, but the markets are looking elsewhere. Survey of reality says, Austerity is throwing gasoline on the fire. There is no possible way that austerity will lead to debt reduction. We need to earn our way out, not starve our way out.

The only way out is, reducing private debt, creating jobs with a full spectrum demand profile, and bringing some market discipline back to the banking sector. We can try all the austerity, all the market fundamentalism, all the shoving money at the banks we want. It is not going to work, because it cannot work. The economy operates from the demand side.

Extreme Economic Weather

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The whole Lancelot v. the Black Knight debt ceiling production ran into trouble last week. You have to wonder what they’re making of the news in Washington and on Wall Street. All this orchestration, set design, sound design, lighting, costumes, staging. It was up and running to record audiences, if not rave reviews, and then the lights go out. Yikes.

People spill out of the theater into the real world and find extreme economic weather. Unemployment at 9.2, and the heat index is now 16.2 (the all-in U6 measure). Then the revised drought reading comes in. GDP is worse – far worse – than has been reported. Real GDP was 1.3 for Q2, but it was a miserable 0.4 for Q1, AND it was revised downward for the past fifteen quarters. So if you thought it was worse than advertised, you were right. The shape of the curve after revisions to GDP now tracks almost perfectly the public works and state support portions of the stimulus. That irrigation project was all that was supporting a meager crop. Now its gone, piped off to freshen the pools of the corporate elite.

A troubling change in the barometric pressure has occurred that may have been overlooked with the other bad news. PCE, personal consumption expenditures, is now below the Real GDP line. By which I mean growth in PCE is now below growth in Real GDP. During the faux recovery period it was above. This is a tornado warning. A little dry lightning and we’ll have a serious wildfire. Bad news for preparedness: Not only has the water gone off to the pools of the oligarchy, but Congress is selling the fire trucks for scrap to pay for the renovations on their mansions.

Is Demand Side rushing in with fresh fears of catastrophe? No. We’ve been here all along. It may be that we want to keep leverage on the rest of the field, making sure nobody is more gloomy than us. Nobody in the business, that is. Obviously a great number of real people have been aware of the real economy. But if you think our alarm is new, please review past episodes. By the way, if the PCE slash Real GDP cross needs clarification, there is a chart online, and another descriptive chart from the blog Worthwhile Canadian Initiative describing the downward revisions to GDP.

It might amuse you to check out the Big Guys’ forecasts over the past seven months. Their attempts to finesse their upside Q1 misses, when they said 3.5 percent and it turned out to be 1.9, now look a little like the toga dropped, since the latest number is a fraction of that at 0.4. Don’t miss the confidence in their voices a couple of months ago when they assured us that the second half is sure to be better than the first.

Not going to happen. The economy operates from the demand side, and they’re in the process of dismantling demand with austerity and threats to social insurance.

Meanwhile, back at the theater, the politicians and Wall Street forecasters are filing out the stage door and beginning to work out how they’ll play in the park, outside, no special effects.

This is not really where we intended to go today, which was into commodity and financial markets, but in tangent to this let’s indulge a return to another question, one we posed earlier in the year, a political question:

What happens to the Reactionary Right if a second leg down in the Great Recession occurs just as they are flexing their obstructionist muscle? Not exactly the best political time to be caught on camera in your robes and torches. Do we really have to endure another verse of “Cut Spending, Lower Taxes and Re-Deregulate?” Won’t that be a little much even for the Fox News junkies? Maybe not. Maybe the Democrats’ rush to the Right will put them in the same frame. And maybe it’s all Obama’s fault for not doing more to stop them. At least THAT would bring everyone up on the same page. Demand Side would be on that page.

On the other hand, maybe the Democrats get a 1932 election. Obama comes out in new costume. No longer Herbert Hoover, now FDR. Maybe we get started on a real recovery. The climate change war is in the wings waiting to appear as World War II magnitude societal mobilization.

Okay. Enough theater. Now casino. What we wanted to talk about today was commodity and financial markets.

One of the things we expected to see when we came out of the woods last week was an oil price in the 80s, if not lower. We had argued that 2011 was a repeat of 2008. The first part of the year would see a commodities bubble that would collapse in the second half. True, cheap credit – an essential ingredient for a bubble – would continue to be available for market players, courtesy of the Fed. But the capacity of a reeling economy to pay, and thus to validate the increasing pressure, was more limited than in 2008. Oil and commodity prices would peak and fall and continue to fall, we said. But the trigger of a second leg down would have already been tripped. What we found was the drop had been halted.

A second market mystery to us: Why no reaction in bond and stock markets to the hysteria dome that has engulfed D.C.? The fundamentalist zealots are hell bent to fulfill their prophesy that government is the problem. Every other segment of the society forced to watch this has come away shaken and fearful. Somebody said on Bloomberg that a downgrade from one of the Cleuceau-like ratings agencies would cost U.S. taxpayers more than $100 billion. But the segment that has most to lose, the bond investors, has reacted with a suppressed yawn. Or so it seems.

Why are these two markets behaving like this?

Oh yeah, we forgot to mention, commodity speculation kills. According to José Graziano da Silva, new director of the UN’s Food and Agriculture Organization, the major cause of suffering in the world is hunger and the major cause of hunger is high food prices. Those high prices are fueled in the short term by speculation. In the long term it is the inability of Third World farmers to compete against the massive agriculture subsidies endemic to the U.S. and Europe. AND investment in commodities is speculation. Commodities are the products of legitimate investment and business activity. They are not investment vehicles.

Commodity prices have long since left the realm of supply and demand and legitimate hedging. Our current hypothesis is that when the smoke clears, you’ll see ETF’s and the Wall Street trading algorithms directly in the middle of the mess. The initial peak in prices fell as it should have in a bubble. We suspect prices have hit this strangely rhythmic choppiness, on account of lots of money needing a place to find a return and lots of players are ready and able to try new strategies. At a minimum, it is the error of believing real things like commodities are going to hold value.

Now quickly on to the bond markets. What does it mean that the bond vigilantes punish Italy and Greece and the like and don’t punish the U.S.? The price signal for fiscal profligacy is clear in Greece, but in the U.S. there is no price signal for absurd governance. If your school says markets are rational and efficient, you need to answer this question before you pass.

To us it is the same reason you make your ransom payment in any country in the world in one hundred dollar bills. The dollar is liquid. All the paper gains around the world are running to the dollar. Liquidity. It is an aspect of the liquidity trap. In this case, like the trap under your sink.

Real assets are deflating — strip malls, office towers, warehouses, older manufacturing or assembly facilities. It may be that the CPI is above zero – prices for consumer goods. But prices for capital goods must be falling. The value of these is a function of the expected return from the stream of their product. Demand and sales are down. The expected return from sales is down. The price of the capital good must be down. Corporations don’t hire people and expand to make stuff these days. They keep their cash on their balance sheets, or use it to nudge up the dividend and hopefully the stock price.

Short form.

Commodity markets are now tables for speculation. You can’t get yield by investing. You have to speculate. Treasury bonds are stable because they are close substitutes for hundred dollar bills and you get a little interest. Investors won’t use the price signal. To get their message out, they’ll have to depend on the whining talking heads they have in such abundant supply.

Real Recession Continues as Political Theater Detracts

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Returning from our three and a half week retreat we expected to see more difference in the economic landscape than actually met our eye. Unfortunately, the political theater is in summer reruns, and nothing of substance has really changed, which means things are getting worse.

The debt ceiling debate has everyone else focused, and I suppose it is possible that disaster might be allowed to happen. After all, it is real fire they are playing with up there on the stage. Many otherwise intelligent people are absorbed in the show. To us the time for fiscal responsibility was when we were making our purchases, not now when the credit card bills come in the mail.

The great crime to us is the madness of austerity, which has overtaken both sides, it seems. So high drama or not, the current game of chicken is not very interesting. It’s like we have become fascinated with a schoolyard shouting match and failed to notice we are standing in the path of a runaway bus.

What is most the same is that we are still claiming to be in a recovery. Once again, as an economic recovery denier, Demand Side has the shorter story to tell. Disaster was delayed, but not necessarily avoided, by a tremendous government intervention in financial markets and by huge federal deficits. Now we are bouncing along the bottom with big and growing downside risks.

NBER, the National Bureau of Economic Research, made the longer story necessary for others by officially calling an end to recession and the start of recovery now more than two years ago. At a minimum, the phrase, “but it doesn’t feel like a recovery,” must accompany any comment or analysis for it to be taken seriously. A fuller and more honest version includes the interesting fact that the recession continues in employment, where we are leveling out at five percent below the peak nearly three and a half years ago. Employment is two-thirds of the economy. This is a level of loss unseen except for one quarter in 1949 when we were transitioning from wartime to peacetime. Construction and housing continue in recession, another footnote sometimes omitted, never mind that housing has led every single recovery – other than this one – in the postwar period.

No. the only recovery in sight has occurred on Wall Street and on corporate balance sheets. It’s a curious thing that markets continue strong in spite of the bad economic news, and perhaps odd that they don’t seem worked up like the rest of us by the preposterous debt ceiling play inside the beltway. But if you think corporate profits, stock and bond prices are the definition of a recovery, then I have a trillion dollars worth of mortgage backed securities you might be interested in. Actually, the Fed and Ben Bernanke already bought them. But I have a good used bridge.

Summarizing the data, courtesy Calculated Risk’s chart gallery.

• More months of jobs have been lost in this great recession than in all other postwar recessions combined. Absolute. Even in percentage terms, we are sure to achieve that amazing mark before we’re through. More months of jobs will be lost in this … downturn … than from all other recessions – all ten others – combined.
• The official unemployment rate has been above 9 percent except briefly since spring 2009. Only the Reagan-Volcker Recession of 1981 produced higher unemployment numbers, and then for a shorter period of time.
• The employment-to-population ratio is four points off the start of the recession and is not recovering.
• The average duration of employment is astronomically high. Over six million people, more than double the number ever before, have been unemployed for more than 26 weeks.
• New home sales have been at all-time lows for more than a year and in depression for more than three.
• Housing starts, of course, same story.
• Mortgage equity withdrawal added 8 percent to demand in the boom years 2003-06. Now it subtracts nearly 4%. That’s a 12% change to the downside.
• Percentage of equity in homes? Used to be 60%, now below 40% and falling
• Multi-family starts bounced off historic lows. Completions continue to fall.
• Ah, good news, apartment vacancy rates falling, market tightening.
• Private construction spending on non-residential projects, in the tank.
• Architecture Billings Index, in contraction mode and falling. Never recovered from 2008.
• Commercial Real Estate prices have fallen further faster, but also somewhat later, than residential prices.
• Office vacancy rates, no surprise, stuck near the historic highs of the early 1990s.
• Mall vacancy – both strip and regional malls – historic highs and rising.
• Investment in offices, hotels and shopping facilities – quelle surprise – low and falling.
• Manufacturing: Capacity utilization below 75%
• Industrial production at 2004 levels, still 6 percent below the previous peak.
• Small businesses: Optimism, low and falling
• Hiring plans low
• Poor sales as the biggest problem, still well above any pre-recession number.
• GDP: 1.8% for Q1. Stagnant at a low level. Demand Side forecasts GDP falling to negative in the second half.
• Ah, more good news, equipment and software investment is up, as corporations take advantage of tax concessions to automate their operations.
• PCE, personal consumption expenditures, inflated by high oil and food prices (cutting into stagnant incomes), but now falling.
• Real personal income now well below the pre-recession levels.
• Real GDP barely back to the pre-recession level of 2007, per capita GDP down down down, as four years more of people are splitting up the same GDP.

But how can you tell for sure we’re not in recovery? The deficit. It is huge and rising. Not a recovery story. We need jobs as in direct jobs programs. We need a recovery in housing and household balance sheets as in renegotiation of principle on mortgages. We need stabilization of government services as in direct aid to state and local governments and remediation of infrastructure.

Maybe we’ll remember the debt ceiling fight as the cause of our hospitalization, but our physician might point to collapsing aggregate demand. As Robert Reich said recently,


For thirty years now we’ve been hearing from Supply Side economists who say that if we reduce tax rates on the rich and on corporations and keep the cost of capital low, we’ll get more jobs and growth, and the benefits will “trickle down” to everyone else. Well, we’ve tried the theory out, and little or nothing has trickled down.

Tax revenues are now 15 percent of the national economy. That’s the lowest in sixty years, and capital is cheaper than ever. But the economy is going nowhere.

Can I be blunt? It’s the demand side, stupid.