(What’s Left of) Our Economy: How Bad Will it Get?

Tags

Baby Boom, CCP Virus, Cold War, coronavirus, COVID 19, Edward Harrison, Federal Reserve, Great Depression, Great Recession, health security, military spending, moral hazard, recession, recovery, secular stagnation, small business, start-ups, technology, Trump, uncertainty, unemployment, World War II, Wuhan virus, {What's Left of) Our Economy

How bad economically? That’s a CCP Virus-related question everyone’s understandably asking these days. In fact, last night one of my social media friends expressed the super-bear case pretty compellingly:

“I can’t see any way this is not going to destroy us. No one will have any money, so they won’t buy anything, won’t pay their bills, can’t pay rent or mortgages. No spending power means no employment. More layoffs. certainly as soon as stores open there wil be a rush to sell everything, a rush to normal, hoping for the best, but I think this is pretty much The End of life as we know it.”

And an economy-watcher I know with an unusually good feel for finance is awfully pessimistic, too – and has been right so far about the virus’ impact on output, employment, and the markets.

I’m feeling even less confident than usual in my economy crystal ball (that’s a low bar). The main reason of course is that the current U.S. nosedive, as I (and nearly everyone else) have observed, isn’t a standard recession or depression. That is, it hasn’t been caused either by some built-in weakness in the economy that finally becomes too big to ignore or paper over, or similar problems in the financial system that wind up wrecking the “real economy.” We can’t even blame the current crisis on some outside economic shock, like the boost in global oil prices that wreaked such economic havoc in the 1970s.

Even so, here are four somewhat related, extremely tentative thoughts that I hope will help readers form their own judgments about the American economy’s future. Spoiler alert: They’re pretty pessimistic.

First, the fundamentally biological nature of the crisis creates the kind of uncertainty that’s unprecedented in modern times, and that consumers, businesses, and investors will hate even more than usual. For example, what if there’s a second wave? Or a third? How will these three groups of economic actors respond to attempted restarts of economic activity that, however gradual or rolling, turn out to be premature?

Worse, what if the CCP Virus is here to stay for the time being, and treatments can only become good enough to reduce it to the status of a really nasty flu? And what if it mutates into something requiring qualitatively different cures?

Second, because of all these possible biology-rooted uncertainties, I fear that many of the standard arguments for expecting a relatively quick, strong rebound should be thrown out the window. All of them, after all – including President Trump’s – apparently assume that the timeout mandated in most of the economy’s consumption (and that therefore inevitably undermines its business spending) is creating lots of frustrated demand that will burst into actual spending once the crisis passes.

One big historical precedent cited: the aftermath of World War II. At that time, officials inside the federal government feared that growth would fizzle at best for two main reasons. First, the massive boost to growth and employment delivered by wartime military spending would dramatically fade. Second, this pessimism was no doubt greatly reenforced by the nation’s immediate pre-war experience – a lengthy and deep depression that showed no signs of ending until the global fascist threat inspired a pre-Pearl Harbor military buildup.

But after the war, consumption came back with a vengeance – because the main threats on everyone’s mind were decisively defeated; because so many Americans had lots of income to spend; because Washington laid the ground for more income-earning with programs like the G.I. Bill, along with war-time advances in science and technology that boasted phenomenal peacetime uses; and because baby-making boomed along with consumption, juicing demand for more housing in particular.

And let’s not forget the Cold War! The household spending binge did slow in 1947 and 1948. But by 1949, defense spending began rising again, and it really took off from 1951 on, once the Korean War in particular convinced policymakers that a global Communist threat was alive and here to stay.

Today, however, determining when the major threat is finally over is much more difficult. Unemployment is sure to rise much higher than the 5.9 percent pre-Korean War peak (in 1949), meaning that not only will incentives to save remain stronger, but that much more income is being lost. And nothing like a post-World War II Baby Boom was even in sight before the CCP Virus struck. Indeed, the arrows were pointing in the opposite direction. A post-virus repeat seems unimaginable.

The one interesting possible reason for purely economic optimism? A new military spending surge – perhaps spurred by worries about China? And new healthcare products investment might jump as well, possibly boosted by government incentives, to prevent a repeat of current supply shortages.

The third consideration weighing on my mind is the separation factor. Even if post-virus improvement is solid, I wonder how sustainable it will be. The main reason is that, at least during past episodes of major job loss (e.g., the last decade’s Great Recession that followed the global financial crisis), many of the unemployed face big difficulties returning to work in any form, and particular difficulties finding work at previous pay levels. Because the longer unemployment lasts, the harder these obstacles generally become, and because of the likely rate joblessness is likely to hit, this separation factor could become considerable even if unemployment insurance and other income supports do turn out to be generous enough to sustain such economic victims until the nation reaches “the other side.” 

The separation factor, moreover, may go beyond workers. I don’t by any means rule out the possibility that significant numbers of small business owners may call it quits, too – either because cratering demand for their products and services will kill off their enterprises, because the the government aid being offered doesn’t cover all their losses for long enough, or because they conclude that applying for the aid just isn’t worth the candle.

Sure, new start-ups will fill part of this gap. But all of it? Not if the abundant pre-crisis evidence of a significant drop-off in such entrepreneurism is any indication.

Fourth, also reenforcing the bear case: Although the roots of the current economic mess are dramatically different from those of the last near-meltdown and recession, the “whatever it takes” response of the federal government and the Federal Reserve are remarkably similar. As pointed out by Edward Harrison, the economy- and finance-watcher I cited above, on the one hand, the authorities probably don’t have a choice. On the other, this thick, pervasive safety net did produce an epidemic of “moral hazard” – financial decisions in particular that turn out to be bad but that initially look smart because confidence in some form of bailout reduces the perceived risks and costs of mistakes.

As I explained previously, the last outbreak of moral hazard took a painful pre-virus economic toll, as the resulting inefficient use of capital helped produce  one of the weakest economic recoveries American history. In fact, it’s produced a theory that I personally find as convincing as it is depressing (personally): secular stagnation. It holds that the economy has become so fundamentally unproductive and inefficient that the only way it’s been able to generate even adequate (not especially strong) levels of growth has been for government to inflate bubbles of various kinds (with all its moral hazard-creating spending and guarantees) that, of course, eventually burst. So it doesn’t seem at all unreasonable to believe that the upcoming recovery will be similarly feeble.

Even worse, according to Harrison, even the current official backstopping might not suffice to prevent defaults by the financially weakest businesses – which would generate their own harmful spillover effects.

I’m not saying that there’s no case for optimism – at least cautious optimism. The overall long-term historical momentum for improvement in living conditions the world over is very impressive. As a result, doom-saying has a lousy record in the post-World War II period in particular. Technological advance isn’t going to stop, and may not even slow much. Maybe most important, at least in the medium-term, the human desire to acquire and consume shows no signs of having vanished.

So maybe the safest conclusion to come to (however unsatisfyingly timid): This time won’t be completely different. But don’t bet on a simple, and particularly a quick, return to pre-virus times.

(What’s Left of) Our Economy: Is the Fed Taking Us to Economics Infinity – & Beyond?

Tags

big govenment, CCP Virus, coronavirus, COVID 19, credit, economics, Fed, Federal Reserve, finance, fiscal conservatism, Franklin D. Roosevelt, Great Depression, Great Recession, Jerome Powell, moral hazard, New Deal, stimulus package, Wuhan virus, {What's Left of) Our Economy

Since I’ve never liked recycling my own material, I’ve rarely written here on specific arguments I make on Twitter. (And I make a lot of them!) But since these times are so exceptional, and have just generated such an exceptional response from the Federal Reserve, an exception here seems more than justified. So here are three longer-than-a-tweet expressions of concern about the broadest impacts of the massive support for the everyday economy (as opposed to the financial system) just announced by the central bank in response to the CCP Virus.

The first has to do with the perils of super-easy money. Fed Chair Jerome Powell has just again made clear in remarks this morning that there’s “no limit” to the amount of credit the central bank can pump into the economy to create a “bridge” over which imperiled businesses large and small, and now state and local governments, can cross in order to return intact to “the other side” of the pandemic.

Yes there are conditions – mainly, the borrowers need to be creditworthy (though the definition of “creditworthy” has been expanded). So at least in principle, previous individual or business “bad behavior” won’t be rewarded and thereby enabled going forward – a practice economists call incurring “moral hazard.” That’s (again, in principle) different from the previous financial crisis-related bailouts, when lots of bad or incompetent behavior, especially by Wall Street and the automobile industry, was generously rewarded.

(More encouragingly, other, impressive conditions have been placed on beneficiaries of previously announced fiscal economic aid – the type provided with taxpayer money by the Executive Branch and Congress – including temporary bans on stock buybacks.)

But moral hazard doesn’t necessarily result from the behavior of apples that are already bad. The concept is so powerful (and has long been so convincing) in part because it holds that showering borrowers with easy (and now free money) tends to turn good apples bad. That’s because a credit glut greatly reduces the penalties created for poor decisions by the normal relative scarcity of capital and the price (interest rates) that lenders normally demand in order to impose some degree of discipline.

The lack of adequate discipline on borrowers is surely one big reason why the post-financial crisis economic recovery had been so historically sluggish: Capital wasn’t being used very efficiently, and therefore wasn’t creating as much output and employment as usual. Maybe, therefore, all these new stimulus programs, whether desperately needed now or not, are also setting the stage for a dreary repeat performance?

Which brings up the second issue raised by the latest Fed and other federal rescue operations: Their sheer scale, and the Powell’s “no limits” declaration strongly undercuts the most basic assumption behind the very discipline of economics: that resources will be relatively scarce. That is, there will never be enough wealth in particular to satisfy everyone’s needs, much less wants.

Think about it. If all the wealth needed or wanted could somehow be automatically summoned into existence, why would anyone have to think seriously about economic subjects at all? What would be the point of trying to figure out how to use resources most productively, or even how to distribute them most equitably?

I remain deeply skeptical about the idea that money literally “grows on trees” (as most of our ancestors would have put it). But Powell’s statement sure seems to lend it credence. Moreover, I’m among the many who have been astonished that the United States hasn’t so far had to pay the proverbial piper for all the debt that’s been created especially since financial crisis hit. So it’s entirely possible that I – and others who have fretted about the spending and lending spree the economy had already been on before the pandemic struck – have had it completely wrong.

It would still, however, seem important for economists and national leaders to make this point at least more explicitly going forward. For if it’s true, why even lend out money? Why have banks and financial markets themselves? Why shouldn’t the government just print money and distribute it – including to government agencies? Why for that matter tax anyone, rich or poor?

Just as important, if “on trees” thinking remains wrong – and possibly dangerous – folks who know what they’re talking about had better make the possible costs clear, too. Because if enough Americans become persuaded that there is indeed this kind of massive free lunch, what would stop them from demanding it? Why wouldn’t it be crazy not to? And how could elected leaders resist?

In fact, I’m also concerned about the emergence of a shorter term, more humdrum version of this situation. (This is my third worry for today.) Specifically, Powell clearly views the new Fed programs as emergency measures, which will be dialed back once the emergency is over. Similarly, at least some of the nation’s supposed fiscal conservatives are claiming that they’ve supported the sweeping anti-CCP Virus because it amounts “restitution” for all those individuals and businesses whose “property and economic rights” have been taken from them by the government decision to shut down the economy.

Nonetheless, let’s keep in mind that as former President Franklin D. Roosevelt was rolling out his New Deal programs to fight the Great Depression of the 1930s, he continually justified them as emergency measures. The President himself tried returning to his previous backing for budget balancing once some signs of recovery appeared.

His optimism, as it turned out, was premature, and helped bring on a second slump. Nonetheless, even had this about-face not failed, is it remotely likely that many other New Deal programs, ranging from Social Security to the Tennessee Valley Authority to the Federal Deposit Insurance Corporation to federal mortgage support agencies wouldn’t be alive and kicking, to put it mildly. Obviously that’s because however much most Americans may talk a small government game, they understandably like big government when it delivers tangible benefits.

As a result, when Powell, and others, promise that “When the economy is well on its way back to recovery…we will put these emergency tools away,” you’re free to smirk. The first clause in this sentence alone is grounds for caution, stating that the aid won’t be withdrawn once the worst is over, or when a rebound starts, but when normality is a certainty. If the national experience following the last financial crisis is any guide, when the Fed, for example, even pre-CCP Virus kept interest rates super low for many years after some growth had returned, “the other side” is going to be a place whose location will keep receding for the foreseeable future.

So the specter of the economy remaining hooked on massive government stimulus both for economic and these political reasons could be another reason for bearishness about a robust near-term rebound. (And no, I’m not trying to give out any investment advice here.)  

I’m not necessarily being critical here of the stimulus packages. Just trying to spotlight the safest bets to make, and the need to examine the future with eyes wide open. Is there any viable alternative?

(What’s Left of) Our Economy: Beyond the Fed Tightening Debate

Tags

Ben Bernanke, bubbles, Employment, Federal Reserve, Financial Crisis, inflation, interest rates, Janet Yellen, Jobs, monetary policy, moral hazard, recovery, zero interest rate policy, ZIRP, {What's Left of) Our Economy

The latest “Fed Day” has now come and gone. The Federal Reserve’s decision-making Open Market Committee has issued its latest monthly pronouncement on where it will set the short-term interest rate it directly controls. (It will stay near zero, where it’s been since the end of 2008). In the process, the central bank revealed a lot about how cheap or expensive the cost of borrowing will be in the U.S. economy at least until its next meeting, in mid-December.

And as always, the effects of this Fed Day will surely ripple much wider, as many investors, businessmen, and consumers look to each new central bank monetary policy statement for clues as to the economy’s health and prospects; for indications of how the Fed will act in the foreseeable future; and for a sense of what kind of rate environment financial markets will face – a key determinant of their performance.

The run-up to today’s Fed statement generated somewhat less suspense or anxiety (take your pick) than lately has been the case. After all, the recent slowing of the American and global economies seemed certain to have eliminated the chance of the Fed raising rates from their current levels just above zero. Chair Janet Yellen and other leading Fed lights, at least, have worried that such tightening could choke off too much growth and therefore hiring, while boosting the odds that a dangerous deflationary cycle could take hold and weaken the economy still further. (Employment and price levels are the Fed’s two main official statutory concerns – its “dual mandate.”)

Yet today’s statement is likely to keep raging the fierce debate in the economics, business, finance, and political communities over what the Fed should do – and what its recent unprecedentedly easy money policies have and have not accomplished so far. For the record, I favor beginning to tighten as soon as possible, for two related reasons.

First, I’ve feared that the artificial life support provided by years of Fed stimulus has so effectively masked the economy’s real weakness that the excesses that built up during the previous bubble decade (also largely enabled by the Fed) can’t undergo painful but necessary corrections. Therefore, the hard work of creating a truly durable foundation for American prosperity keeps getting postponed.

Second, even if the Fed’s gargantuan support prevented a 1930s-style depression, the credit flood it continues to supply is now actually encouraging further excesses – for reasons I spelled out in a post last month. So I’m worried that the United States – and by extension, the world, given America’s still outsized role – can’t avoid another financial crisis without tightening (i.e., starting to normalize) monetary and credit conditions; reimposing genuine market disciplines on economic activity; and making sure that risk is accurately priced (and indeed priced at all).

But as far as I’m concerned, my own views on tightening now or later are much less interesting than what this debate reveals about how well the economy’s ills are understood by both supporters and opponents of the Fed’s record these last few years. I’m simplifying a bit here, but I worry that the looser money advocates – include the apparent majority of Fed officials – are too focused on supporting growth (and hiring) literally at all costs, without thinking about the quality and sustainability of that growth. Weirdly, they appear to understand fully just how weak the economy remains, but seem to believe that all that’s possible is to prop up growth and employment indefinitely with monetary steroids.

I’m also, however, concerned about tightening arguments. Its champions seem to understand the intertwined economic and financial dangers of fostering low quality growth. But most of them appear to overestimate the economy’s underlying strength, and seem to believe that raising interest rates (at whatever pace, to whatever heights) will quickly restore genuine economic health.

Unless this paradox is somehow resolved, it’s hard to imagine recipes for solid recovery emerging that are properly targeted and based on realistic expectations of turnaround.

To be fair, neither side in this debate, much less Fed officials themselves, believes that monetary policy alone can fix the economy. Of course, the favored policies vary widely, but everyone I’m familiar with emphasizes the need for the rest of the government to start doing its part. But this observation brings up another concern. Undoubtedly, the forces that have produced and maintained D.C. gridlock are strong, and show few signs of weakening. But arguably, one of these has been the Fed itself – which may be creating a form of moral hazard in American politics.

For just as overly indulgent policies in economics and finance can convince businesses that, however massively they mess up, Uncle Sam will come to the rescue, it’s certainly possible that, at least in the backs of their minds, U.S. politicians are convinced that they can continue grandstanding unproductively because the Fed will keep the economy slogging along acceptably enough to prevent major voter backlash – and thus keep them in office.

In this vein, it’s fascinating – and a little disturbing – that former Fed Chair Ben Bernanke has also just suggested a belief that the Fed can and should back stop dysfunctional governing systems. In an interview last week with the Financial Times, Bernanke stated that “One of the Federal Reserve’s key functions is to act quickly and proactively when the legislative process is too slow.” Although the central bank was structured to be independent of short-term political considerations and pressures from office-holders, I’ve never heard anyone ever aver that the Fed should in any way substitute for elected politicians.

Does Bernanke’s successor, Yellen, agree? She’s scheduled to appear before Congress in early December. Maybe someone could ask?

(What’s Left of) Our Economy: Why Today’s Fed Rates Announcement Really Matters

Tags

asset prices, bubbles, federal funds rate, Federal Reserve, Financial Crisis, financial markets, Great Recession, interest rates, investors, Janet Yellen, moral hazard, Obama, OECD, recovery, {What's Left of) Our Economy

As the world economy anxiously awaits the Federal Reserve’s announcement this afternoon about how much longer it will keep the interest rates it controls near zero, the release yesterday of a new official report on global growth prospects is especially well timed. The latest global economic assessment from the Organization for Economic Cooperation and Development (OECD) valuably reminds the world’s leaders and publics alike that the main economic challenge of our time is not quickening the slow pace of recovery from the financial crisis and Great Recession. Instead, it’s generating the kind of robust growth that won’t almost inevitably trigger another crisis.

The OECD, an organization of the world’s high income countries (and some middle-income countries, like Mexico), raised its projections for overall global growth, and for growth in most major countries and regions, from those in its previous forecast in November. (Most of the main old and new numbers were conveniently presented in this Financial Times piece.) But the OECD also warned that too much of this improvement stems from the same forces that during the last decade inflated asset bubbles around the world that eventually burst disastrously.

In addition to lower oil prices, OECD chief economist Catherine L. Mann contended, monetary easing has “brought the world economy to a turning point, with the potential for the acceleration of growth that has been needed in many countries.” But she also specified that “excessive reliance on monetary policy alone [like the massive easing implemented by the Federal Reserve since the crisis broke out] is building-up financial risks, while not yet reviving business investment.”

As the United States and the rest of the world should have learned since the dark days of 2007-2009, no challenge is easier for governments to meet than creating the illusion of growth temporarily. They can simply promote borrowing and spending that have nothing to do with genuine wealth creation and the rising incomes it produces.

Actually, I’ve been surprised at how long easy money from the Fed and other leading central banks has kept the world economy afloat in the last few years. But this extraordinary official subsidization of economic activity is showing big signs of the same dangerous consequences produced by wildly excessive credit creation before 2007-8. It’s spurred a flood of capital into ever more dubious schemes from investors desperate for decent returns but also fully confident that governments will protect them from any risk. After all, if resources can be created at will by monetary authorities, and losses will be covered, why not throw caution to the wind? Why spend lots of time trying to figure out how to use them carefully or productively?  Why not take full advantage of what economists call “moral hazard”?

Ironically, and encouragingly, these worries about oceans of capital being invested without significant market disciplines seem to be shared by what has so far been the world’s biggest credit pusher – the Federal Reserve, or at least many of its leaders. At least as of this morning, that’s why it’s been widely reported that Chair Janet Yellen and her colleagues will start preparing markets and the rest of the world for the likelihood that they’ll raise the federal funds rate sooner rather than later – if only by a little. That also appears to be mainly why, for all the boosterism surrounding the U.S. economy throughout the current recovery – including President Obama’s claim that the nation has “turned the page” – American investors are reacting to even a modest rate hike so bearishly. They recognize that artificial legs have been the only legs that asset prices and the underlying real U.S. economy have been showing.