Friday, September 11, 2009

Meltzer and Reich on the State of the Economy Today

There are those arguing about whether or not this recession is the worse since the great depression. There are also those oblivious to the current crisis. And then there are those, like us, worried about what is going to happen next. Most likely a period of sluggish growth for longer than most anticipate and which is going to limit America's ambitions and cripple its aspirations.

I have been arguing in the spring of 2008, one year before I started this blog ,that the worst was still to come. Then the crisis really hit us. First, in the fall of 2008 and again in March 2009. I then took the view that this was not the end of the world. And starting in the Spring, when I started the blog, I started to argue against the logic of the green shoots, stating that we were not out of the woods yet. See my first entry.

It's not that I like being a contrarian. Rather, I consistently maintained my forecast of long term subpar growth. When consensus views swung to the extremes (from recovery to depression to recovery again), I stood firm, like the sun, while the consensus orbited around my steady view.

I still believe for about 18 months now that we have entered into an era of subpar growth for a period of five years that still has, at least, three years to run. Not so much because of extended over-indebted consumers - although it does not help - but rather mainly because of the disorderly unwinding of this over-leverage. This situation is made worse by the fact that the US government has also committed a lot of resources to avoid the worse which means that the future will call for fiscal restraints which, with the current administration, also likely means higher taxes for all.

Below, I present two authoritative views about the current outlook for growth. One is issued by a conservative. The other one by a liberal. They both represent a realistic assessment of the situation and they dissent from the consensus view which, for now, is that everything will be back to normal soon.

Alan Meltzer, a professor of economics at Carnegie Mellon University and the author of "A History of the Federal Reserve" argues, in What Happened to the 'Depression'?, that the depression bluff may have been played by the Administration to justify its stimulus package. I am not sure. I think instead that policy-makers may have been just a bit too "careful" and used a bazooka to ensure that we would survive. Yet the result is the same. Our guns are now dry. Read on.

“Day after day, economists, politicians and journalists repeat the trope that the current recession is the worst since the Great Depression. Repetition may reinforce belief, but the comparison is greatly overstated and highly misleading. Anyone who knows even a bit about the Great Depression knows that this is false.

“The facts we face today are very different than the grim reality Americans confronted between 1929 and 1932. True, this recession is not over. But it would have to get improbably worse before it came close to the 42-month duration of the Great Depression, or the 25% unemployment rate in 1932. Then, the only safety net was the soup line.

“The current recession is also much less severe than the 1937-38 Depression. A more accurate comparison is to the 1973-75 recession. Today's recession is as deep and most likely won't be much longer than the one we experienced some three decades ago. By pointing this out, I do not intend to minimize the damage that the economic crisis has had on individuals and businesses. But as policy makers make decisions in order to alleviate the recession, they are not helped when economists overstate its severity.

“The table nearby compares the current recession, the 1937-38 depression and some past severe postwar recessions. If the recession ends this summer—as many experts predict—the record will show that it was not very different from other postwar recessions, but very different from the 1937-38 and 1929-32 Depressions.

“So why do many opinion makers insist on inaccurate and frightening analogies that overstate the severity of present conditions? I believe there are several reasons.

“First, there is a strong political motivation to make this recession out to be worse than it actually is. The Obama administration wanted to make it appear as though it saved us from an incipient disaster, so it overstated its achievements. The White House also wanted to foist its huge "stimulus" program on the country in order to redistribute income. That pleased many Democrats, but did very little to restore growth.“Many others repeated the administration's hyperbolic claims. One reason is because there is genuine uncertainty about what has happened and what is likely to come. Short-term forecasts have major errors, and extrapolation of current data adds to misinformation. Then there are economists who would like to see government take a larger role in the economy. They've chosen to use the recession as a pretext for arguing for this change.

“New York Times columnist Paul Krugman and the International Monetary Fund repeatedly proclaimed that more government spending was a necessity. Most economists now believe that the recession is expected to end before much of the government spending takes hold. And while the improvement in recent GDP data reflects a big increase in government spending, consumer spending declined again in the second quarter. The $787 billion of fiscal stimulus has done little for consumers. Keynesian economists always fail to recognize the powerful regenerative forces of the market economy. The financial press—many of whom share their same political assumptions—endlessly reproduces their beliefs.

“The Federal Reserve also shared this Keynesian viewpoint. It provided unprecedented monetary stimulus, increasing the monetary base by more than $1 trillion. Much of this increase corrected for its major mistake: allowing Lehman Brothers to fail. After 30 years of bailing out almost all large financial firms, the Fed made the horrendous mistake of changing its policy in the midst of a recession. That set off a scramble for liquidity and heightened the public's distrust in the market.

“This had world-wide repercussions. For four months, many financial markets remained frozen and real activity collapsed. Allowing Lehman to fail without warning is one of the worst blunders in Federal Reserve history. Extrapolation caused many market participants to conjecture that we were in a depression. The New York Times and others piled on, speculating foolishly about the end of capitalism.

“Now, with recovery in sight, we need to ask what kind of a recovery to expect and what kind of policies are appropriate. My best guess is that the recovery will be a bumpy ride along a low-growth path. Recovery will be helped by lots of monetary stimulus and low inventories. Some calendar quarters will see healthy growth, but trend growth will be low because housing will remain weak, the cash for clunkers program borrowed sales from the future, and the Obama administration's economic program raises business costs and reduces profits.

“Many pundits argue that we need another stimulus package. I disagree. The proper response now is to repeal what remains of the misguided stimulus and avoid the cap-and-trade program.

“In their response to the recession, Congress and the administration were more interested in redistributing income than encouraging growth. They also ignored the lessons of the successful Kennedy and Reagan reductions in marginal tax rates. They added to their mistakes by enacting a temporary tax reduction as a main element of the $787 billion stimulus. Don't they know that Presidents Ford, Carter and Bush failed to stimulate spending with temporary tax reductions?

“A sensible administration would revise its policy. It should start by scrapping what remains of the stimulus. As the world economy recovers, the United States should choose to expand its exports so that it can service its large and growing foreign debts. That means reducing corporate tax rates to increase investment. Instead of implementing policies that increase regulation and raise business costs, we need to increase productivity. And the Fed should soon begin to reduce the massive volume of outstanding bank reserves, which is the raw material for future money growth.”

Next, is the opinion of Robert Reich, who served as Labor Secretary during the first term of Bill Clinton. In The Real News About Jobs and Wages - An Ode to Labor Day (click on the link then go to the September 4th entry), Reich argues that the media is oblivious to mounting job losses.

His blog post that day could have been entitled "What Happened to the 'Recovery'?" as it is exactly the mirror of Meltzer's WSJ article. Meltzer thinks that claims of the coming depression were exaggerated while Reich argues that claims of the coming recovery are overdone. Yet, they both come to the same conclusion: We are going to grow slowly for a while and we better acknowledge this fact pretty soon if we do not want to dig ourselves into a deeper whole.

Here is Reich's blog post:

"Why aren't we hearing more about the worst job and wage situation since the Great Depression?

"The latest employment figures (released this morning) show job losses continuing to grow. According to the payroll survey, job losses are increasing more slowly than in previous months. According to the household survey, they're accelerating -- from 9.4 percent of the workforce in July to 9.7 percent in August. Bottom line: almost one out of six Americans who need a full-time job either can't find one or is working part-time. Meanwhile, wage growth among people who have jobs has just about stopped. The Economic Policy Institute reports that between 2006 and 2008, wages grew at an annualized rate of 4.0%; by contrast, over the past three months annual wage growth has plummeted to just 0.7%. At the same time, furloughs -- requiring workers to take unpaid vacations -- are on the rise: recent surveys show 17% of companies imposing them. More than 20% of companies have suspended their contributions to 401(k)s and similar pension plans.

"So why isn't the media screaming? Partly because these job and wage losses are not, for the most part, falling on the segment of our population most visible to the media. They're falling overwhelmingly on the middle class and the poor. Unemployment among those who have been in the top 10 percent of earnings is closer to 5 percent, and their earnings continue to climb -- although, to be sure, much more slowly than before the meltdown. It's much the same with health-care and pension benefits. Among people under 65 who are in the bottom 20% of incomes, only 21.9% have employer-sponsored health insurance -- if they have a job at all. Half of all people nearing retirement age have a 401(k) balance of less than $40,000.

"I keep hearing that the economic meltdown has taken a huge toll on the stock portfolios of the rich. That's true. But the rich haven't lost nearly as much of their assets, proportionately, as everyone else. According to a report from the Bank of America Merrill Lynch ("The Myth of the Overleveraged Consumer"), analyzing data from the Federal Reserve, the bottom 90 percent of Americans hold 50 percent of more of their assets in residential real estate, which has taken a far bigger beating than stocks and bonds. The top 10 percent of Americans have only a quarter of their assets in housing; most of their assets are in stocks and bonds. And although the stock market is still a bit tipsy, it has rallied considerably since it hit bottom earlier this year. Home values, on the other hand, are down by an average of a third across the country, and are still falling.

"What does all this mean for the economy as a whole? It raises the fundamental question of where demand will come from to get us out of this hole. If so many Americans are losing their jobs and wages, you have to wonder who will be returning to the malls.

"That same Bank of America Merrill Lynch report notes cheerfully that 42 percent of consumer spending before the meltdown came from the top-earning 10 percent of Americans (not too surprising given that the top 10 percent was raking in half of total earnings) and the top 10 percent continues to do relatively well. So, says Bank of America Merrill, we can rely on the spending of the top 10 percent to get the economy moving again. Indeed, they conclude, Congress and the White House should be careful not to raise taxes on the top 10 percent, lest the consuming ardor of these most privileged members of our society be dampened.

"This logic is morally and economically indefensible. If we've learned anything from the Great Recession-Mini Depression of the last 18 months, it's that the skewing of income and wealth to the top has made our economy far less stable. When the majority of middle-class and poor Americans are either losing their jobs or feel threatened by job loss, and when those who still have jobs are experiencing flat or declining wages, there's simply no way to get the economy back on track. The track we were on -- featuring stagnant median wages, widening inequality, and job insecurity -- got us into this mess in the first place."

Again, very joyful reading!


  1. While high flying statistics and opinions from on high are interesting, the reality is America will continue to slowly sink. In my area (northern Minnesota) the average FAMILY income is $35,000 a year. For decades, I have watched $8 to 15 an hour become a typical income for tens of millions. These people don't have any health care and, most certainly, don't have the time to protest anything. While the moneyed elites of the country argue and debate the this or that of some subject or another, people are struggling just to get by and, in many cases, sliding below the survival line. And things have been getting steadily worse for decades. I, strongly, suspect that for thousands of economists and other ramblings about the state of things, the only source of their belief system is theories with the word reality far from their thought processes. Job losses, health care, pensions and a host of other real life problems are simply numbers with little, if any, reality connected meaning.

    Often, I wander through the back roads of different areas of the country. I see the empty houses, the closed businesses, the population losses, dying small towns, etc, etc. These are people's lives. These are people that lost everything and started over in a rented apartment at very low wages. At least once, it was me, so I've been there.

    To me, there is only one fact. Long ago, America lost it's way. When wages did not keep up with life styles, the debt pile up began at every level. Without massive debt, we do not have an economy and the debt levels must, daily, increase or everything begins to stop. When I see the word "recovery", I think recovery to what? I've watched our government do everything in it's power to get us back to the insane spending of the recent past. So like a little kid wildly spinning in the yard, we are cranking ourselves ever tighter to spin ever faster. I suspect, like the little kid, it's only a matter of time until we fall down.

    For me, the numbers become meaningless. I just returned from a 5000 mile trip. I saw the closed malls, the empty houses, boarded up businesses and the stuff for sale along the road. From years of watching, I know it's not a collapse, it's a slow death with "there's another empty house" that wasn't there last spring.