No end in sight to US
jobless rise
By Hossein Askari and Noureddine Krichene
The unemployment rate in the United States rose to 9.5% in June
2009 from 3.6% in October 2000 and 4.1% in October 2006. Most
puzzling, as indicated in the chart below, has been the obvious
failure of Federal Reserve chairman Ben Bernanke's unprecedented
aggressive monetary policy to produce the quick economic recovery
that he promised at each interest rate cut.
The more he cut interest rates and the more he inflated the
balance sheet of the Fed, the higher unemployment has risen.
Unemployment has kept on rising even though the federal funds rate
has been near zero since December 2008. The unfulfilled promise of
Bernanke, a proclaimed expert of the Great Depression, has been
certainly disappointing. However, Bernanke and his supporters have
kept crediting themselves that, without unorthodox cheap monetary
policy, the unemployment rate would have been much higher.
The climbing unemployment rate has also been puzzling in face of
unprecedented expansionary fiscal policy and gigantic stimuli
packages. The George W Bush administration ran large fiscal
deficits which reached US$455 billion in 2008. House speaker Nancy
Pelosi's stimulus package of $165 billion in 2008 was intended,
with announced certainty, to bring recovery in the third quarter of
2008. The Barack Obama administration initiated its own gigantic
stimuli package of $787 billion in February 2009 at a scale touted
to be sufficiently powerful to force a turnaround in the
economy.
With the aim of quickening the economic recovery, the Obama
administration has decided to run the largest fiscal deficit in
peacetime US history at 13% of GDP. Yet, in spite of record fiscal
deficits, the unemployment has kept on rising. The Harvard
multiplier has seemed to work in reverse, a performance that would
be disappointing to Keynesians who faithfully predict that fiscal
deficits turn stone into bread and multiply income and
employment.
It is baffling that such extraordinary expansionary fiscal and
monetary policies and gigantic stimuli have failed to at least
arrest job losses. The job losses have even accelerated from
322,000 in May 2009 to 467,000 in June 2009. It would be very
difficult to think of more unorthodox monetary policy or more
expansionary fiscal policy in order to bring about economic
recovery.
Despite deepening economic recession, Bernanke and his counterparts
on the Obama team were still faithful to their prescription that
unorthodox fiscal and monetary policies would eventually produce a
miracle and set the economy booming again. Bernanke has recently
restated his long standing view that "final demand should be
supported by fiscal and monetary stimulus".
Prominent US policymakers and academicians have related economic
recession and rising unemployment to the housing crisis. For
instance, former Fed chairman Alan Greenspan in a recent Financial
Times (FT) article firmly believed that economy recovery would take
place once housing prices stabilize: "I conjectured over a year ago
on these pages that the crisis will end when home prices in the US
stabilize. That still appears right. Such prices largely determine
the amount of equity in homes - the ultimate collateral for the
$11,000 billion of US home mortgage debt, a significant share of
which is held in the form of asset-backed securities outside the
US. Prices are currently being suppressed by a large overhang of
vacant houses for sale."
Greenspan rejected pressing calls to stabilize housing prices in
2003-2004. He let the housing bubble inflate on with cheap fuel
from the Fed, inflicting trillions of dollars in losses on the
banking system and triggering millions of foreclosures. In his
recent FT article, he was not explicit how housing prices could be
stabilized when the Fed was injecting $1.5 trillion in mortgage
loans. He was also not explicit about the level at which housing
prices should stabilize.
With the current Fed policy to re-inflate housing prices and the
government policy to prevent foreclosures and subsidize homeowners,
it would be difficult for housing prices to stabilize around a
market-determined equilibrium price. Greenspan was certainly
confusing causes and effects. Prices of any good or service are the
result of demand and supply and policies that affect demand and
supply. Hence, prices cannot be stabilized around a market
equilibrium level as long as they are being distorted by monetary
and fiscal policies.
Greenspan had certainly a partial view of prices. The US economy
has faced not only distorted housing prices, but also distorted and
speculative prices in other key markets such as food and energy
markets and well currency markets. The US auto industry was hit
directly by oil prices and not housing prices. Auto sales crumbled
when oil prices soared to $147 per barrel. Demand for SUVs and
gas-guzzling cars suddenly disappeared with consumers opting for
hybrids and small cars.
In the same vein, when food prices rose by three to fourfold, food
riots erupted and demand for food was squeezed; and although we are
in the middle of a recession, food prices are back up again. Not
only housing prices have to stabilize but all prices have to
stabilize. Since housing and commodity prices are influenced by the
same monetary and fiscal policies, these prices will not be
stabilized until these policies are stabilized.
Contrary to Greenspan's narrow view of the recession, Irving Fisher
(1933) forcefully argued that deep recession and large-scale
unemployment can only be explained by, and attributed to,
over-indebtedness and overly cheap monetary policy. The
Greenspan-Bernanke excessively aggressive money policy has caused
many distortions in the US economy, pushed the ration of credit to
gross domestic product to unsustainable levels, and saddled banks
with trillions of dollars in toxic assets that finally played havoc
with real economy and with employment.
In other words, the rapid escalation of unemployment to 9.5% in
June 2009 cannot be explained except by the aggressive cheap money
policy of the Greenspan-Bernanke era. Such policy pushed trillions
of dollars to subprime markets that melted down and consequently
bankrupted the banking system in the US and Europe. It provided
free wealth to borrowers. It set off unparalleled speculation in
housing, stock, and commodity markets.
The collapse of stock prices inflicted trillions of dollars of
losses in pensioners' savings. Excessive mortgage payments and
rising property taxes combined with exorbitant food and energy
prices have weighed dramatically on household budgets and forced
real cuts in demand for both essential and non-essential
goods.
The deliberate policy of Bernanke has been to re-inflate housing
and asset prices instead of stabilizing these prices. The June 2009
statement of the Federal Open Market Committee reads: "In these
circumstances, the Federal Reserve will employ all available tools
to promote economic recovery and to preserve price stability. As
previously announced, to provide support to mortgage lending and
housing markets and to improve overall conditions in private credit
markets, the Federal Reserve will purchase a total of up to $1.25
trillion of agency mortgage-backed securities and up to $200
billion of agency debt by the end of the year. In addition, the
Federal Reserve will buy up to $300 billion of Treasury securities
by autumn."
Besides reducing interest rates to nearly zero, the Fed is mounting
the largest scale long-term liquidity injection under numerous
lending facilities, and is also bearing directly the risk
associated with these loans under these Fed facilities. Hence, with
a bid to re-ignite housing speculation and send housing prices
soaring again, the Fed is pushing close to $1.5 trillion in
mortgage loans. Such a re-inflationary attempt cannot succeed
unless banks are ready to "play it again" - making loans to
borrowers who cannot service them; and borrowers put their heads in
the sand yet again - taking on forbidden mortgages they cannot
repay.
However, not withstanding the death of securitization, banks
continue to suffer dramatic mortgage losses and homeowners remain
unable to service their mortgages. Hence, banks and homeowners
would hardly accept to play the Fed's game despite the willingness
of the Fed to print money and bear all mortgage losses. The Fed has
also established the Term Asset-Backed Securities Loan Facility
(TALF) to inject $1 trillion in consumer (auto and credit card) and
small business loans. The Fed wants to drown consumers in debt and
make them spend out of loans instead of out of earned incomes in
order to force an economic recovery.
Bernanke seems determined to further undermine the safety of the US
financial system in spite of the highest default rates in consumer
loans. Cheap monetary policy will in time turn out to be
inflationary and distortionary and will inflict more financial
losses on the banking system and on the government in form of
trillions of dollars in future bailouts.
Bernanke's Fed and the Obama administration are caught in an
unsustainable expansionary fiscal and monetary trap. Politicians
would prevent interest rates from rising above zero or any return
to stable macroeconomic policies. The US Treasury is building the
highest US public debt and would oppose any rise in interest rates.
Major reserve central banks would oppose any rise in interest rates
and loose competitive ground relative to other countries.
Hence, the world economy could be stacked at near zero interest
rates and largely negative real interest rates for a long period to
come. These low interest rates will discourage real savings and
private investment and therefore constrain economic growth. They
would be propitious to consumption, speculation in asset and
commodity markets, and preclude stability in prices.
Employment is related to real output through a physical relation
called the production function. Demand for labor is a derived
physical demand related directly to the real output of goods and
services. Thus a fall in real output would, in turn, lead to a fall
in employment. Although the Fed has all along denied inflation by
considering solely core inflation that excludes food, energy, and
asset prices, real demand in the US has contracted under powerful
inflationary forces in housing, energy, food prices, and
substantial depreciation of the dollar exchange rate.
As wages do not change quickly, pension levels are fixed, and
interest income is low, the real incomes of workers and pensioners
have been eroded by high inflation causing a fall in real personal
spending. The latter fell by 2.75% in 2008 Q3 and 2.99% in 2008 Q4.
The cooling off of food and energy prices, however, caused a slight
increase at 0.95% in 2009 Q1. Although interest rates were largely
negative in real terms, real private investment showed negative
growth during 2006-2008 and fell dramatically by 8.2% in 2009 Q1.
Such a drop in real private investment caused an interplay of the
accelerator-multiplier effect and depressed real output, falling by
6.3% in 2008 Q4 and 5.5% in 2009 Q1. The record fiscal deficits
will squeeze real private savings and crowd out further real
private investment, thus impeding sustained economic
recovery.
Milton Friedman argued in 1968 that the central bank cannot control
the unemployment rate nor can it control real interest rates. It
can only control money supply and credit. In turn, he called for a
stable monetary policy. The Fed has so far inflicted heavy
financial and economic losses and pushed unemployment to 7 million.
The Fed, with a view to boosting aggregate demand and reabsorbing
unemployment, has decided to inject trillions of dollars in new
long-term liquidity under various lending facilities at a time when
the banking has been overloaded with toxic assets and consumers
were over-indebted.
The credit to GDP ratio stood at 350% in 2008 and was obviously
unsustainable as it caused large loan write-downs and bankruptcies.
Forcing this ratio further up will only compromise the safety of
the banking system. As the mountainous liquidity being injected by
the Fed will not be hoarded in mattresses, it will eventually cause
runaway inflation, stifling economic growth and employment as has
been the experience since August 2007.
The Fed has created immense distortions in the economy and has
pushed private debt to still higher levels. The Obama
administration has decided to push public debt to levels that would
have been unimaginable a year ago. Unsustainable private and public
debt will constrain economic growth for many years to come.
Historically, unsustainable fiscal and monetary policies have
not been conducive to growth and employment. High uncertainties
prevail in the economy and discourage private investment and
employment expansion. Unsafe credit has been a factor in every
financial crisis, including the Great Depression and the recent
financial crisis.
Financial crises have called for new regulation, including the
Pearl Act in 1844 in the United Kingdom and the Roosevelt
administration regulations in 1935. Yet, these regulations did not,
and could not, prevent crisis when central banks deliberately
undermined them. Inflationists have taken advantage of costless
money-printing to debase money and push unsafe credit with a view
to boosting aggregate demand and employment.
Demand policies are insufficient to achieve sustainable economic
growth; supply side policies are also needed. It would appear that
the US economy is trapped in disorderly fiscal and monetary
policies that could delay recovery and employment creation for some
time to come.
Hossein Askari is professor of international business and
international affairs at George Washington University. Noureddine
Krichene is an economist at the International Monetary Fund and a
former advisor, Islamic Development Bank, Jeddah.
http://www.atimes.com/atimes/Global_Economy/KG10Dj02.html
