The Limits of Economic Policy

Are the financial markets in denial about how soon the recovery will come and how impressive it will be? Mohamed El-Erian, for one, thinks so, and he points to the unemployment rate as a key reason why things are not going to get noticeably better any time soon:

The unemployment rate will increasingly disrupt an economy that, hitherto, has been influenced mainly by large-scale dislocations in the financial system.

In just 16 months, the US unemployment rate has doubled from 4.8 per cent to 9.5 per cent, a remarkable surge by virtually any modern-day metric. It is also likely that the 9.5 per cent rate understates the extent to which labour market conditions are deteriorating…

Notwithstanding its recent surge, the unemployment rate is likely to rise even further, reaching 10 per cent by the end of this year and potentially going beyond that. Indeed, the rate may not peak until 2010, in the 10.5-11 per cent range; and it will likely stay there for a while…

This possibility of a very high and persistent unemployment rate is not, as yet, part of the mainstream deliberations. Instead, the persistent domination of a “mean reversion” mindset leads to excessive optimism regarding how quickly the rate will max out, and how fast it converges back to the 5 per cent level for the Nairu (non-accelerating inflation rate of unemployment).

The US faces a material probability of both a higher Nairu (in the 7 per cent range) and, relative to recent history, a much slower convergence of the actual unemployment rate to this new level…

The combination of stubbornly high unemployment and growing government debt will not play well.

I completely agree with all of this. The markets seem to be having difficulty adjusting from a happy world where the key unemployment number is the first derivative, to the current unhappy world where the key unemployment number is the sheer deadweight number of unemployed Americans, who aren’t spending and who are going to be a major drag on economic growth for the foreseeable future.

As for the possibility of a higher Nairu, we’re so far away from there right now that for the time being such discussions are probably academic. But clearly the higher that Nairu gets, the higher the tail risk of a stagflationary spiral — and the less that policymakers can do to get us out of one. Governments managed to avert the most disastrous consequences of the financial crisis. But they might be powerless in the face of the current global economic crisis.

Comments

[Moon Kil Woong:]

I think all eyes turn to Treasury Bonds. Rising rates will signal further supress any recovery, may spur inflation, and will tie the government's and Fed's hands at any further stimulus. In essence, such an event will be like a back to back recession. Things will not improve for years to come and QE will blow up in our face.

If somehow rates drop and deflation encourages dollar holding, we will have a collapse in green shootists and even mild deflation with a crash in equities. however, we probably can recover faster than the first scenario. It would be the climax of a very nasty economic down cycle prolonged by massive wasteful government interventions.

Jul 06 04:24 AM

[John Galt:]

16 months of rising unemployment, half a year worth of Obama, green shoots, and now we hear our Vice President say they misread the economy.
www.bloomberg.com/apps...

Did they "misread" the economy or were we in a "crisis of confidence" where the wool was supposed to be pulled over our eyes so people would...
1) Spend money to not make things worse
2) Investors invest in financial stocks so they would in effect be bailing out the banks rather than more government money...

Does that mean the stock rally is over now? The pump job is over???

Jul 06 06:08 AM

[User 353732:]

It is not that the markets are in denial about increasing unemployment/underempl... looming inflation and new waves of credit defaults, including muni, state and sovereign defaults, but that with the consent of Washington, Dc the equity and bond markets have been successfully manipulated.
It is the retail investor and the ordinary American citizen, wilfully deceived and misled by our political, media and financial bosses who is in denial.
As a dismal economic Spring has turned into a worse economic Summer in the US and across many parts of the world, this denial is gradually and grudgingly yielding to reality.
Slowly and reluctantly ordinary people are starting to conclude that there has not been a chicken in every pot for many long months and there will be no chicken in every pot for many painful quarters ahead. There are far more pots than there are chickens.
Current Government policy is to steal, slaughter and redistribute chickens while penalizing and oppressing the chicken producers. If enough Americans come to understand and believe this, no amount of economic propaganda and pretence can keep equity and bond markets from reflecting most of the truth about joblessness, inflation and credit default . The commodity markets, in this regard ,have been much better at reflecting the truth about the consequences and obvious limits of US, EU and Japanese economic fantasies and policies.

Jul 06 06:24 AM

[nobby73:]

I agree with the comment about Treasury markets being the key, but this will be the heart of the battle between those who wish to continue this charade that the current prices are an indicator of the state of the economy and those who believe the market should be allowed to adjust to reflect basic economic principals such as supply and demand.

I expect the next stage will be to introduce further restrictions into our "free and unfettered" markets, so that all we can do is buy overprices equities or Treasuries with what is actually a negative real yield, whatever the CPI data may suggest.

Anyway, as for making money in the near term, either bet with the bullshit or sit it out...

Jul 06 06:54 AM

[TradingHelp...:]

"Vice President, Biden, misread the economy". Too true but also, I misread how intelligent the kings of Wall Street were. I knew the box-tickers in government were pretty stupid, That's a given. But I thought there was enough intellectual substance in Wall Street (and London etc) to avoid a systematic collapse in the financial and banking sector.

I am as guilty as Joe Biden. He knew the economy as well as I understood Wall Street's level of intelligence - not well enough.

I humbly suggest I am not alone.


On Jul 06 06:08 AM $ John Galt wrote:

> 16 months of rising unemployment, half a year worth of Obama, green
> shoots, and now we hear our Vice President say they misread the economy.
>
> www.bloomberg.com/apps...;sid=aZy7bvgx1f7I
>
>
> Did they "misread" the economy or were we in a "crisis of confidence"
> where the wool was supposed to be pulled over our eyes so people
> would...
> 1) Spend money to not make things worse
> 2) Investors invest in financial stocks so they would in effect be
> bailing out the banks rather than more government money...
>
> Does that mean the stock rally is over now? The pump job is over???

Jul 06 07:08 AM

[adenovir:]

When Obama took office he talked down the economy for some time because the didn't want to be held responsible for the severe credit recession that he inherited. Right wing blowhards like Larry Kudlow bloviated that he was too negative and that he should stop being so pessimistic.

After a while, Obama started to be a bit more optimistic to avoid being labeled a doom'er and gloom'er by the Kudlows of the world.

Obviously, our economy remains in the toilet. Obama knows it but also knows that a little hope can go a long way. The only recovery that we've seen is a bit of stimulus, massive govt guarantees on credit to keep things moving a bit and a maxing out of the rate of decline (terminal velocity).

Biden, with his chronic foot-in-mouth disease was trying his best to explain the strategy that they have pursued.

Bottom line: there has a been a lot of talk, a little action and we continue to slide. Nothing anyone can do will make a huge difference at this point, the only hope is to spin it so that the blame doesn't get pinned on you.


On Jul 06 07:08 AM Michael Young wrote:

> "Vice President, Biden, misread the economy". Too true but also,
> I misread how intelligent the kings of Wall Street were. I knew the
> box-tickers in government were pretty stupid, That's a given. But
> I thought there was enough intellectual substance in Wall Street
> (and London etc) to avoid a systematic collapse in the financial
> and banking sector.
>
> I am as guilty as Joe Biden. He knew the economy as well as I understood
> Wall Street's level of intelligence - not well enough.
>
> I humbly suggest I am not alone.

Jul 06 07:17 AM

[LilBob:]

The real problem with our economy is that we're too productive. Given the productivity of the American worker, and advances in the division of labor and the productive capacity of machinery, we're able to produce everything that the nation needs to consume, as well as a healthy surplus for export, using a relatively small fraction of the population. Unfortunately, this threshold creates a negative feedback loop that results in increasing unemployment, ergo declining consumption, ergo increasing unemployment... There are many potential solutions to this problem, but the root problem will always remain the same: we're able to produce too many goods and services while the capacity of the general public to consume those goods and services is in rapid decline.

Jul 06 07:19 AM

[ain't no fo...:]

We continue to attempt to quantify the "new normal" that has been injected into our economic reality the past 2 years. We wonder "Where and when will unemployment bottom out", when a more relevant question is "what is the REAL unemployment level to begin with... is it the U-3, the U-6, John Williams' Shadow Stats? Somewhere in the middle?"

And "How long will this nebulous level of unemployment stick around its lows?" "What will be the new level of Nairu once we (presumably) come off the lows and some sort of economic "recovery" gains traction?"

There are a vast number of American consumers living in a terrifying shadowland where they are afraid to spend, afraid to invest, afraid to make any type of major change in their consumption and life style patterns for fear that they too will be sucked into the widening unemployment vortex in all its iterations and conflicting definitions and lose what remaining assets they may feel fortunate to still possess.

And so they, and the American economy in toto sit frozen in place, waiting for the next news headline, the next neighbor to tell them in embarrassed, hushed tones that he has just lost his job, that there are no new prospects, no meaningful savings, that at best his house will have to be thrown into a huge whirlpool of similar houses for sale in thousands of neighborhoods throughout America.

Many millions of American workers wake up every day wondering whether today will be THE day that their life changes for the worse with one quick summons to their supervisor's office, and so America's once powerful economic engine sits paralyzed, as banks don't loan, and consumers don't buy, and businesses don't borrow for growth, and there are no clear signs on the horizon that we can snap ourselves out of this bad dream for a long while to come.

And nowhere is this dynamic playing out more tragically than in the ranks of the American middle class which was once the lifeblood of an economic miracle that was the envy and model for the world.

Jul 06 09:55 AM

[John Lounsbury:]

Michael Young and adenovir - - -

I am always in the dark. I try to follow Eleanor Roosevelt's advice and "light a candle rather than curse the darkness", but the wind keeps blowing out the candle. I keep going at that bloody stone wall, nonetheless, and keep applying icepacks and bandages to my head.

wpdragon - - -

You ask, "what is the REAL unemployment level to begin with... is it the U-3, the U-6, John Williams' Shadow Stats? Somewhere in the middle?"

I try to address that question today in seekingalpha.com/artic...

Jul 06 12:07 PM

[The Aft Deck:]

The problem with the current Economic policy is it contains no economics, it is just politics.

Jul 06 12:13 PM

[MichaelJ007:]

I agree w/ LilBob's point of "Overproductivity". We overproduce and overconsume frequently, what's worse is that we build upon this framework as the Norm for our consumption. Houses, autos, electronics, and homegoods are the perfect example. The problem is we've overallocated our means of production to goods and services that the demand has recently dramatically decreased. Our business model and economies of scale (14 mil new cars a year) for producing those goods has just completely crashed. we can try to prop up our dying business model all we wan't but it WILL NOT WORK. America has to reinvent itself as a producer of Techonology and Alternative Energy. That would be the most entrepreneurial thing to do... btw, wasn't that our claim to fame a few decades ago?

Jul 06 04:02 PM

[Graham and ...:]

The American people are being misled by their economic and political leaders because most of them want to be.

Jul 06 06:49 PM

[ain't no fo...:]

Thanks John. I made my way over there - it was a great article and well worth the time invested in reading through it.


On Jul 06 12:07 PM John Lounsbury wrote:

> Michael Young and adenovir - - -
>
> I am always in the dark. I try to follow Eleanor Roosevelt's advice
> and "light a candle rather than curse the darkness", but the wind
> keeps blowing out the candle. I keep going at that bloody stone
> wall, nonetheless, and keep applying icepacks and bandages to my
> head.
>
> wpdragon - - -
>
> You ask, "what is the REAL unemployment level to begin with... is
> it the U-3, the U-6, John Williams' Shadow Stats? Somewhere in the
> middle?"
>
> I try to address that question today in seekingalpha.com/artic...

Jul 06 10:52 PM

[perceptions...:]

I agree, Denial, Deceipt, Deflation & Defaults, followed by Deleveraging and possibly Depression!

In all, a Dismal result for Democracy, thanks to all, in Dc!


On Jul 06 06:24 AM User 353732 wrote:

> It is not that the markets are in denial about increasing unemployment/underempl...
> looming inflation and new waves of credit defaults, including muni,
> state and sovereign defaults, but that with the consent of Washington,
> Dc the equity and bond markets have been successfully manipulated.
>
> It is the retail investor and the ordinary American citizen, wilfully
> deceived and misled by our political, media and financial bosses
> who is in denial.
> As a dismal economic Spring has turned into a worse economic Summer
> in the US and across many parts of the world, this denial is gradually
> and grudgingly yielding to reality.
> Slowly and reluctantly ordinary people are starting to conclude that
> there has not been a chicken in every pot for many long months and
> there will be no chicken in every pot for many painful quarters ahead.
> There are far more pots than there are chickens.
> Current Government policy is to steal, slaughter and redistribute
> chickens while penalizing and oppressing the chicken producers. If
> enough Americans come to understand and believe this, no amount of
> economic propaganda and pretence can keep equity and bond markets
> from reflecting most of the truth about joblessness, inflation and
> credit default . The commodity markets, in this regard ,have been
> much better at reflecting the truth about the consequences and obvious
> limits of US, EU and Japanese economic fantasies and policies.

Jul 07 01:57 AM