A Global Problem with No Solution

Mohamed El-Erian, the CEO of Pimco, sent me a note this morning which sums up the dire straits of the economy, as revealed in today’s employment report, in one sentence:

The problem is that very few people in DC are thinking of this as a structural challenge. Until they do, there is little basis for the sketch of a potential solution.

Here’s the issue: unemployment is at 10.2%, and broader underemployment is at 17.5%. For the foreseeable future, both of them are going to be extremely high — it doesn’t really make much difference, at the margin, whether they’re going up or down. Financial markets are used to looking at first derivatives, but in this case it’s the absolute level which is important.

When you’re unemployed, you don’t spend. So long as unemployment remains high consumer demand will be depressed. That’s going to be true even if the savings rate starts dropping, thanks largely to the enormous debt burden that US consumers have already placed upon themselves. That’s important for the US economy, and it’s also a major sea-change for the global economy. As El-Erian says in today’s FT:

There is one public good that needs to be replaced: the key role that the US has played as the engine of global growth. This role is now constrained by the debt of US households.

The implications of this are huge. If the US no longer drives the global economy, then the rest of the world will be much less inclined to fund its twin deficits to the tune of trillions of dollars per year. Meanwhile, the high unemployment rate means that the Fed is going to keep the Fed funds rate at or near zero, which bodes ill for the dollar. These are huge forces, acting in an extremely complex global financial system, and you don’t need to be Nassim Taleb to know that the end result of such a state of affairs is likely to be large, unpredictable, and potentially catastrophic.

Which brings me back to Washington. Here’s El-Erian again:

The best defence against these outcomes is early recognition and coordinated action. Key economic powers must shape their expectations and policy strategies to the changed contours of the global economy. They must also actively manage policy changes at the national and multilateral level in a way that broadens the provision of global public goods.

They must, yes. But will they? I fear — and clearly Mohamed fears too — that the answer is no. So far I’ve heard nothing out of Washington which says to me that the White House has a plan for addressing long-term structural problems in terms of unemployment, capital flows, and interest rates. A lot of these problems have been around for many years, and most of them have been diagnosed sharply at one point or another by Larry Summers. So it’s not like Washington is oblivious to what’s going on. But we’re at the limits of what monetary policy is able to achieve, and the nation cannot afford to repeat the monster hit to the US fisc which we’ve seen over the past couple of years.

Maybe, then, there simply isn’t a solution: the problem is just too big, too complex, and too intractable. It’s a depressing conclusion, but also a pretty compelling one.

Comments

[tunaman4u2:]

"When you’re unemployed, you don’t spend"

When they are on continued benefits... they sure can

Crush the dollar will get people further into debt as interest rates rise & wages don't outpace cost increases...

Its going to be uglier later... people are spending now & will spend less later when benefits for unemployment have to run out

Nov 06 11:43 AM

[a fat panda:]

Soapbox please.... (Sorry I just get tired of the whole its too big to fix nonsense.)

There is a solution, innovation. Change the way you produce goods and look to put them into larger markets. It is called capitalism. I get so tired of hearing ... "There is no silver bullet". The problem we have is that our leaders (in politics and business) don't even have the creativity to make up their own cliches.

And I know I am going to hear give me an example. Here is an example of a way to help the housing crisis. It isn't going to fix it in its entirety, but the point is that if you have enough drops you will fill the bucket even if it is "tooooo biiiiiggggg aaaaannnndddd tooooo ccccccccoommmpllllexxx".

seekingalpha.com/insta...

The biggest problem with the TARP is that it is trapping capital in the hands of the visionless.

Nov 06 11:54 AM

[Alex Filonov:]

How about a bigger global problem? Consumption in the most countries is at much lower level than in US. If other countries aren't going to pick up on consumption, who is going to buy all this stuff made? In other words, if consumption isn't going to grow in the world, economy is going to stay in the slump.

Nov 06 12:00 PM

[morph366:]

"I’ve heard nothing out of Washington which says to me that the White House has a plan for addressing long-term structural problems in terms of unemployment, capital flows, and interest rates"

Over the last 9 years since the Nasdaq bubble popped the White House, Fed and its various incumbents have had a plan - keep encouraging the financial sector to find new bubbles to inflate.

Nov 06 12:57 PM

[Al-USA:]

Good article and I agree, the "gig" is up.

There is no solution within the limits of the profit system, none. Been there tried that, as the historians among us know. Other than a massive expansion into new markets, like the opening up of the New World by the European capitalists in the 15th century, or the opening up of China, and then the former Soviet territories, forget about it.

We can't even try what worked last time the limits of the profit system were reached in the 1930's, World War. I mean, imagine the conclusion to that among combatants armed with nuclear weapons. Sure, there will be massive profits to be made in the reconstruction later, but who will care? As Eisenstein said in reference to a nuclear Third World War, "I don't know how WWIII will be fought, but the fourth will be fought with sticks and stones."

However, for the hear and now, get your shorts ready, because from now on, the "easy" money will be made on the downside as, sad to say, the unfolding Greater Depression sinks into the consciousness of the masses.

Nov 06 03:06 PM

[user396040:]

Structurally, we need a much better educated work force. We also need a value added tax to give our industry a level playing field in the international market. Why not adopt a value added tax and go to the Japanese system of school 12 months a year taught by teachers paid 6 figure salaries.

Nov 06 04:53 PM

[Tony Petroski:]

This is from the article quoting Mr. Mohammed:

"The best defence against these outcomes is early recognition and coordinated action. Key economic powers must shape their expectations and policy strategies to the changed contours of the global economy. They must also actively manage policy changes at the national and multilateral level in a way that broadens the provision of global public goods."

This can't be the best Keynesianism and demand-side economics can offer. Because if it is, I'm turning in my We are all Keynesians Now card.

You've had more than a year. Unemployment is over 10%. The G-20 has issued 1413 memos. I guess it will have to get back to making things profitable for those who produce stuff.

Nov 06 04:54 PM

[redven02:]

As a person from outside the US, I am appalled by the level of immaturity in the debate on financial direction - there seem to be just the two extremes, namely, the perception of complete government control that eliminates the "free market" or laissez-faire capitalism. The simple fact is that both government and private enterprise have evolved for a reason and they both complement each other. The US until the "everything-should-be-run as a corporation" philosophy took hold in the late 80s and 90s was a great example of how the model works. The government pumped money into various projects - Eisenhower's interstates, Kennedy's space program, Reagan's military spending - that created excellent infrastructure and new technologies but the projects were executed by the private industry. In other words, the government furnished the money to the industry but provided direction to ensure that what was produced had value. Thus, the government borrowing was truly invested to produce long term value. However, in the 90s, the Republican philosophy was to pump money into the private sector through low interest rates and low taxes with the only message being that the private sector was to make more profit, and that would be good for everybody. And sure enough, the private sector did just that very efficiently - it inflated real estate and created CDOs and MBSs and high-frequency trading and shipped real production to China and outsourced to India and made money for the sake of money until it woke up one day and said this money isn't worth anything because we're now a nation of BSing sales guys who don't really know how to make anything of value that someone else can't make cheaper.

The fact is that government's horizon is long-term (around 40 years) while the private industry's is short term (it should be 4 - 5 years, but has degenerated into a circus based on quarterly earnings). A great example is the internet which just turned 40. In 1969, a couple of universities in California, funded by the government, sent a couple 1s and 0s between two computers. I can just see the "no government, free enterprise" clowns going "Where's my ROI??" in 6 months and canning the project. But 40 years later, the companies that are actually doing well in the US are Google and Cisco. In fact, the research that led to Google was funded by the National Science Foundation. One fact that is rarely mentioned by the "government is bad" camp is the fact that US government is probably the best venture capitalist. However, the recent trends in the country towards short term results and anti-intellectualism don't bode very well for the future.

The debate should make sure that both government and private industry play their roles. It takes a certain amount of trust in both institutions to allow this to happen effectively. I'm always perplexed by Americans who toot the "world's greatest democracy" line while saying that they absolutely do not trust the government.

The world has learned a lot from the US and in general has adopted a lot of the things that made the US successful. I do hope that the childish quibbling will give way to a more thoughtful direction for the future, one in which a great country can find its greatness again.

Nov 06 11:13 PM

[Greame H:]

Waaaaaaaaaaaay too much common sense in these comments. The great masses dont want to hear this message and nor do the politicians ( hmm, they may just be irrelevant ! ) Someone mentioned above about "small drops".....yes, to some extent thats true. The old capitalist adage about self help, take care of yourself first, ........at the mega level, it does work. But until people get really scared and get off their duffs and start working and innovating again, the structural changes needed to put the economy on a new sustainable path, just wont hppen. And, if we let the currency debase too much and the inflationary seeds grow, then coming out of this will be SO MUCH worse. Suck it up people and bite the bullet.


On Nov 06 04:53 PM user396040 wrote:

> Structurally, we need a much better educated work force. We also
> need a value added tax to give our industry a level playing field
> in the international market. Why not adopt a value added tax and
> go to the Japanese system of school 12 months a year taught by teachers
> paid 6 figure salaries.

Nov 07 08:27 AM

[bob adamson:]

Very well said, redven02!!

Nov 07 07:38 PM

[VanceHammersly:]

I'm not entirely sure the world's environment can handle another economic boom. Would a few years of decreased commerce be that entirely bad? It seems to me innovation moves just as well during recessions and expansions. Let clean technology have a chance to move forward before we ramp up production again. No growth should be far preferable to stupid growth, at least in the long run. Political suicide yes, but worth noting.

Nov 08 03:16 AM

[BRUCE E. W.:]

When the health of the US economy is equated through the central currency flow of either Wall Street or the Financials & Big Banks it tends to read the corrections as one dimensional equations reinforced by market logic.
If the complexity of a "unified field theory" for the sectioned; segmented; inverted; reverted; stratified; factioned and fractioned, and then still fragmented into reactionary and counter-reactionary activities in cross-sectional and interdependent "markets" were truly possible; it is doubtful that you could just throw money at it to solve its impingements, excesses or gridlocks with a simple flow chart writ large.
Isn't it quite possible that when a system of fiat currency has been so disjointed it can have dillution problems with liquidity crisis at one or several interacting levels, while it has counterproductive constriction and interdependent solvency problems interacting at other spectrums of essential economic segments?
Until we begin to assess a comprehensive and interactive vertical WITHOUT a DIRECTIONAL BIAS (up/down demand / supply) along with interactive factors from horizontal measures,... these "classic economic terms" for banking and finance do more to "razzle & dazzle" than actually provide handles on a healthy correction for a stable All American Economy (let alone a model for a Global base and reserve). Perhaps worse, they just keep pushing us from one end of "WRONG" to the other!

Perhaps the Fed should do something tailored to the contemporary issues instead of the 1920s and its politically loaded class factional history.
A selected variable set of interest rates directed at different segments of finance might be a consideration. Why should the rate of borrowing to refinance a bad debt be the same as the rate to build a new office building or add to a constructive infrastructure? If debt rates were differentially programed for the desired effect , everything from residential and commercial neccessities to a full gamut of "less vital" essentials (increasing debt...pure speculation) could be graded. Why can't the "cost" of money be ajusted to be a market itself!

This is the innovative fiat capital of the world. Why can't we have a differential "smart rated" differential interest rate for selected sectors? Obviously "universally cheap" money is not going where we want it, so why not mark the bills and follow the money as we would if it were authentic investment capital?

One of the reasons Mr. El-Erion has on his side is that his domain of bonds are more closely linked and secured as an asset class. The interests of PIMPCO should be taken with caution, but the suggestion of a "structural" solution speaks more to a substantive resolve and implies a "comprehensive" appraisal that is truly systemic. As long as a small group of Economic Theorists are trying to secure their perceived world and their political economic theories, we will continue to get more of the same. If we are to break this feeding chain we must start with a dissection of the economies that make up our markets and begin to appraise them one segment at a time...with appropriate remedial actions that can be reassesed and for real measurable results and continual positive guided adjustments for the optimum desirable outcome.

Nov 08 03:48 PM