This morning, we have just witnessed dismal job creation in May. Only 69,000 jobs were added and the unemployment rate went up to 8.2%. Why is this recovery so slow and painful?
The current problem in the United States is not debt; it is insufficient investment. We need more government spending.
It is widely observed these days that businesses in the United States are hoarding cash. Going down the list of the Dow components, Caterpillar (NYSE:CAT), Microsoft (NASDAQ:MSFT), Johnson & Johnson (NYSE:JNJ), General Electric (NYSE:GE), Chevron (NYSE:CVS), and even Coca-Cola (NYSE:KO), are all building up cash pile without investing it to good use. The big banks, in particular Bank of America (NYSE:BAC), CitiBank (NYSE:C), JP Morgan Chase (NYSE:JPM), and Wells Fargo (NYSE:WFC) are all not lending enthusiastically.
Why? There are a few reasons.
First, uncertainty in the economy still exists. The Eurozone is a mess. Fear of bank runs has deteriorated, turning the recent crisis into chaos. If banks are not safe, what can businesses (including banks themselves) do? They have to keep more cash on their accounts. This is especially true in the case of banks. It is also a major reason why I think the banks are now much better buffered against a chaotic Europe.
Second, deflationary pressure is still high. The biggest risk after the housing bubble burst in 2008 was deflation. The Federal Open Market Committee, led by Ben Bernanke, did its work. While deflation has been kept in check, it is not going away. In particular, the historically low interest rate might have an unintended consequence. On the demand side of loans, borrowers still have tight pockets. They expect housing price to go down further, hence hesitant to borrow even at such low interest rate. The supply side of loans (i.e., banks) are not lending with enthusiasm because the low interest loans will not be very profitable in the long run -- the Fed will eventually raise the interest rate. Therefore, whatever the Fed does, it cannot resolve the lenders' concerns for future profitability.
Third, with a lot of cash and a not-so-profitable outlet in loans and mortgages, what would the financial institutions do? They put money elsewhere -- for example, to conduct proprietary trading for higher returns. The vivid example is JP Morgan's recent trading loss of at least $2 billion from a "hedging" department. Although it is hard to be sympathetic of the case, it is understandably a market driven event. If the long term mortgage rate stays this low, and borrowers still wouldn't (in some cases, couldn't) bite the bait quick enough, the hoarded cash will go chasing riskier bets.
So what is the solution?
The Fed has lowered the interest rate to virtually zero, and had two events of quantitative easing (QE). At this point, other than more QE, the Fed is running out of bullets. But QE doesn't work as well as it used to, mainly because the reason mentioned in point 3. Financial institutions are hoarding cash without lending it out. Like an old saying, "One can only lead the horse to water; one cannot make it drink." The Fed cannot force the banks to lend.
When the choices in monetary policy run dry, usually the fiscal side can help. In this case, the United States government should expand public programs and spend more money (but no more wars please). There are numerous ways the government can spend in sectors such as infrastructure improvements, education, and scientific research. Not only do such investments create jobs in the short term, they are also likely to generate long term positive returns to the whole economy. By spending more, the government elevates the inflationary pressure on the private sector, making it costly to hoard cash. A positive feedback loop is thus established. By the time business starts to borrow and spend, the economic recovery will be in full throttle, and the Fed can gradually raise the interest rate accordingly.
The current situation? The political environment makes it hard to increase public spending in the short term. The whole country has to move slowly with the political system. Maybe, just maybe November's election will bring some changes.