Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve System in a speech given at Jackson Hole, Wyoming on Friday defended the record of his tenure in the position he now holds, indicated his belief that the economy is not growing as rapidly as he would like to see it grow, and hinted that further monetary easing might be forthcoming…as early as September.
Jon Hilsenrath, of the Wall Street Journal, left little doubt what was emphasized in the speech:
"Federal Reserve Chairman Ben Bernanke offered a robust defense of the effectiveness of the central bank's easy-money policies in his Friday speech at the Fed conference in Jackson Hole, Wyo., and left little doubt that he is looking toward doing more to give the economy a lift at the Fed's next policy meeting in September."
In terms of the state of the economy, Bernanke referred to the minutes of the August meeting of the Open Market Committee, indicating that the Fed had not changed its view of the economy during the month of August. In terms of when more action might be taken by the central bank, the emphasis is on the next meeting of the Open Market Committee on September 12 and 13.
The interesting point in the speech to me was Bernanke's discussion of the weakness in the labor market. The Chairman indicated that he…and others at the Fed…believe that problems in the labor market are still just cyclical and not structural in nature.
Hilsenrath calls reference to this in his article:
"Importantly, the Fed chairman also says that the job market's weakness, to date at least, is the result of cyclical problems in the economy (that is, a lack of demand) and not structural problems (such as a mismatch between the skills people have and the skills employers are looking for.)"
The specific reference from Bernanke's speech:
"The unemployment rate remains more than 2 percentage points above what most FOMC participants see as its longer-run normal value, and other indicators--such as the labor force participation rate and the number of people working part time for economic reasons--confirm that labor force utilization remains at very low levels."
But, the Chairman continues:
"The literature on this issue is extensive, and I cannot fully review it today. However, following every previous U.S. recession since World War II, the unemployment rate has returned close to its pre-recession level, and, although the recent recession was unusually deep, I see little evidence of substantial structural change in recent years. "
The problem with this conclusion is that the unemployment rate does not include in its calculation workers that have left the labor market, who either are not seeking a job at the present time or who have a part-time job and would like to have a full-time job. The economy can, therefore, return "close to its pre-recession level" within a worsening situation for the labor market as a whole.
The problem is that since the 1970s, almost every cyclical swing in the unemployment rate has always left more people "underemployed" than in the previous "pre-recession level." That is, the under-employment rate has increased in a secular fashion over the last forty years or so.
Another fact supporting this secular decline in under-employment is the data on the capacity utilization of manufacturing facilities in the United States. This economic series was begun in the latter half of the 1960s. The recovery in capacity utilization during every recovery since the 1970s has been at a lower peak than in the previous recovery.
In the current recovery, after three years of economic expansion, capacity utilization still remains below the level it was at its previous peak.
Both of these series indicate that over the past forty years there has been a secular decline in the utilization of both labor and capital in the United States. Consequently, I would argue, very strongly, that many of the problems the United States economy is facing at the present time are of a secular nature and not just of a cyclical one. If this is true, further monetary actions to "goose up" economic growth will have little or no effect but will just add more monetary assets to the economy that will have to be dealt with at a later time.
This "mis-focus" to me is reminiscent of the "mis-focus" of the Federal Reserve…and the federal government…during the recent financial crisis. Colm O'Shea, a global macro hedge fund trader (in an interview written up by Jack Schwager in his new book "Hedge Fund Market Wizards") states that "The big mistake people were making (in 2008 and beyond), and still make, was to confuse liquidity with solvency." (page 25) As a result, central bankers…and others…focused on the inability of people to sell assets and not on the fact that the assets were "underwater." (This is something I have written about a lot over the four years that this blog has been in existence.)
Mr. O'Shea, as he relates in the interview, made a lot of money during this time because, "If you started with the premise that there was a solvency issue, they everything that happened was straightforward." (page 26) Obviously, if you thought the problem was one of liquidity, everything that happened did not "make sense" and you, generally, could not make a lot of money off of it.
In my view, Mr. Bernanke and the Federal Reserve, are making a major mistake if they believe that the problems in the economy are just cyclical in nature and do not have a structural cause. Consequently, in my view, for the Fed to try and provide further stimulus to the economy at this time is unnecessary…and will not accomplish much positive.
However, as an investor, we need to look at the situation from the perspective of Mr. O'Shea. If Mr. Bernanke and the Fed are wrong in their interpretation and do attempt to gain further monetary ease, it will create interesting investing opportunities for those that can take advantage of it. I will discuss some of these potential investing opportunities in an upcoming blog post.
I have a hard time "making sense" out of what is happening assuming that the situation in the labor market…and in capacity utilization…is just cyclical in nature. However, when I put the existing situation within the context of a secular story "everything that happened (is) straightforward"…to quote Mr. O'Shea.