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The Distorted Shape of Our Emerging Recovery

Hints are emerging. The Baltic Dry Index is up, UPS sees a bit more traffic and multinational corporations are starting to do much better, especially from their foreign operations. My take looking forward is that, domestically, unemployment is likely to rise, income will grow too slowly and dissention will at some point break out in Washington. The economists and policy makers that have been running the show are already beginning to lose credibility. It is happening slowing, but it is happening. Why is interesting.
Too many economists, either expressly or impliedly, operate off of a macro economic model to predict what is going to happen. As Milton Friedman said many times that is a bad idea because models are only a shabby shadow of the true economy, they ignore too much that is going on, their chronological view is too narrow and they don’t take politics into account. A savvy economist who studies the numbers, such as Nouriel Roubini and others, has a better sense of what is going to happen, than almost all the economists using models do. That is why Paul Krugman, a model man himself, wrote his introspective piece in the N.Y. Times on how was it so many economist got it wrong and did not foresee the financial crisis and seriousness of the recession that was coming. He missed the mark there, too. Roubini and several other didn't, but who was listening?
Considering how much such models leave out or ignore, it is not surprising at all. Consider what they ignore. They don’t consider – and the policy makers using them tend not to consider -- (1) the mega trade deficit and, more specifically, what we should actually be doing about it; (2) the horribly skewed distribution of income which has sucked the life out of the middle class (60% get 21% of the income) and which has sent excess income from the rich into worldwide financial asset markets to drive up prices, exacerbated by our low interest rate environment; (3) what is happening to the stimulus program and the monies we allocated for it -- another poor result and a disaster; (4) why TARP I and II were so expensive and have not worked to fix the banks; (5) the off-shoring of jobs, factories, tax base, etc by multinationals, globalizing their operations to avoid taxes and regulations, basically gutting too much of America’s industrial structure and killing much employment in the U.S.; (6) the mess with our banks and what to do about them as financial moving targets, etc, etc., etc,. Models are not equipped to deal with these most essential concerns because they don’t factor them in.
The importance of these issues and their implications for our economic welfare is why the present economists serving as our policy makers, who believe in models, along with Paul Krugman and others, are eventually going to lose favor and be replaced by people with more practical economic savvy who understand the issues that do matter and have some ideas on how to fix them. Unfortunately, it will be a late end game of catch-up, with a public that has largely lost confidence, not only in those people, but substantially in the present Administration and government as well.
The rest of the world, England excepted, will largely and more quickly recover than we will. For that reason, our big multinational corporations will do much better. They have off-shored jobs, factories and other overhead to avoid taxes, regulations and higher costs and they have also too much hopped off U.S. tax rolls as well. They will be sitting pretty, compared to most. Much of their revenue will come increasingly from the rest of the world and not as much as before from the U.S. 
The mess the multinationals have left behind of lost revenues, unemployment and empty factories will saddle the domestic recovery quite badly so that, with our large unaddressed trade deficit, the U.S. domestic economy will remain largely sitting in a hole. The problems of TARP I and II and the maldistribution of income push us into that same hole. All of these pieces are not in the economic models being used or on the radar screens of too many policy makers. They are coming back to bite us.
Larger companies, and some smaller ones as well, that do considerable business with the large U.S. and other multinational companies should also fare well in the distorted recovery coming and will provide much of the economic lift we will see in the U.S. Unemployment will hang like a shroud over our heads though, as we struggle to fix, expand and streamline the stimulus program and also to repair the banking system. Job sharing should emerge forcefully. Public patience with our efforts will become thin. Obama will become less and less popular. Republicans will smell blood. Wild suggestions about what to do will fill the air and print media. Talking heads on TV will have a field day. The demand for neckties should increase.
With larger declines in tax revenues, governments at all levels will have a tough time. Much government debt will be floated, along with substantial cutbacks in personnel. That will increase unemployment. Unemployment will also rise because too many people with jobs now are hanging on to them by a mere thread. If there is not a robust recovery in the U.S., even more will become unemployed. A second major wave of unemployment will accompany the realization that the U.S. economy is not recovering very well.
Many in Congress will get their walking papers in the next elections. Lobbying will come under more scrutiny. Taxes may need to be raised which would further slow a domestic recovery. There will be threats to the independence of the Fed. The core arguments will be that the Fed undermines economic stability, the Fed has failed to fix the banking system and the Fed has been financially imprudent with its policies. The Taylor rule stands a good chance of being adopted.
Whether we will seriously address our trade deficit problem remains to be seen. So far, we have kept our head in the sand. What or who might cause us to pull it out and seriously look at and fix the problem by whatever means necessary is not at all clear now. Tough measures are called for and presently we are not up to it.
Ultimately, the infrastructure stimulus program will be expanded, cleaned up and streamlined. It will be most effective in reducing unemployment in the interim. Americans will take heart from the improvements they see. But the problem of how to create longer term jobs will remain with us for some time.
Recovery of the world economy outside the U.S. and England, will certainly help, but until then, the infrastructure repair and maintenance work is America’s best intermediate hope. What the longer term solution is for unemployment in the U.S. is unclear, but it will certainly have to include making life much easier for small businesses in America. That has not even occurred to governments yet, but it is absolutely crucial.
Bubbles in one or another asset class will expand and contract. Crises of one type or another will come and go. If the Fed raises interest rates, financial asset prices will fall generally and there will be much consternation. If the Fed doesn’t raise rates, financial asset prices will continue to bubble up. The Fed is not likely to face that problem very soon or the problem of how to mop up excess liquidity in the banking system.
If and when the Fed does try to mop up, it will likely get it wrong, unless it is done in the context of FDIC-like reorganizations of the big money center banks. However, if the economy does not really pick up and unemployment increases, more bad loans will surface and banks will still need yet more help that the public will be reluctant to give them. Fixing the banks will be like shooting at a moving target. The situation is a vicious circle. Increasingly, it seems, banks will have to live off of their trading operations, Fed interest on their excess reserves and nickel and diming their customer bases.
We are in for some prolonged trouble, I'm afraid. Let's hope I am wrong and we are able to find our way blindly out of this mess. It is possible, but it is just not very likely.

Disclosures: none.