Our Limping Economic Recovery—Posner

In my first book on the economic crisis (A Failure of Capitalism: The Crisis of ’08 and the Descent into Depression), which was completed in February 2009, I argued that the crisis should be called a depression rather than a recession, in part because of the enormous debts that the government was assuming in an effort to overcome the crisis. In my second book (The Crisis of Capitalist Democracy), completed in January of this year, I further emphasized the potential long-term adverse consequences of the crisis, and argued that a depression or recession should not be considered over until GDP rejoins its growth path. GDP in real terms is essentially unchanged from what it was two and a half years ago (2007), which means it’s roughly 7.5 percent below the growth path (which assumes 3 percent real growth annually), and suggests that it will be years before the economy gets back on it.

 

I continue to insist that this is the proper way to evaluate an economic crisis. Most journalists and many economists believe that the “recession” as they like to call it (or “Great Recession”—indicative of a mindless proliferation of labels) ended in the third quarter of 2009, when GDP began to increase, after having been flat in 2008 (though falling sharply in the last quarter) and falling in the first half of 2009. But the current performance of the economy, and the likely political and long-term economic consequences, convince me that we are in the midst of a depression, much as we were in 1936 (before a sharp drop in 1937–1938), even though the economy had grown rapidly since the bottom of the depression in 1933.

 

Why is the economy so sluggish at present? The basic reasons are, I think, first, the reduction in household wealth, due to the fall in housing and common stock values (with the fall in housing values precipitating many foreclosures); second, the high rate of unemployment, underemployment, and reductions in wages and benefits; and third the continued weakness of the banks.

 

The reduction in household wealth increased the amount of leverage (debt-equity ratio) in consumers’ personal finances, and consumers have been deleveraging by increasing their personal savings rate (which has increased from 1.7 percent three years ago to 6.4 percent today), leaving them with less money for consumption. One might think that today’s very low interest rates would discourage savings, but the other side of this coin is that savers must increase the amount of their savings in order to obtain the interest income they obtained when interest rates were higher.

 

With less consumption, there is less production and hence less private investment. These effects are being compounded by the weakness of the labor market from the perspective of workers, which reduces incomes and, by increasing insecurity, increases the propensity to save. And while banks are making good profits because of the very low interest rates at which they can borrow, they continue to hold many sick assets (mainly investments in home and commercial mortgages) on their books, making them reluctant to lend. And anyway loan demand is way down. Most borrowers from banks are either small business or consumers (large businesses tend to borrow by issuing bonds or commercial paper rather than by taking out banks loans), and neither group is in the mood for increasing its indebtedness.

 

One spur to recovery from a depression is the need to rebuild inventories and replace durable goods that have worn out. This need may explain, along with the stimulus program enacted in February 2009, the growth in GDP that began in the third quarter of 2009 and seems now to be fading. As long as demand for consumption goods is weak, sales will slow after inventories are restocked and worn-out durable goods are replaced. Modern products tend to be highly durable and inventories tend to be much smaller than they used to be, so one cannot expect these standard spurs to economic recovery to have much staying power.

 

The uncertainties and long-term debt created by the Obama Administration excessively ambitious domestic programs (notably health care and financial regulatory reform) on top of the deficit spending of the Bush years, the plunge in federal tax revenues resulting from the depression-induced decline in taxable income, and uncertainty about which Bush tax cuts will be allowed to expire in the coming year, have impeded private investment. They have done this by exacerbating concerns about what the economic picture will look like both in general and for individual businesses and consumers in the next several years, and perhaps much longer.

 

A further worry is the volatility of the stock market. The tendency is to view the market’s gyrations as reflections of changing estimates of future corporate earnings and of efforts by investors in the market to guess what other investors are likely to do. But when as at present a large fraction of the population has a significant part of its savings invested in the stock market, market volatility increases economic anxieties and thus dampens spending.

 

As long as private investment and interest rates remain very low, there is a case for further stimulus (deficit spending), especially since federal stimulus spending has been offset to a degree by reductions in state and local government spending. Cautious or fearful consumers save in safe forms, such as insured bank deposits, Treasury bills, or cash. Such savings are inert; under present conditions they do not get translated into productive investment, since banks are reluctant to lend but instead keep most of the deposits they receive in either cash or government securities. The government, to whom no one is afraid to lend, could put all these inert savings to work on infrastructure and other projects that would employ the unemployed.

 

That is in principle, but because the Obama Administration botched the design, execution, and public relations of the $862 billion stimulus program (President Obama, despite his undoubted eloquence and intelligence, has proved to be a poor explainer of his economic policies), and because of the soaring public debt (to which the stimulus contributed), there is no political stomach for a further stimulus of any consequence.

 

What is to be done? With Congress in recess and the mid-term elections looming, probably very little. The best hope may be that  the President’s bipartisan deficit commission (the National Commission on Fiscal Responsibility and Reform) will issue a first-rate report. (Its report is due December 1.) If the commission, chaired by President Clinton’s chief of staff, Erskine Bowles, and former Republican Senator Alan Simpson, produces an economically sound and politically palatable program for restoring the nation’s long-term fiscal soundness—a program to which far-reaching tax reform will be central—this may alleviate economic uncertainty and encourage more consumption and private investment in the near term.

Comments

[Tom Rekdal]

If our present economic problem were simply a matter of private debt weighing on consumers, this story would have a happy ending, because that debt is coming down one way or another.

The more serious issue is the trajectory of public debt, both national and local. We are already broke as a nation. There is simply no way that our promises to Social Security and Medicare, at the national level, or public pensions at the local, can be met with minor tinkering in spending and taxes. This reality is concealed by a deluded bond market which assumes that we will eventually fix the problem.

What are the odds of that? Fixing the problem would mean developing a national consensus on (a) the size of the welfare state we mean to have, and (b) a tax structure that would pay for it with minimal damage to economic growth. Our constitutional structure fragments power and was designed to prevent exactly such a consensus from ever forming. Obviously, I cannot be certain that such a consensus will never materialize, but I am skeptical. Color me part of the problem

[Dennis Tuchler]

The problem with coming to a consensus, at least among those whom we hire to make decisions, is this: representative democracy. Given the desire for election, the voter will not be given any useful information by those who run for office. Given the desire for reelection, the representatives will not come together on a sensible plan for recovery so long as those whose money the representatives need for reelection will be offended by such a plan.

[back relief seeker]

@ Dennis Tucher...I totally agree with you said.

[ffxiv gil]

This story would have a happy ending, because that debt is coming down one way or another.

The more serious issue is the trajectory of public debt, both national and local. We are already broke as a nation. There is simply no way that our promises to Social Security and Medicare, at the national level, or public pensions at the local, can be met with minor tinkering in spending and taxes. This reality is concealed by a deluded bond market which assumes that we will eventually fix the problem.

What are the odds of that? Fixing the problem would mean developing a national consensus on (a) the size of the welfare state we mean to have, and (b) a tax structure that would pay for it with minimal damage to economic growth.

[tina]

i agree with you, it is so vogue wiki!!!

[Hyena]

I fail to see how concerns about marginal tax rates or the long term debt position of the US government have much impact on economic growth going forward.

There are two lines of reasoning which lead to this point, fundamental and empirical.

Fundamentally, the only thing that increases in marginal tax rates do is reduce personal capital available for investment. They do not impact the cash-on-hand of a business nor, really, are they necessarily significant for business owners, the investments into their own business being neatly deductible. Even if the owners were worried about maintaining their real rate of pay, the obvious conclusion is to aggressively expand the business. That the long term debt position of the government would dominate in an actuarial environment where business survival is unlikely within three election cycles is utterly laughable. That's like a 20 year old with a 20% chance yearly of contracting a terminal disease being worried about heart disease in his 50s.

Empirically, neither factor can be said to dominate. The Bush tax cuts were passed into an uncertain environment and were set to expire. So too were Reagan's tax cuts set to increase as they had cut deeply into finances of the government. Likewise, under both administrations you saw massive increases in the public debt. Business was, however, largely bouyant in its opinions, though in the latter case it was markedly less so in actual performance.

When dealing with the opinions of businesses you have to separate raw partisanship--most business owners are Republicans--from actual business decisions, about which politics generally means little.

[sam vinson]

Professor Becker and Judge Posner touch on some incisive points. Perhaps Posner's point about the stimulus being badly botched is most important. Battery factories in Holland, Michigan? increased Medicaid reimbursement rates for states? If the original Obama stimulus program or a second one focused on reducing the capital gains rate, an investment tax credit for business, reducing the corporate tax rate, or a permanent reduction in high income rates, it would have or still could trigger a V-shaped boom. Instead, it was a program designed by the best thinking of Robert Reich,Paul Krugman and Moveon.com.

An analysis that uses as a hypothesis "Even if the owners were worried about maintaining their real rate of pay", is very demonstrative of the mythological world this stimulus was designed in. Of course business owners are worried about maiuntaining their real rate of pay--but only when government has gotten so bad that hopes of increasing it are pollyannish.

The creators, builders, makers, and manufacturers will check back into this economy when DC begins to make it worth their while. And that requires an anti-trust division that stops creating uncertainty by the bushelful, a political culture that recognizes that growth in an industry is good not bad (think healthcare), and an understanding that you cannot deal with unemployment by more government hires.

The program we have witnessed "invested" (read, expended)more money than the first two Soviet 5 year plans combined with predictable results.

Remember, in 1981 the first Reagan year, the GDP was $3 trillion; in 2008, the last Bush year, it was $14.5 trillion. Nearly 5 times greater. It may be that prices are not perfect. They certainly are enormously preferable to command and control.

While I was initially derisive of Judge Posner's use of the D word in describing the American economy, the uncertainty created by this government does rival that of FDR and may condemn us to a 30 years of missed opportunity. Hopefully, in less time someone like JFK will come along to say "we can do better" and will cut business taxes. And perhaps he will be the heir of a smuggler of liquids (probably petroleum) as well.

[Gordon Longhouse]

It would be nice to be able to say that all you have to do is push this, pull that, and twist the other and your problem will be over and then to denounce as silly and/or interested any unable to see the obvious wisdom of these solutions.
I don't think that it will be all that easy for the US because of the factor identified by Posner: excessive debts have not been worked off only disguised.
Many borrowers are still under water on their mortgages which means that many banks are underwater also even if they have not recognised it.

Instead US banks are borrowing from the Fed at zero and lending to the US government at 2% effectively making money from nothing and so repairing their balance sheets. Small wonder there is nothing left for small business. Until they have balanced their losses with arbitrage profits banks won't get back into the business of lending money to people who want to spend it or invest it.
The US is in diabolical trouble now because it used its borrowing capacity, both private, business (any one remember "lazy balance sheets") and government, in the period prior to the the GFC when borrowers least needed to borrow.
Now would be a good time to borrow against previous austerity but there is none.
Now the US is faced with either paying off previous debts to in order to lay the ground work of future prosperity at the cost of contraction of consumption and therefore production today or maintaining or increasing debt which probably will only result in the postponement of the inevitable showdown. Who is going to get it in the neck\; those who borrow or those who lend?

[rose]

ed hardy

[Hyena]

@Sam

I've actually never met anyone who was seriously involved in business--though I've met a number who fancy themselves "consultants"--who ever made a decision based on the hotly debated policies in Washington, least of all personal tax rates.

The most common concern is industrial standards and regulations. Things measured in ppm, not news cycles.

For most entrepreneurs and business owners, this is their career. Running companies is what they do. They aren't about to pack it up because of the top marginal rates--which most, in fact, don't pay--anymore than some Republican attorney is going to stop chasing the brass ring because of a 4% increase in their tax rate.

[Jeff]

Agree with the comments on compromise. There is no compromise between large government and a free market.

We ought to reform the tax system to make it flatter, with less write offs, and much lower marginal rates. Combined with doing away with the cap gains tax, and a lower corporate tax.

On the spending side, end corporate subsidies, like crop supports, and many other un needed govt. programs.

The only way out. Otherwise we slip into permanent western european socialism

[anewhope]

Although I don’t think the end of the world is coming, I’d be lying if I didn’t think the value of the US Dollars could drastically drop during in the next couple of years. This could be the equivalent of the fall of American Civilization. I hate being pessimistic but it seems foolish to not think about it. And it isn’t just the American economy, but Europe’s and Asia’s economies as well. For example, when Greece’s economy collapsed in May 2010 it brought down the value of the Euro throughout Europe. It was only because of England buying 1 billion dollars worth of Euro bonds that the damage done to the European economy was reduced. Rebecca Costa discusses in her new book “The Watchman’s Rattle” how human insight is the key to solving the complex problems and recognizing which human behaviors actually prevent optimum decisions from being made. It might be a problem with no solution, but doing nothing is definitely not an option.

[luckcat]

hello i am chinese i want make your friend sorry my english is not very good my MSN is :hb1140qw@msn.cn
that is all http://www.sz-shandao.com/

[TwoPlusTwo]

Indeed Hyena, there does not seem to be visible widespread change of behavior on part of innovative and top producing people in America. Do you see the Steve Jobs’ dropping like flies? No. So how is the economic misery that Backer and Posner allude to, going to come about? It will come about through the VICIOUS CYCLE.

THE VICIOUS CYCLE:

While there is no widespread feeling that productive people are dropping out of the economy like flies, at the margin, some productive people will retire a little earlier, some will work a little less and spend more time with their families, some will take more sabbaticals in the Caribbean, some dual income families will revert to single income, some overtaxed Californians will move to lower cost areas and relax into being a little less productive etc.

While these will not be drastic changes in behavior, there will be some minor loss of productivity, let’s say just 2% to make an example. While a 2% loss in productivity, is not an enormous amount, it will nonetheless be felt to some mild extent by the entire nation, through somewhat lower prosperity, somewhat higher unemployment, and somewhat higher economic distress in general. And how does typically the population respond to economic distress? By voting for a little more class warfare, a little more regulation, a little more central planning, all further productivity incentive reducing measures which then decrease productivity by another 2%. Thus you have the unstoppable VICIOUS CYCLE. A cycle which has started moving the enviable US standard of living towards worldwide mediocrity.

But, unlike what most people may think, this is not just our children’s problem. Things move fast in the 21st century, and accelerating. Therefore, unless you have a life expectancy of 5 years or less, it is your problem too. The vicious cycle will accelerate soon. I doubt that it will take more than 5-10 years to see significant, detrimental and unfortunately irreversible, changes. And our comments will be here to re-read.

[The Recapitulator]

Its classic Fisherian debt deflation. Judge Posner is correct in admonishing the Fed Gov not performing its role as "spender of last resort" in a recession.

As for the notion of the nation being "broke", I find that deficit hysteria is largely misguided. In my view, taxation is merely a demand management system, and Fiscal spending injects "money" into the economy. It simply changing numbers in spreadsheets.

Furthermore, the U.S. does not need to "get" dollars to "finance" fiscal spending. Since deflation is the major risk here, the Fed Gov should worry less about inflation and "spend".

But how should it spend? Not from top-down sources like silly stimulus bills, rather, it should lower payroll taxes to zero immediately and let aggregate demand recover organically.

[Brian Davis, Austin, TX]

I agree that the bond market is "deluded." There's a valuable piece on page C-1 of today's WSJ about the banks' $17 Billion exposure to Fannie and Freddie for poorly-underwritten boomtime mortgages and mortgage-backed securities that the GSEs are "putting back" to sellers, issuers, and mortgage insurers. We're a long way from resolution. That's why the banks are afraid to make loans. That's why the Fed's still selling them free money. In an economy that was 70% consumption-driven, you decide, you calculate how much of aggregate U.S. "wealth" MUST have been floating on leveraged real estate - in particular home - "value." I.e., debt-inflated value. Cash with which to repay the debt is evaporating as rapidly as cash with which to pay taxes. We're well into DEFLATION. Wall St investors with cash are chasing anything that smells like yield. Main St Americans who still have a job are stuffing their dollars into the mattress. Confidence is gone. There must be resolution; there must be pain. We know it from the Panics of the late 19th Century and the Great Depression of the 1930's. I wish I could see daylight but it's not there.

[Web Design Norwich]

Great article.

[anewhope]

Why do we have a tendency to fight one another when we know sharing results in the most optimum outcome for everyone? How does our biology cause us to hurt the ones we love, hoard resources and compete with one another.
http://www.facebook.com/video/video.php?v=1493017207106

Here's the Facebook community page with 8 other videos

http://www.facebook.com/thewatchmansrattle

[Van Gogh]

interesting what you got goin on here. could you share a few pointers maybe? im sturggling to get my blog even off the ground. you have my email if you don't want to post it here for everyone to see

[jeux motorola]

This story would have a happy ending, because that debt is coming down one way or another.

The more serious issue is the trajectory of public debt, both national and local. We are already broke as a nation. There is simply no way that our promises to Social Security and Medicare, at the national level, or public pensions at the local, can be met with minor tinkering in spending and taxes. This reality is concealed by a deluded bond market which assumes that we will eventually fix the problem.

What are the odds of that? Fixing the problem would mean developing a national consensus on (a) the size of the welfare state we mean to have, and (b) a tax structure that would pay for it with minimal damage to economic growth.

[asset protection]

it's not actually a recovery that we're in. the greater depression is inevitable, and it's on hold.

[chudai]

i was exited about obama administration for tax, still no hope.

[John Jones]

Bernanke likes to remind everyone that he is an expert on the great depression and knows how to prevent it from happening again in the US. Apparently he is also an expert on Japan and its struggle with chronic deflation following its housing bubble in the 1980's. In fact Bernanke wrote an article in 2000 titled "Japanese Monetary Policy: A Case of Self-Induced Paralysis," where he goes on to lecture BOJ officials about what they could and should have done differently in order to to avoid a deflationary outcome. He goes on to postulate that the BOJ was not trying hard enough to stimulate the economy and that 0% interest rates are just one tool to beat deflation. The Fed Chairmen even goes so far as to assert that he knows how to escape a liquidity trap caused by 0% interest rates. The reason I bring this up is because it gives people a good idea of what Bernanke's next move may be. The US is dangerously close to falling into the dreaded "liquidity trap" as deflation takes hold and monetary policy loses its effectiveness.

Here are some of his suggestions to the BOJ:
http://blackswaninsights.blogspot.com/2010/08/bernanke-explains-how-to-escape.html

[grinder mill]

Your opinion is very unique

[Account Deleted]

A young and energetic student with average academic has done wonders in the field of science. Little did he know then, that his love for the subject would win him world wide appreciation. His contribution has given a new face to science.
--------
Ebooks With Resell Rights