Is the Fed Predicting Economic Stagnation for the US?

By: Gerard Jackson | Sun, Jul 5, 2009
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For sometime now I have been pointing out that things would be bad, not because I prefer gloom to joy but because the Fed's disgraceful monetary shenanigans over the years made the current situation inevitable. In the meantime, the profoundly ignorant Obama and his statist cronies are making things far worse. And what do we get from the Fed? Well, allow me to refer you to Janet Yellen, President of the San Francisco Fed, who opined that the US can look forward a very slow recovery marked by high unemployment.

What was particularly interesting was her other comment: "It's not outside the realm of possibility that the fed funds rate could stay at zero for the next couple of years". It seems to me that Yellen is telegraphing economic stagnation. When a sustained recovery gets under way interest tend to rise. Keeping rates low for too long would cause inflation to accelerate forcing the Fed to prematurely slap on the monetary brakes. So if the Fed thinks it will have to keep rates low for at least two years one must presume the worse. This cannot be goods news for Obama, let alone the rest of the country.

I predicted that this recession would be different. Economic laws never change but governments do -- and the Obama administration has created the most anti-business climate since Roosevelt, which definitely proves that elections have consequences. The monetary rule of thumb is that manufacturing should start recovery six to nine months after a monetary expansion begins. The stock market usually responds within the first quarter. Well, we got our monetary injection last year, and the job situation is still deteriorating while manufacturing -- which is now down to 65 per cent capacity -- is still contracting. How can this be so? The yield curve is very steep indicating that monetary policy still remains extremely loose.

Pundits are pointing to "green shoots" and other "bright spots" as evidence that recovery, no matter how sluggish is under way. But it all sounds very desperate. What they cannot point to is evidence of a broad-based recovery. Despite so-called green shoots there can be genuine recovery while unemployment continues to grow. Judging by some the articles I've read a few commentators still expect monetary policy to kick in any day now. They point out that thanks to Bernanke the banks are holding about $800 billion in excess reserves.

They believe that when this money finally comes down the pipe consumers will be able to jump-start the economy. But this is not how it works. Monetary policy operating through artificially low interest rates has always stimulated recovery through manufacturing, never through consumer borrowing. Moreover, lending out the banks' excess reserves would cause the money supply to explode resulting in surging inflation and a depreciating dollar. Even if the Fed were able to engineer a consumer boom this would only succeed in keeping manufacturing depressed. So what we need to know is why manufacturing in particular and business in general is not borrowing. Economists should always keep in mind the fact that

while there is always some rate of money interest which will check an eager borrower, there may be no rate of money interest in excess of zero which will stimulate an unwilling one. (D. H. Robertson, Banking Policy and the Price Level, Augustus M. Kelley, 1989, p. 81, first published 1926).

We already have part of the answer: manufacturing is still contracting. The economic punditry has frequently written of financial imbalances. What it doesn't realise that even more importantly there exists real imbalances. I think these imbalance -- distortions in the capital structure -- are so severe that it is taking a considerable time to liquidate them, a vital process that the administration's fiscal policy is seriously retarding.

The continuing rise in unemployment is, I believe, clear evidence that the liquidation of these malinvestments is still proceeding, which brings us back to the unemployment situation, a situation that is even more dire than the statistics suggest. We now know that the average number of hours worked per week has dropped to 33, the lowest in 40 years or so. What this means is that if the working week had been maintained the official unemployment rate would probably exceed 12 per cent, meaning that underemployment is keeping the official unemployment figures down.

That the situation is still deteriorating was rammed home by the fact that not only were 467,000 jobs lost last June but business investment plummeted by 37.3 per cent in the first quarter. When an AP reporter asked Obama's opinion on last month's job losses he replied with the incredibly asinine comment:

If we're weatherising every building and home in America, if we are creating windmills and solar panels and biofuel facilities, that is a huge promising area not only for jobs here in the United States, but also for export growth.

This is pure unadulterated rot. What he is proposing will -- if fully carried through -- result in the massive destruction of capital and a savage cut in living standards.

 


 

Author: Gerard Jackson

Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes economics editor.

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