The 27 Million Persons in Job Stress, Financial Regulation and Failures of Economic Policy

The 27 Million Persons in Job Stress, Financial Regulation and Failures of Economic Policy
Carlos M Pelaez

The objective of this post is to analyze the job stress in the US that is increasingly being related to failures of economic policy. Section I considers the 27 million persons in job stress; II analyzes the failures of economic policy and III financial regulation; financial turbulence is documented in IV, economic indicators in V and interest rates in VI; VII concludes.
I The 27 Million in Job Stress. Economic policy appears to be failing at least in the most important task, which is employment creation, requiring more effective policy strategy. The nonfarm payroll survey finds 125,000 job losses in Jun with a decline of temporary workers employed in the Census 2010 by 225,000 and an increase in private-sector payroll employment of 83,000 (http://www.bls.gov/news.release/pdf/empsit.pdf ). The unemployment rate of the household survey stood at 9.5 percent while the civilian labor force fell by 625,000 because people desisted from finding a job. Thus, the unemployment rate fell not because more people found jobs but as a result of 625,000 people dropping out of the labor force by interrupting their job searches. In the past two months more than one million persons dropped out of the labor force, stopping the search for jobs because of various factors such as the end of unemployment benefits that forces them to engage in job-searching, returning to school to bridge the difficult times and so on while the US population increased by 361,000 (http://blogs.wsj.com/economics/2010/07/02/why-did-the-unemployment-rate-drop-2/ ). There were 27 million people in job stress composed of: 14.6 million unemployed (of whom long-term unemployed of 6.8 million or 45.5 percent who have been unemployed more than 27 weeks), 8.6 million working part-time because they could not find a better job, 2.6 million marginally attached to the labor force (who wanted and were available for work and had search for work in the prior 12 months) and 1.2 million discouraged workers (who believe there is no job for them or had not searched for work in the prior four weeks). The most relevant period for comparison of the current situation is not with the Great Depression much the same as pointed out by Franco Modigliani relative to a speech in 1981 in which President Reagan “began by suggesting that ‘we are in the worst economic mess since the Great Depression,’ a statement than an objective review of the situation would find highly exaggerated” (Franco Modigliani, Reagan’s economic policies: a critique. Oxford Economic Papers 40 (3), 399). Modigliani’s arguments apply currently to exaggerated statements by government officials and others comparing the current crisis to the Great Depression (Pelaez and Pelaez, Regulation of Banks and Finance, 198-217). The rate of unemployment increased from 6.3 percent in January 1980 to a peak of 10.8 percent in December 1982, declining at year end to: 8.3 percent in 1983, 7.3 percent in 1984 and 7.0 percent in 1985 (http://data.bls.gov/PDQ/servlet/SurveyOutputServlet ). The problem is that the current rates of economic growth are not repeating those in the expansion after the 1980s contraction. US GDP increased in the current expansion at the annual seasonally-adjusted percentage rate of 2.2 in QIII09, 5.6 in QIV09 and 2.7 in QIII10 (http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=2&FirstYear=2009&LastYear=2010&Freq=Qtr ). These rates of growth may be insufficient to recover full employment. In the recession of the 1980s the quarterly annual percentage rate of growth of GDP was: -7.9 QII80, -0.7 QIII80, 7.6 QIV80, 8.6 QI81, -3.2 QII81, 4.9 QIII81, -4.9 QIV81, -6.4 QI82, 2.2 QII82, -1.5 QIII82 and 0.3 QIV82. During the recovery phase GDP grew at the quarterly annual percentage rate of: 5.1 QI83, 9.3 QII83, 8.1 QIII83, 8.5 QIV83, 8.0 QI84, 7.1 QII84 and thereafter at rates in excess of 3 percent. The quarterly annual rate of growth of -6.4 percent in QI82 was followed a year later by 9.3 percent in QII83 while the quarterly annual rate of growth of GDP of -6.4 percent in QI09 is followed a year later by only 2.7 percent in QI10.
II Failures of Economic Policy. The fiscal stimulus of over $1 trillion, the monetary stimulus of the Fed balance sheet of $2.3 trillion with the objective of reducing long-term interest rates (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1 ) and zero interest rates of fed funds since Dec 2008 have failed in recovering the economy and employment. The most effective redistributive policy during recessions is job creation and strong labor markets not the use of taxation and stimulus for redistribution of income and wealth that causes job losses and weak labor markets. The uncertainty shocks of restructuring major economic activities and future increases in taxes and interest rates are frustrating growth and job creation. Alan H. Meltzer finds that the stimulus has not worked as planned, resulting in low economic growth and high unemployment (http://professional.wsj.com/article/SB10001424052748704629804575325233508651458.html?mod=WSJ_hp_mostpop_read&mg=reno-wsj ). The fact that the administration is requesting another dose of stimulus constitutes an admission of the failure of the larger stimulus provided by the American Recovery and Reinvestment Act of 2009 (ARRA). The failure of the stimulus is attributed by Meltzer to two major factors. First, the administration did not calculate carefully the costs of finding long-term solutions to problems, resulting merely in wasteful spending of taxpayer money instead of stimulating the economy. Second, uncertainty in the costs of doing business by legislative restructurings in multiple sectors created adverse expectations that frustrated investment and job creation. A case against the administration’s fiscal stimulus is provided by Jeffrey Miron (Harvard Journal of Law and Public Policy 33 (2, Spring 2010)). There are three important issues in this analysis. First, the stimulus by government spending was $787 billion provided by ARRA. Government spending may occur too late to have an impact on recovery because of the delay in implementation and the lag in effect after disbursement. Second, government spending may be less effective than private investment that takes into account the discounted or present value of benefits net of costs. Private decisions may be more effective in allocating resources to activities that increase jobs in the private sector while also promoting long-term economic prosperity and employment. Martin Feldstein analyzes a variety of tax policies: introducing an investment tax credit to stimulate business investment; increasing the R&D tax credit to prevent decline in R&D expenditures; reducing the corporate tax to levels comparable to other countries to induce job-creating investment in the US; and maintaining low tax rates on capital gains to induce increases in stock prices that could recover consumer wealth, stimulating spending that would create jobs (Martin Feldstein, Rethinking the role of fiscal policy. American Economic Review 99 (2), 556-9). Meltzer and Miron consider alternative stimulus routes such as reductions in corporate income taxes during the Kennedy-Johnson administration and the Reagan administration that eliminate the double taxation of corporate profits first as profits in the balance sheets and then again as dividends in the returns of shareholders. The resulting business investment and spending would create new jobs. The type of stimulus may be more important than the size. ARRA used stimulus in “shovel ready” public works, energy efficiency and research that has very limited and short-lived impact in job creation. Third, spending was allocated to multiple restructurings of economic activities for alleged long-term benefits, which were also rushed and not based on their benefits relative to costs. The agenda focused on the restructurings, neglecting job creation. The prolonged period of job stress in the short and medium term erases the benefits of restructuring most of the economy for alleged long-term benefits.
The Wall Street Journal provides clear and informed analysis of the US fiscal situation (http://professional.wsj.com/article/SB10001424052748703426004575338991852947182.html ). The government increased expenditures sharply to 25 percent of GDP while tax revenue declined from 18.5 percent of GDP in 2007 to 14.8 percent of GDP in 2009, remaining at nearly the same level in 2010. The strategy for adjustment of the fiscal deficit is by increasing taxes such as a trial balloon of a value added tax and perhaps a federal energy tax. Another possibility is an increase of the tax on the income, dividends and gains from capital but it is possible that general tax revenue may fail to increase because the reductions in those taxes caused an increase in tax revenue of 44 percent between 2003 and 2007. At the very best the strategy would attain a balanced budget. There is vast literature on the effects of spending and taxes. A revealing essay by Olivier Blanchard and Roberto Perotti concludes that: “we find that private investment is consistently crowded out by both government spending and, to a lesser degree, by taxation; this implies a strong negative effect on private investment of balanced-budget fiscal expansion” (Quarterly Journal of Economics 117 (4), 1363). The “balanced-budget fiscal expansion” is popularly known as “tax to spend.” The problem of the restructurings of economic activities from the private sector to the government is the frustration, or crowding out, of private investment by government investment that is not typically based on sound cost/benefit criteria. The uncertainty generated by legislative restructurings is resulting in a slower US economy that will be less efficient and internationally uncompetitive in the long term. Nearly all employment creation in the US is created by the private sector. The continuing strategy of “tax to spend” may create permanent conditions of 27 million people in job stress. The unemployment rate will decline by people dropping from the civilian labor force. There is high need of reevaluating the economic policy of the US by eliminating the crowding out of private investment in order to generate required economic growth needed for employment creation and sustained prosperity. There is a critically important role for government intervention (Pelaez and Pelaez, Government Intervention in Globalization, 1-12) but this role has to be balanced more toward the government providing the structure of services and regulation required for investment in employment creation by the private sector. Large-scale spending on infrastructure financed with taxes crowds out the private investment required for job creation that can alleviate the plight of 27 million persons who are willing to work but cannot find employment and the rapidly growing number of those that are not counted in the labor force because they desisted in finding a job.
III Financial Regulation. John B. Taylor is the author of a must-read book on how government policies caused, deepened and prolonged the credit/dollar crisis and global recession (http://www.amazon.com/John-B.-Taylor/e/B001IQZHL2/ref=sr_tc_2_0?qid=1278096179&sr=1-2-ent ). Taylor’s analysis finds that the Dodd-Frank regulation threatens growth of the economy (http://professional.wsj.com/article/SB10001424052748703426004575338732174405398.html?mod=WSJ_Opinion_LEADTop&mg=reno-wsj ). The law will reduce bank capital and financing, raising interest rates and flattening the expansion path of the economy. The Dodd-Frank bill was already approved in the House and appears that will also be approved by the Senate. The complexity of the 2319 pages of the bill is as worrisome as the multiple sections and subsections (Ibid). An important deficiency found by Taylor is the misdiagnosis of the causes of the financial crisis. The various regulatory agencies had powers to avert the crisis and prevent its deepening by controlling the alleged causes of the crisis on which the Dodd-Frank bill is supposedly based. There is no sound argument for additional powers to agencies that did not use the existing ones in preventing and resolving the crisis by acting on the causal and propagation factors alleged in the erroneous crisis analysis of the architects of the bill. The Fed has superior staff and board members who have the knowledge in the frontiers of research on systemic risk such that the creation of a new office of research on systemic risk is a waste of taxpayer money. Bailouts are not eliminated but rather institutionalized in the powers given to the FDIC to liquidate companies. In fact, the bill sanctions the “too politically important to fail,” beginning with open-ended bailouts that may eventually cost one trillion dollars for Fannie and Freddie. The bill may make unviable currently viable individual financial entities and maybe the entire financial system. Overall, the Dodd-Frank bill will make the financial system more prone to crisis. The Bureau of Consumer Financial Protection may cause the same reduction of credit lines and increase of interest rates as the CARD (Credit Card Accountability, Responsibility and Disclosure) Act of May 2009. The chair of the board of directors of a savings and loan bank in Ohio finds that the Dodd-Frank bill will cause the end of community banking by arbitrarily preventing loans to creditworthy clients (http://professional.wsj.com/article/SB10001424052748703964104575334611037072320.html?mod=wsjproe_hps_LEFTWhatsNews ). The Dodd-Frank bill will restrict the financing of innovation by entrepreneurs that has been the major driver of US economic growth and prosperity, accentuating the vulnerability of the financial system to crises. There was a set of four government policies that interacted with each other in creating excessive risk, low liquidity, short-term financing, high leverage and unsound credit: (1) near zero interest rates of fed funds in 2003-2004; (2) suspension of auctions of 30-year Treasuries in 2001-2005 to lower mortgage rates; (3) housing subsidy of $221 billion per year; and (4) purchase or guarantee of $1.6 trillion of nonprime mortgages by Fannie Mae and Freddie Mac (Pelaez and Pelaez, Financial Regulation after the Global Recession, 157-66, Regulation of Banks and Finance, 217-27, International Financial Architecture, 15-18, The Global Recession Risk, 221-5, Globalization and the State Vol. II, 197-213, Government Intervention in Globalization, 182-4). The Dodd-Frank bill is not based on correct analysis of the causes of the credit crisis, rendering it worthless in its intent of preventing the repetition of another financial crisis. The valid parallel of the Dodd-Frank bill is with the rush to regulation in the form of the Banking Act of 1933 (12 U.S.C. § 371a) that prohibited payment of interest on demand deposits and imposed limits on interest rates paid on time deposits issued by commercial banks. The consequence of the Banking Act of 1933 and Regulation Q was the exporting of banking from New York to London (Pelaez and Pelaez, Financial Regulation after the Global Recession, 57-8).
IV Financial Turbulence. Major stock market indexes continue to fall (http://online.wsj.com/mdc/public/page/mdc_us_stocks.html?mod=topnav_2_3010 ). This is not typical behavior of equities during expansion phases of the business cycle. The percentage performance of major US indices was: DJIA -13.6 from the recent peak on Apr 26 to Jul 2 and -4.5 in the week; S&P 500 -16.0 from the recent peak on Apr 23 and -5.0 in the week; and NYSE Financial -20.3 since Apr 15 and -6.4 in the week. The percentage performance of major world stock markets from Apr 15 to Jul 2 was: Dow Global -18.4 and -6.7 in the week; Dow Asia Pacific TSM -12.5 and -3.1 in the week; Shanghai -24.7 and -6.7 percent in the week; and STOXX Europe 50 -15.3 and -4.3 in the week. The euro strengthened, trading at $1.2560/EUR on Jul 2. The dollar has gained 20.4 percent since the recent trough relative to the euro on Nov 25, 2009, but lost 1.5 percent in the week. The DJ UBS commodity index fell 14.5 percent since the recent peak on Jan 6 and lost 3.7 percent in the week. The European Central Bank (ECB) appears to have made the transition from the non-renewal of the one-year 1 percent facility to 90-day facilities (http://professional.wsj.com/article/SB10001424052748703426004575338334107767598.html?mod=wsjproe_hps_MIDDLEThirdNews ). The three-month dollar LIBOR is virtually unchanged at 0.5336 percent and the LIBOR-OIS spread, measuring willingness to lend among banks, was also stable at 33.63 basis points, much higher than before the financial turbulence but without further deterioration. The swap spread measures the difference between the swap rate of floating for fixed-interest payments and the 2-year Treasury yield, widened slightly by 0.87 basis points to 37.25 basis points (http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=a97fGOdOIyDU ). These critical indicators of financial risk climbed to higher levels during the financial turbulence but have remained stable in the week.
V Economic Indicators. The most encouraging information is about continuing expansion in industry but with an apparent slowdown. Conditions in housing markets continue under pressure. Employment continues softer than would be expected after three quarters of GDP growth. Personal income increased by 0.4 percent in May and personal consumption expenditures (PCE) by 0.2 percent; real disposable income increased by 0.5 percent in May and real PCE by 0.3 per cent (http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm ). The business barometer index of the Chicago Institute of Supply Management (ISM) stood at 59.1 in Jun relative to 59.7 in May (https://www.ism-chicago.org/chapters/ism-ismchicago/files/ISM-C%20June%202010.pdf ). The ISM purchasing managers’ index (PMI) declined from 59.7 in May to 56.2 in Jun (http://www.ism.ws/ISMReport/MfgROB.cfm ). There may be some deceleration of global demand as suggested by the PMIs of various major economies (http://www.ft.com/cms/s/0/fa81dd7c-8536-11df-9c2f-00144feabdc0.html ). New orders of manufactured goods fell by 1.4 percent in May after eight consecutive months of increases (http://www.census.gov/manufacturing/m3/prel/pdf/s-i-o.pdf ). The pending home sales index of the National Association of Realtors (NAR) dropped by 30 percent on contracts signed in May after three consecutive monthly increases as buyers took advantage of the fiscal credit expiring in April (http://www.realtor.org/press_room/news_releases/2010/07/phs_drop ). Construction spending fell in May by 0.2 percent and was down by 8 percent relative to May 2009 (http://www.census.gov/const/C30/release.pdf ). The 10-city S&P Case-Shiller index of house prices is higher by 4.6 percent in Apr 2010 relative to Apr 2009 and the 20-city by 3.8 percent relative to a year earlier. Improvements in housing markets may only occur in 2011 (http://www.standardandpoors.com/indices/sp-case-shiller-home-price-indices/en/us/?indexId=spusa-cashpidff--p-us---- ). Initial unemployment claims in the week ending on Jun 26 increased by 13 thousand to 472 thousand from the revised prior week’s 459 thousand (http://www.dol.gov/opa/media/press/eta/ui/current.htm ).
VI Interest Rates. The US yield curve continues to shift downwardly as investors exit risk and move funds to the temporary safe haven of Treasuries, other sovereign bonds and highly-rated mortgage-backed securities and corporate debt. The 10-year Treasury yield declined to 2.98 percent on Jul 2, substantially lower than 3.11 percent a week earlier and 3.35 percent a month earlier. The 10-year German government bond traded at 2.58 percent for a negative spread of 39 basis points relative to the 10-year Treasury (http://markets.ft.com/markets/bonds.asp?ftauth=1278151076312 ).
VII Conclusion. The most important issue in the agenda of the United States is alleviating the dramatic situation of 27 million people who are unemployed or underemployed involuntarily in part-time occupations. Many more are dropping from the labor force by stopping their job searches. The fiscal stimulus of $1 trillion, the Fed balance sheet of $2.3 trillion and the zero interest rate on fed funds since Dec 2008 are failing in promoting faster economic growth that can create jobs. Policy should be reoriented toward reducing the crowding out of private investment by government spending and reduction of uncertainty in business decisions. The most effective redistributive policy with this high level of 27 million people in job stress is inducing the private sector to create jobs. (Go to http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10 )