How Low Will We Go?: Long Term Perspectives on a Flailing Economy
By Robert E. Wright, Nef Family Chair of Political Economy, Augustana College SD
11:30 am, Friday, 24 February 2012, CJ Callaway’s Event Center (69th and Minnesota)
Nine days ago, at the Augustana Academy for Seniors, I delivered a speech called “Little Business on the Prairie: Exploring How Entrepreneurs Keep South Dakota’s Economy Vibrant.” That speech, which like this one is posted on my personal blog called finance history and policy dot blogspot dot com, that’s finance history and policy dot blogspot dot com, was about South Dakota’s economy and was much more upbeat than today’s pessimistic talk, which is about the national economic outlook. I fear that the national economy will remain in a funk – a period of no to slow growth – for a decade or more, perhaps, like Lenore, for evermore. That’s from Edgar Allan Poe’s poem “The Raven,” by the way. To invoke Poe once more, this time his place of death, I fear the entire U.S. economy will soon resemble that of Baltimore in the HBO Series The Wire – very po’ indeed. Seriously, barring a major natural catastrophe or war, the odds of America degenerating into third world-like poverty is slim but without major political reforms I think our economy is likely to slip into the same superpower retirement community inhabited by Persia, Rome, the Mongols, the Mayans, Holland, England, Japan, and so many other has beens.
The United States is the third most populous nation in the world behind China and India and has almost a 100 million more people than number four Indonesia, so it is going to remain an important player on the world stage for a long time to come. But if it continues down its current path it will not long remain the most important one, economically, politically, or militarily.
South Dakota may benefit from these changes, at least in relative terms, due to its entrepreneurial culture and pro-business economic climate. As you may know, famed economist Arthur Laffer and the American Legislative Exchange Council recently ranked South Dakota second, behind Utah, in overall economic outlook. South Dakota ranked first, of all U.S. states and Canadian provinces, in the Fraser Institute’s economic freedom index and the state has for seven years in a row ranked number one in the Small Business and Entrepreneurship Council’s small business survival index, well ahead of runners up Nevada and Texas. But no state can soar too far above the others without attracting enough people and capital to bring it back into orbit around the national economy. In other words, if the overall U.S. economy stagnates, so too will that of each of the states, at least eventually. The American Dream will die first but what consolation will that be when South Dakota’s Reverie follows it gently into that good night? That’s not Poe, by the way, and enough with the po-etry for today.
One particularly troubling sign that the state and national economies are stagnating is the recent rise in what was traditionally called sharp business practices. It’s not as apparent here in Sioux Falls as elsewhere but even our burgeoning little metropolis has its share of shysters. Several kiosks in the mall, the big one, have been selling shoddy quote unquote No Way products because there is no way the vendors will refund your money and no way the products should have been sold in the first place. And at least one major local car dealer is getting a reputation for overcharging for repairs. Well, overcharging even more than it used to. What is troubling is that those and other businesses engaging in sharp practices must not envision a more prosperous future on the horizon. They are trying to get as much as they can today even though they must know that if they persist in scamming their customers they will not be around tomorrow. As a business strategy that only makes sense if they are on the verge of bankruptcy or believe that the economy is.
Please keep in mind that I am not predicting that national economic stagnation must occur. There is nothing inevitable about it that I can see. Rather, America’s, and hence ultimately South Dakota’s, economic future hinges on its policies, which are ultimately a function of its politics. If numerous people argue persuasively that the economy will remain in a funk they may change public sentiments and politicians’ agendas enough to drive implementation of reforms that will break the funk and hence the nation’s relative economic slide. If that comes to pass, historians, decades hence, will chide and deride the pessimists not realizing that their vocal lamentations indirectly saved the nation’s economy, just as the wails of George Washington and Alexander Hamilton in the 1780s initiated the reforms that launched America on its modern growth trajectory a decade later.
I’d like nothing better than to regale you with a three hour lecture explaining how Hamilton et al turned an unstable, bankrupt, economic backwater into a major nation in a single lifetime. But if you are really that interested you could pick up my One Nation Under Debt, which is really reasonably priced on Amazon right now. Suffice it to say here that the U.S. implemented constitutions at the national and state levels that protected people’s lives, liberties, and properties without dipping very deeply into their pockets or intruding much into their day-to-day lives. Confidence in government led directly to the financial and corporation revolutions that made possible the agricultural, transportation, and industrial revolutions that transformed the continent into the most productive in history to date.
Reforms are necessary again today because current policies are clearly not working. The economy is showing few signs of growth in the short term, faces a major conundrum in the intermediate term, and the most important long term driver of growth, confidence in government, has disintegrated in recent years. If the economy does soar anytime soon, be on the lookout for yet another speculative bubble at the heart of it and signs of the financial cataclysm that must inevitably follow. Please allow me to explain the reasoning behind those claims in some detail.
Nobody can predict short run movements in the economy consistently and with precision but consensus economic forecasts are often quite accurate and go well beyond stock prices, which you may have noticed have been up recently. Just like they were in 1929 and 1999. The VIX, a stock market volatility index, is just a quarter of the level it was during the crisis of 2008, in fact at almost exactly the same level it was before the financial manure hit the fan that year. So it is difficult for me to rest easy simply because the VIX is low, or because the stock market is up.
Certainly watch the VIX and the equities markets -- the Dow, the S&P, and the Russell 2000 -- but don’t be a lemming. There are numerous other, more important economic indicators out there. In our 2011 book, The Wall Street Journal Guide to the 50 Economic Indicators That Really Matter, Simon Constable and I show that even lay investors can peer a few months into the future with some confidence by carefully studying the clues that the economy is constantly creating about its current condition and direction. Most of those clues or indicators are still showing signs of weakness and even the economy’s few bright spots could be, perversely enough, signs of its shaky condition. To call a turn in the economy, many forecasters like to see the so-called three Ps: pronounced, persistent, and pervasive movements in the data. Pronounced means large, persistent means a trend, not a random bounce, and pervasive means not limited to just a few indicators. Right now, the economy has zero Ps.
Let’s overview the short-term outlook in more detail:
1. GDP growth in 2011 was positive but still anemic. That means each person on average produced a little bit more than they did in 2010 but not by much. Some forecasts for 2012 are more optimistic but others are pessimistic and hardly anyone expects breakout growth. The headline for the Philadelphia Fed’s most recent survey of professional forecasters is quote Forecasters Predict Lower Growth and Higher Unemployment in 2012 and 2013. unquote
2. Unemployment has decreased of late, job growth is up, and new jobless claims are down. Unemployment, however, is still above 8 percent nationally and is likely to remain higher than optimal throughout the rest of the year. That means continued weak demand for consumer durables, more mortgage defaults, and continued stress on government budgets.
3. The Federal Open Market Committee’s promise to keep the Federal funds rate, its overnight interbank interest rate target, at almost zero for the foreseeable future suggests that the Federal Reserve and many investors remain pessimistic about the economy’s growth prospects this year. It also means that fears of future inflation and asset bubbles loom large.
4. The Federal Reserve’s January Beige book, its summary of current economic conditions, pointed to modest improvements in manufacturing and retail but also noted continued problems in financial services and real estate.
5. Consumer confidence grew steadily last Fall but has recently weakened again. Consumer spending was sluggish in December despite early claims to the contrary. Investor confidence also declined recently, mostly due to uncertainty about Europe. Small business confidence indicators are up, but only slightly. Business inventories are slowly building but remain lean.
6. Consumer credit recently jumped $20 billion, way above the consensus forecast. Some of the news here is good – about $5 and a half billion went to new car sales, which are showing a little life, probably because people like me are finding it too expensive to keep our old clunkers running. But the rest of the news is bad – people are running up their credit card balances again. That means that many of the little glimmers of hope we have seen recently may be the result of people running deeper into debt prior to bankruptcy. Our bankruptcy laws give people big incentives to do that now, you know.
7. Nonfarm productivity is at its lowest levels since 2008.
8. At just over 4 percent, Mortgage Rates are still a major bargoooon but Mortgage Applications are down over 3 percent. Existing Home Sales are up but only because Home Prices continue to erode. Nationwide, in January alone the median price fell 4.6 percent and the average price fell 4 percent. There are a few signs, like the recent improvement in the National Association of Home Builders’ housing market index, that a bottom nears. Inventories of Homes for Sale are down to 6.1 months, its lowest level since the crisis. Until housing prices actually regain some lost ground, however, more foreclosures and economically damaging lawsuits are in the offing.
9. Manufacturing is pretty strong, but largely because of last year’s earthquake in Japan and the weakness of the dollar, which has boosted exports for the third year in a row. If the dollar continues its recent uptick, manufacturing will probably hit the skids again.
10. The Non-Manufacturing index surged in January but it did the same thing a year ago before declining yet again.
11. Construction is finally showing signs of life but it is coming off extremely low levels of activity.
12. Gasoline demand is at its lowest levels since the financial crisis and of late demand for natural gas has been lower than expected, even adjusting for the mild winter.
13. The Philadelphia Fed’s Aruoba-Diebold-Scotti Business Conditions Index is slightly above zero but flatter than a prairie meadow.
14. The coverage of retail sales has been kind of humorous. When the weather is bad, analysts claim that sales are down because people stayed home. When the weather is good, the same analysts say that sales are down because people don’t need to buy winter clothes, emergency supplies, and so forth. How about sales are down because people don’t have much money and their credit cards are all maxed out? In any event, December’s numbers have been revised downward and January’s numbers were weaker than expected.
15. Last but not least, zombies still stalk the land. No, I’m not referring to the human flesh craving monsters that roam AMC every Sunday night at 8 Central, I’m talking about banks that are economically dead, that are technically bankrupt -- due in part to an ever growing inventory of foreclosed homes of dubious value -- but that remain on regulatory life support. Such banks, we learned during the S&L Crisis, will often take big risks to try to get their balance sheets back into the black. A few will succeed but most will not, further straining the financial system and the government’s elaborate but strained bailout net.
Zombie banks also cloud the horizon in the intermediate term because their existence increases what economists call asymmetric information. Banks don’t know which of their brethren they can trust and borrowers don’t know if they were turned down for a loan because they are a bad credit risk or because their bank is brain dead. Zombie banks can be overly litigious too. Instead of rationally settling debts caused by the continued gloom in the housing sector, they sue, and sue, and sue so some executive can book a quote unquote profit when a judgment is obtained. That’s a great boon for banks’ lawyers but destroys the credit of Americans with good incomes who pay their bills but who can’t get above water on their mortgages or who had to relocate because of a new job, a growing family, or the deterioration of their neighborhood due to all of the crackhead-infested, boarded-up houses that have not so mysteriously appeared in it over the past few years.
As the housing crisis grinds into yet another year, such frivolous lawsuits are growing in number and overall economic drag but policymakers are reluctant to address the problem in a significant way. A few weeks ago, for example, the government settled with five big banks accused of abusive foreclosure practices for a mere $25 billion. Homeowners helped by the legislation will receive around $2,000 each sometime in the next three years. A writer Forbes, not exactly a leftwing business periodical, called that sum a quote unquote spit in the bucket. The editors at equally radical Bloomberg agreed that quote the settlement amount is a pittance. Unquote A hundred, hundred fifty years ago any bank that systematically presented fake evidence to courts would have been liquidated, their directors sued into poverty, and their executives jailed.
Intermediate term growth prospects are also clouded by the possibility of inflation. If the economy ever heats up, the Fed will have to raise interest rates aggressively to stop the general price level from rising rapidly or another asset bubble from forming and that may stop the economy in its tracks. If the Fed doesn’t boost rates fast enough, the economy could suffer from a bout of stagflation, or high inflation, high unemployment, and low growth, similar to the 1970s. A decade ago, when confidence in the Fed’s ability to fine tune the economy was at its apex, the seriousness of the Fed’s conundrum would have been downplayed. Today, few would estimate the probability that the Fed can engineer a robust, low inflation expansion at much above one in three. That’s a big reason why gold is way up. The price of gold is off its highs but the precious yellow stuff is still up over 25 percent on the year and over 150 percent over five years ago. Investors buy gold when they fear inflation, perceive high levels of policy uncertainty, and/or foresee a period of civil unrest.
Civil unrest is not an impossibility because long term growth prospects are extremely weak. Anybody remember the 1960s? I don’t because I wasn’t born until the tail end but I heard the family stories about grandma Wright sitting on the front porch with a loaded side by side while rioters looted and burned stores just a few blocks away. And of course I’ve studied the history. A few more years of economic despair for our young adults and another round of bank bailouts, especially one widely perceived to have been caused by European fiscal profligacy, and it could be 1967-68 all over again. Hell hath no fury like someone with high expectations scorned. And while large scale rioting might help the manufacturers of riot gear, tear gas, billy clubs, and so forth, it is not good for the economy. The 1960s riots contributed mightily to the quote unquote malaise of the 1970s, which was just Jimmy Carter’s hokey term for the economy’s astonishingly low rate of productivity growth in that dreadful decade.
Economic growth is not about, and never has been about, jobs per se. Good jobs are a result of economic growth, not a cause of it. Economic growth is about efficiency, about producing the same quantity and quality of goods from less input: fewer hours worked, less energy wasted, fewer raw materials consumed. That means that prosperity is ultimately built on driving people into new lines of work and capital into new industries. The first factory operatives and miners were farmers made obsolete by improved agricultural techniques and tools, the agricultural revolution unleashed by the national and state constitutions and Hamilton’s financial reforms that I mentioned earlier. Likewise, today’s modern service economy is built upon the brains of the sons and daughters of factory workers, people no longer needed to build stuff due to sundry innovations in production techniques from Ford’s assembly line to robotics to just-in-time inventory systems.
So, again, what matters for long term growth is efficiency, doing more with less. Businesses and industries become more efficient only when people have incentives to work harder and smarter. The incentives are the main thing, not the particular technologies that they spawned. Americans invented, improved, or commercialized cotton gins, steamships, telegraphs, light bulbs, automobiles, mainframe computers, personal computers, the Internet, and literally millions of lesser inventions and innovations because they believed that they would be fairly rewarded for doing so. Americans were no smarter than other peoples – we’re just a genetic hodge podge and cultural stew of them anyway – but since the ratification of the Constitution we’ve been among the best compensated for enhancing efficiency.
Incentives to work harder and smarter, the long range drivers of the American economic miracle, are, however, deteriorating along with the Constitution. We seem determined to teach our children that the way ahead is to cultivate cozy relationships with government officials, create shoddy but clever products, foist them off on unsuspecting dupes, reap millions, and then take refuge in government bailouts and incompetence.
Many Americans now believe that they live in a very sophisticated kleptocracy. More obvious, more brutal kleptocracies, like Saddam’s Iraq, Fidel’s Cuba, Kim’s North Korea, Mao’s China, or Muammar’s Libya, to name just a few, remained extremely poor because nobody had any incentive to work harder or smarter for fear that they would lose their property or even their lives. Despite the passage late last year of the National Defense Authorization Act, legislation that allows the military to detain U.S. citizens on American soil indefinitely and without trial, most Americans are not yet worried about government-issued jack boots kicking in their doors late at night so they continue to go to work and school. But increasing numbers of them do perceive that income inequality is rising and civil liberties are weakening. They sense that the rich and politically powerful are more equal than the rest, so real wages are likely to flat line even as taxes increase. Life is still pretty good – as a conservative think tank recently pointed out, most Americans own things like TVs and refrigerators. But many people sense that conditions are not likely to improve no matter what actions they, as individuals, undertake, a fear effectively exploited in a recent TV commercial where a grandfather wonders aloud if his grandson will ever be able to own a big house like his. One of our hoariest and most useful myths, that of Horatio Alger and the self-made person, has passed into history and with it the innovations that would have reinvigorated our moribund economy.
A weak economy does not bode well for Obama’s re-election this Fall, which will sadden the Democrats in the room – both of you – and encourage the Republicans. But more and more Americans seem to be coming to the view that the nation’s economic trajectory does not rest on which party controls the White House, Congress, or even the entire government. Both major parties and the federal bureaucracy appear to be in Washington to help themselves, not to promote a vision of the greater good, however defined. That is why Congress’s approval rating is now 10 percent, lower than pornography, lower than polygamy, and even, I suspect, lower than polygamist pornography. The sense that politicians and government bureaucrats are in it for themselves is also why not one, not two, but three apostate political factions, the Tea Party, Ron Paul, and Occupy Wall Street, flourish.
Members of each of those factions know that the status quo is rife with serious problems but for ideological reasons focus their wrath too narrowly. Tea Party folks are riveted on government budgets. Taxes, deficits, and government expenditures are certainly important issues – some of you may know that I called for the creation of the Tea Party, albeit with a less stupid name, in a Los Angeles Times op ed way back in March 2008 – but as the movement evolved, entirely without my involvement I should add, it became partisan and ideological. Budget reform has proven intractable because members of both parties, as well as government employees of course, have incentives to borrow and spend. Instead of becoming the independent party opposed to both existing parties that I called for, the Tea Party allowed itself to be co-opted by the Republicans.
Members of the Occupy movement -- which by the way I can’t be blamed for in any way, shape, or form -- fixate on the influence of the rich, the now infamous one percent, on government policies. The uber-wealthy do seem to have undue influence, and gained still more in recent years thanks to the proliferation of SuperPACs and SCOTUS’s seriously flawed Citizens United decision. Seriously, I mean seriously flawed. As in laughable were it not so tragic. Unfortunately, the Occupiers are also too partisan, blaming rich Republicans for the power they wield instead of blaming a system that gives the wealthy members of both parties, and even of other countries, too much of a say in American electoral politics.
Ron Paul is nominally a Republican but he is not going to win the Republican primary. His numbers in the polls and primaries held to date, however, have been remarkable, about twice what he polled four years ago. More than 1 in 10 American voters throughout the country believe the federal government has taken its wars, monetary policies, and civil liberties restrictions too far. But like the Tea Party, Paul and his disciples place too much blame on the government per se and not enough on manipulation of the government by powerful special interest groups. Paul insists on auditing the Federal Reserve directly, for example, rather than auditing its owners and clients, the commercial banks that it has, unsurprisingly, been bailing out the last three plus years.
The differences between these three groups are deep and heartfelt. Occupiers love to bash Paul and vice versa. Ditto Tea Partiers and Occupiers. And of course most Tea Partiers blanche at Paul’s stand on defense, the so-called wars on drugs and terror, and a number of social issues. There is a chance, however, that the three groups could coalesce under a single, neo-progressive banner. A century ago, Progressives, a motley crew of Republicans, Democrats, and Populists ranging from Theodore Roosevelt to William Jennings Bryan, sought to purify all levels of government by fighting corruption and inefficiency with a variety of reforms, the most important and lasting of which were electoral. It was the Progressives who revitalized American democracy by pushing the secret ballot, initiative, referendum, recall, direct primaries, direct election of U.S. Senators, and women’s suffrage. Progressives, believe it or not, were major players in South Dakota’s political scene a century ago and could become so again.
The neo-progressive movement that I have in mind would not espouse specific economic policies – it would immediately splinter if it did -- but would instead work to reinvigorate American democracy beginning, perhaps, with campaign finance reform. Citizens United must be overturned, Super PACs obliterated, and the power of political party machines over candidate selection reduced if not eliminated. Initiative, referendum, and recall need to be extended to the federal government in intelligent -- which is to say more Dakotan than Californian -- ways. And if that doesn’t work to restore the public’s confidence in their national government, more radical reforms – like random selection of legislators -- must be contemplated, debated, and tested.
But what if such reforms lead to the implementation of the wrong economic policies, ones that injure long-term growth prospects? Frankly, I do not think that is possible. First, it may very well be the case that economic policies are not “right” or “wrong” per se but rather that any policy widely perceived as legitimate will turn out to be growth-inducing because it will establish known rules that will be widely followed. Rationing and price controls, for example, largely worked during World War II but flopped in 1971 because the public saw the wartime measures as necessary but easily saw through Tricky Dick Nixon’s New Economic Plan. If this view is correct, the problem with Obamacare, Social Security, the recent bailouts, and the like is not their intrinsic characteristics but the fact that many Americans see them as illegitimately enacted and continued, as de facto unconstitutional whether the Supreme Court rules it so or not.
Second, it seems unlikely that a well-functioning democracy – something the neo-progressives could help the nation to re-create -- replete with diverse economic interests would allow one group to exploit another to any significant degree, much as Madison argued in Federalist Number 10. If that is the case, a quote unquote wrong policy would quickly be corrected. If a policy benefitted no one, repeal would be easy. If it benefitted a minority interest, the expropriated majority would soon overturn it. Policies that injured the overall economy but benefitted a majority would be rare but difficult to dislodge if not checked by the Senate or a presidential veto before their implementation. Overall, though, there is little to fear from quote unquote wrong policies. What we need to worry about is what we now have in spades, illegitimate and unconstitutional policies that benefit small special interest groups at the expense of taxpayers and hence overall economic health.
A neo-progressive small d democratic movement might also be able to coalesce around corporate governance reform. Stockholders have long since lost control of the corporations they nominally own to executives, which to a first order approximation is why executives get paid so much. In my book Corporation Nation: Rise and Demise of the American Economic Juggernaut, forthcoming from the University of Pennsylvania Press late this year or early next, I describe several reform proposals that would return control to stockholders and hence make corporations less likely to take on excessive but executive bonus enhancing risks. Occupiers could see those reforms as “regulations,” and hence good, while followers of Paul and the Tea Party could see them as property rights protections, and hence something they should support. A side benefit of corporate governance reform is that returning control to stockholders would also likely limit corporate politicking, just as it did in the nineteenth century. Corporations will still lobby for special perks for themselves but won’t find it cost effective to back candidates for ideological reasons.
Finally, a neo-progressive movement might reduce America’s economic malaise by directly reforming its emerging kleptocracy. The disparate parts of the movement could be brought together simply by recognizing that both governments and corporations can and do steal from the American people. Governments steal from taxpayers whenever they allow inefficiencies like Amtrak or the Post Office to persist and whenever they allow markets to become or stay uncompetitive, views already held by some Tea Party and Paul followers. Corporations steal from consumers whenever they engage in uncompetitive practices or obtain special favors such as bailouts, views already held by Occupiers and some of Paul’s followers. Unlike members of the current factions, neo-progressives would recognize that they cannot hope to reform the government or big businesses but rather that both must be brought to heel through the concerted efforts of everyone who recognizes the damage that kleptocracy can, has, and will continue to inflict on the economy by diminishing Americans’ incentives to work hard and smart.
So there you have it. Leading economic indicators show few signs that the U.S. economy will pick up soon, intermediate-term growth prospects are clouded by the specters of asset bubbles, zombie banks, and runaway inflation, and long-term growth prospects remain dim due to levels of political and business corruption unseen since the Progressive era a century ago. If Paulites, Tea Partiers, and Occupiers can concentrate on common ground, however, they could implement reforms that would restore Americans’ faith in their government and give them reasons to work hard and smart once again. Without the restoration of such incentives, the U.S. economy will continue to stagnate, eventually dragging down even the vibrant economy of the Northern Plains. The nation will probably remain comfortably affluent but will slip relative to Brazil, China, India, and other large up and comers and inequalities of income and influence will grow, how far nobody knows. Beyond that, I dare not speculate.
