Stephen King: The US economy requires realism to beat the slump – not quick fixes

Outlook: Bernie Madoff may have created the biggest private-sector Ponzi scheme but theUS economy as a whole was slowly turning itself into something similar
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The Independent Online

While the UK Government frets about happiness (or the lack of it), the US Administration worries about jobs. America doesn't have enough of them. On Friday, we learnt that the US unemployment rate had, unexpectedly, jumped to 9.8 per cent in November from 9.6 per cent in the previous month, only a whisker below the 10.1 per cent peak recorded in October of last year. America's much-vaunted labour-market flexibility is badly misfiring. Despite a massive policy stimulus, not enough people are managing to get back to work.

Continual difficulties within the US real estate market provide one obvious reason for persistently high US unemployment. An eye-watering 19 per cent of construction workers are currently without jobs. They won't be finding new work within the construction sector any time soon. And given the way the rest of the economy is currently behaving, only limited opportunities are likely to arise for those looking to take their careers in new directions.

Admittedly, last year's 10.1 per cent peak was not, historically, America's highest unemployment rate. Post-war, that dubious honour belongs to November 1982, when unemployment rose to 10.8 per cent following a couple of years of savage monetary aggression from a newly-emboldened Federal Reserve led by Paul Volcker. At one point, short-term interest rates threatened to rise beyond 20 per cent. The cost of successfully squeezing the inflation of the 1970s out of the economic system was a huge increase in unemployment.

Today, there are no such excuses. Interest rates are down at zero. Far from being too high, inflation is remarkably low. Yet the labour market continues to misbehave. Indeed, on some counts, the situation today is even worse than it was in the 1980s. The US has just lived through the biggest rise in unemployment in its entire post-war history. At the last cyclical trough in 2007, the unemployment rate was a mere 4.4 per cent: the jump since then has been without precedent. And whereas unemployment typically falls quite quickly once it passes a localised peak, on this occasion the rate has remained stubbornly high. In the post-war period, this lack of progress has been seen on only two previous occasions; at the beginning of the 1970s and in 1980. The first of these signalled the beginnings of a major Western crisis which was associated with both an absence of growth and excessive inflation while the second took place in the middle of what is now referred to as the "double-dip" recession.

America's jobs misery stands in stark contrast to the experience of other nations. Even though its recession was extraordinarily deep, Germany's unemployment rate has been falling, in part as a consequence of subsidies paid by the German government to keep people in work. The UK labour market is hardly strong, but again the unemployment rate has remained remarkably subdued given the output losses seen over the last couple of years. Arguably, the UK's case was helped by the momentous decline in sterling in 2008, which boosted the profits of exporting companies, reduced the competitiveness of foreign imports and, perhaps, helped to limit job losses.

Does this mean that America's policymakers just got things wrong? Plenty has been said about the unfocused nature of America's fiscal stimulus. Meanwhile, many US Congressmen would dearly like to see a much weaker dollar. Yet, despite all this carping, it's still the case that American policymakers threw everything bar the kitchen sink at America's economic and financial crisis. With the Federal Reserve now manning the printing press, they continue to do so. The absence of jobs is not for want of trying.

There is, however, a good reason why America's economic performance has been so slovenly. This is not a post-war crisis. It is, instead, a pre-war crisis, a crisis which unfortunately shares many traits with the Great Depression in the 1930s. House price declines, defaults, bank failures, low interest rates, hopelessly weak credit expansion, high unemployment, depressed levels of economic activity: the ingredients were all there in the 1930s and they're back again today. The good news this time around is that policymakers have been far more aggressive: this economic crisis is nothing like as bad as the 1930s, when the policy response was miserably timorous. The headwinds, however, are huge and it's for that reason that there has been no return to business as usual.

Finally, reality has caught up with the US economy. Ten years ago, just before the stock market crash, it was fashionable to talk about the so-called "new economy". The US had mastered technological advances beyond the understanding of mere mortals living in other parts of the world. Yet, behind all the bluster, the US economy was slowly succumbing to some "old economy" problems. Massive increases in income inequality were masked by a growing addiction to credit.

Heavy borrowing from the rest of the world was initially invested in harebrained internet schemes and then, when those went wrong, in a massive expansion of US housing investment, the returns on which proved to be more than a little dubious. Bernie Madoff may have created the biggest private sector Ponzi scheme but the US economy as a whole was slowly turning itself into something very similar.

All the while, structural changes at the global level were poorly understood. US interest rates were low not because bond market vigilantes were congratulating the Federal Reserve on a job well done but, instead, because high levels of saving in fast-growing emerging nations – such as China, Russia and Saudi Arabia – were beginning to warp the cost of capital. The failure of Western policymakers to acknowledge this distortion left them turning a blind eye to the inevitable huge increases in securitisation and in house prices which then followed.

More recently, rapid rebounds in US corporate profits and business confidence have been wrongly interpreted as signs that the US economy's wounds are quickly healing. They're doing nothing of the sort. Corporate profits are high because companies have slashed domestic costs. Meanwhile, their investments increasingly are taking place in other parts of the world where labour costs are that much lower.

How should US policymakers react to these difficulties? They should start by injecting a much-needed note of realism, admitting that their macroeconomic box of tricks cannot fix all problems. The US needs to wean itself off its debt dependency. It needs to forget about "quick fixes" such as dollar depreciation. Instead, it needs to focus on the microeconomic foundations of past economic successes: the mobility of labour, the flexibility of finance in areas such as private equity and its pioneering entrepreneurial spirit. Without a return to these values, the danger is that the US increasingly looks to blame somebody else for its problems. That, however, will only take us into a world of isolationism, protectionism and worse. And that won't make any of us happy.



Stephen King is managing director of economics at HSBC

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