The business cycle has more pain in store, even as unemployment grows
Charles Hugh Smith
Charles Hugh Smith
Sep 29th 2009 at 2:00PM
As my colleague Douglas McIntyre described in "Unemployment problems are worse than meet the eye," unemployment in this recession is different -- what many are calling structural unemployment, meaning a decline in the jobs base, which is not going to bounce back quickly due to deep structural problems in the U.S. economy.Having been unemployed in the last three major recessions -- 1974, 1981 and 1991 -- I have experienced the gamut of wrenching emotions first-hand and know how those running low on money and hope feel. The deepest downturns since the Great Depression, the 1974-75 and 1981-83 recessions caused widespread unemployment and misery. In the '70s, the problem was stagflation, a combination of tepid growth and rising inflation which eventually required a direct frontal attack on inflation by President Reagan and Federal Reserve Chairman Paul Volker, who jacked up interest rates to 16 percent. This tightening of credit slayed the inflation monster but at the cost of millions of jobs.
That hard-won victory over 10+ percent annual inflation enabled the great 25-year bull market and a massive expansion in employment.In contrast, the early-'90s recession ended when the PC/Internet boom ignited a major expansion of enterprise and jobs -- what economists call "organic growth" as opposed to a government-funded spurt.The typical business cycle is one of expansion of business and credit to the point of over-capacity and general giddiness, at which point risks are downplayed and leverage reaches a peak.Inevitably, risky bets fail, bad debt is written off and business and consumers retrench, saving money which can then be invested in the next expansion.We all know what happened in 2001: fearing a deep recession, Federal Reserve Chairman Alan Greenspan lowered interest rates and flooded the financial sector with liquidity. That cheap, abundant credit launched a boom in asset prices, most notably housing, which reached bubble proportions around the globe.In the general giddiness of the boom, American households extracted $5 trillion from home equity and indebted themselves to unprecedented levels.
Bubbles inevitably lead to over-capacity and over-leverage, and the deflation of the global financial bubble took household wealth, sales and profits down with it.Now the Federal Reserve, the Treasury and the Federal Government are attempting to reflate the economy with essentially the same formula which appeared to work in 2001: super-low interest rates, stupendous expansion of liquidity ("quantitative easing") and massive Federal stimulus spending -- the Keynesian model of recession-fighting.On top of this unprecedented "pump-priming," the government has funded or guaranteed financial-sector bailouts to the tune of $11 trillion -- three times the entire cost of World War II. (Adjusted for inflation, the U.S. spent about $4 trillion fighting a two-front global war.)Unfortunately, the economy is now staggering beneath a debt load which is roughly four times the level of the 1970s and '80s. Total debt (government, corporate and household) now exceeds 375 percent of GDP, compared to a postwar average of about 100 percent.Households are over-indebted, and are only starting the long process of paying down high debt loads to historic averages. And they are doing so against strong headwinds: their assets have plummeted by about a quarter ($12 trillion) and the equity in their homes has fallen to levels not seen since the 1974 recession. Millions have lost their jobs and millions more have seen their hours or salaries cut. The numbers are unimaginable. According to the Bureau of labor Statistics' August 2009 Employment Situation Report,14.9 million people are unemployed, 9.1 million are "working part time for economic reasons," and 2.3 million are "marginally attached to the labor force," that is, they want a job but have not actively sought one in the past four weeks.That totals 26.3 million people unemployed or under-employed. (For context, civilian employment in 2008 stood at 137 million.)Even this horrendous number probably understates the loss of household income, as the Bureau's "household survey" counts self-employed people such as real estate agents, free-lance designers and business consultants as employed, even though their incomes may have fallen dramatically or even to zero.The hope is that the $787 billion in Federal stimulus funds being spread over the land will "prime the pump" of organic growth -- that is, spark a new business cycle of expanding credit, spending, profits and confidence. But can an organic (non-government funded) expansion take root when debt levels are extraordinarily high in every level of the economy? To say "yes" is to fail to understand that the business cycle must move through renunciation of bad debt and the accumulation of real savings before an organic business expansion can begin.Can a decade of excessive capacity, leverage, risk-taking and financial fraud be wiped clean in a year? By bailing out financial institutions and pumping stimulus funding around the nation, the government is attempting to bypass the pain delivered by the organic business cycle. But in so doing, it is simply piling up more deadwood for the next financial forest fire.
As my colleague Douglas McIntyre described in "Unemployment problems are worse than meet the eye," unemployment in this recession is different -- what many are calling structural unemployment, meaning a decline in the jobs base, which is not going to bounce back quickly due to deep structural problems in the U.S. economy.Having been unemployed in the last three major recessions -- 1974, 1981 and 1991 -- I have experienced the gamut of wrenching emotions first-hand and know how those running low on money and hope feel. The deepest downturns since the Great Depression, the 1974-75 and 1981-83 recessions caused widespread unemployment and misery. In the '70s, the problem was stagflation, a combination of tepid growth and rising inflation which eventually required a direct frontal attack on inflation by President Reagan and Federal Reserve Chairman Paul Volker, who jacked up interest rates to 16 percent. This tightening of credit slayed the inflation monster but at the cost of millions of jobs.
That hard-won victory over 10+ percent annual inflation enabled the great 25-year bull market and a massive expansion in employment.In contrast, the early-'90s recession ended when the PC/Internet boom ignited a major expansion of enterprise and jobs -- what economists call "organic growth" as opposed to a government-funded spurt.The typical business cycle is one of expansion of business and credit to the point of over-capacity and general giddiness, at which point risks are downplayed and leverage reaches a peak.Inevitably, risky bets fail, bad debt is written off and business and consumers retrench, saving money which can then be invested in the next expansion.We all know what happened in 2001: fearing a deep recession, Federal Reserve Chairman Alan Greenspan lowered interest rates and flooded the financial sector with liquidity. That cheap, abundant credit launched a boom in asset prices, most notably housing, which reached bubble proportions around the globe.In the general giddiness of the boom, American households extracted $5 trillion from home equity and indebted themselves to unprecedented levels.
Bubbles inevitably lead to over-capacity and over-leverage, and the deflation of the global financial bubble took household wealth, sales and profits down with it.Now the Federal Reserve, the Treasury and the Federal Government are attempting to reflate the economy with essentially the same formula which appeared to work in 2001: super-low interest rates, stupendous expansion of liquidity ("quantitative easing") and massive Federal stimulus spending -- the Keynesian model of recession-fighting.On top of this unprecedented "pump-priming," the government has funded or guaranteed financial-sector bailouts to the tune of $11 trillion -- three times the entire cost of World War II. (Adjusted for inflation, the U.S. spent about $4 trillion fighting a two-front global war.)Unfortunately, the economy is now staggering beneath a debt load which is roughly four times the level of the 1970s and '80s. Total debt (government, corporate and household) now exceeds 375 percent of GDP, compared to a postwar average of about 100 percent.Households are over-indebted, and are only starting the long process of paying down high debt loads to historic averages. And they are doing so against strong headwinds: their assets have plummeted by about a quarter ($12 trillion) and the equity in their homes has fallen to levels not seen since the 1974 recession. Millions have lost their jobs and millions more have seen their hours or salaries cut. The numbers are unimaginable. According to the Bureau of labor Statistics' August 2009 Employment Situation Report,14.9 million people are unemployed, 9.1 million are "working part time for economic reasons," and 2.3 million are "marginally attached to the labor force," that is, they want a job but have not actively sought one in the past four weeks.That totals 26.3 million people unemployed or under-employed. (For context, civilian employment in 2008 stood at 137 million.)Even this horrendous number probably understates the loss of household income, as the Bureau's "household survey" counts self-employed people such as real estate agents, free-lance designers and business consultants as employed, even though their incomes may have fallen dramatically or even to zero.The hope is that the $787 billion in Federal stimulus funds being spread over the land will "prime the pump" of organic growth -- that is, spark a new business cycle of expanding credit, spending, profits and confidence. But can an organic (non-government funded) expansion take root when debt levels are extraordinarily high in every level of the economy? To say "yes" is to fail to understand that the business cycle must move through renunciation of bad debt and the accumulation of real savings before an organic business expansion can begin.Can a decade of excessive capacity, leverage, risk-taking and financial fraud be wiped clean in a year? By bailing out financial institutions and pumping stimulus funding around the nation, the government is attempting to bypass the pain delivered by the organic business cycle. But in so doing, it is simply piling up more deadwood for the next financial forest fire.
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