The Economy Is in a Depression - Fools

Prof. Peter Morici
Global Politician
January 16, 2009
The Labor Department reported on Jan. 9 that the economy lost 524,000 payroll jobs in December, and average employment was 1.3 million lower in the fourth quarter than in the third quarter. I believe the economy is already in the jaws of a depression.
Companies have shed 2.6 million jobs since December 2007 as the full weight of the banking crisis, trade deficit with China and burdens imposed by high-priced imported oil are bearing down on manufacturing, construction and the broader economy with unrelenting pressure.
Unemployment increased to 7.2% in December. However, factoring in discouraged workers, unemployment is closer to 9.4%. Add workers in part time positions that cannot find full time employment and the hidden unemployment rate is 14.5%.
Recession or Depression?
The economy contracted at about a 5% annual rate in the fourth quarter. This looks worse than a recession to me.
Recessions are like stock market corrections — after a time, equity prices rebound without government intervention. Federal Reserve interest rate cuts and stimulus tax rebates and spending have shortened the lives and eased the impact of post-World War II recessions, but those policies did not end them. The economy self-corrected.
A depression is not self-correcting. Roosevelt administration stimulus packages — huge deficit spending — eased the pain but failed to end the Great Depression. Roosevelt’s policies did not put the U.S. economy on a sustainable growth path because New Deal policies worsened structural problems that pulled the economy down in the first place. For example, the New Deal proliferated monopoly pricing, extended the life of undersized farms, raised structural savings rates, and created a system of home lending too dependent on federally sponsored banks.
The challenges facing President-elect Barack Obama could not be clearer. The current economic slowdown has two structural causes — bad management practices at the large money center banks and the huge foreign trade deficit. These problems are not self-correcting.
The economy will not recover without fundamental changes in banking and trade policy. A large stimulus package, though necessary, will only give the economy a temporary lift. Then unemployment will rise again and continue at unacceptable levels indefinitely without successively larger stimulus packages and huge federal budget deficits. The economy is in a depression, not a recession
Obama must ensure that the banks use the trillions of dollars in federal bailout assistance to renegotiate mortgages and make new loans to worthy homebuyers and businesses. Obama must make certain that banks do not continue to squander federal largess by padding executive bonuses, acquiring other banks and pursuing new high-return, high-risk lines of businesses in merger activity, carbon trading and complex derivatives.

Industry leaders like Citigroup have announced plans to move in those directions. Many of these bankers enjoyed influence in and contributed generously to the Obama campaign. Now it remains to be seen if a President Obama can stand up to these same bankers and persuade or compel them to act responsibly.
In addition, Obama must address the huge cost of imported oil and the trade deficit with China. Otherwise any effort to resurrect the economy is doomed to create massive foreign borrowing, another round of excessive consumer borrowing, and a second banking crisis that the Treasury and Federal Reserve will not be able to reverse.
Ultimately, reducing the oil import bill will require higher mileage standards for automobiles and assistance to automakers to accelerate the build-out of alternative, high-mileage vehicles. Fixing trade with China will require a tax on dollar-yuan transactions if China continues to refuse to stop subsidizing dollar purchases of yuan to prop up its exports and shift Chinese unemployment to the U.S. manufacturing sector.
Near term, a stimulus package focused on infrastructure is critical for resuscitating growth. The recent round of tax rebate checks ended up in savings accounts or spent at the Wal-Mart on Chinese goods, and did little to create jobs or accelerate growth. Whereas projects to repair roads, rehabilitate schools and refurbish public buildings would create high-paying jobs at home and provide a legacy in capital improvements that assist growth now and in the future.
But without fixing the banks, energy and trade with China, the lift provided by the stimulus package will be temporary and unemployment will rise again. The economy would then require progressively larger stimulus packages — and foreign borrowing to finance them — to keep Americans employed. Eventually, the foreign line of credit would run out, and widespread unemployment, depression and economic decline would follow.
Politically correct promises to create millions of new jobs producing alternative fuels makes effective presidential campaign slogans, but realistic policies for governing require aggressive development of more conventional oil and gas, as well as non-conventional energy sources, and efforts to improve the energy efficiency of personal transportation. If the Democrats are not willing to drill for more oil off shore and take on the automobile industry’s resistance to significantly higher mileage vehicles, the U.S. economy will be even more indentured to Persian Gulf oil exporters at the end of President-elect Obama’s first term than it is today.
Finally, the dollar is too strong against the Chinese yuan, Japanese yen and other Asian currencies. The Chinese government intervenes in foreign exchange markets to suppress the value of the yuan to gain competitive advantages for Chinese exports, and the yuan sets the pattern for other Asian currencies. Similarly, Beijing subsidizes fuel prices and increasingly requires U.S. manufacturers to make products in China to sell there.
Ending Chinese currency market manipulation and other mercantilist practices are critical to reducing the non-oil U.S. trade deficit, and instigating a recovery in U.S. employment in manufacturing and technology-intensive services that compete in trade. Yet neither President Bush nor congressional leaders like House Ways and Means Chairman Charles Rangel and New York Sen. Chuck Schumer have been willing to seriously challenge China on this issue, and Sens. John McCain and Obama appeared comfortable with continuing their approaches during the campaign.
Now Obama must alter his position and get behind a policy to reverse the trade imbalance with China, or preside over the wholesale destruction of many more U.S. manufacturing jobs.
In the end, without assertive steps to fix trade with China, as well as fix the banks and curtail oil imports, the Bush years will seem like a walk through the park compared to the real income losses Americans will suffer during the Obama years.
The choices for the incoming president are simple. It’s either recovery or depression. Fix the banks, energy policy and the trade situation with China or become America’s Nero.