naked capitalism

From Veneroso Associates’ US Economy October Employment Report, ” Huge Discrepancy Between the Payroll and Household Surveys:

Executive Summary

1. According to BLS, payrolls fell at a 188,000 a month rate over the last three months. But their own household survey says employment fell at a 589,000 a month rate.

2. Why the discrepancy?

3. Chris Manning of the BLS told us last month that payrolls were overestimated in the twelve months ending March by 824,000. The source of this error was the birth/death model. BLS used “plug” numbers for the number of births and deaths. These “plug” numbers were wrong. They led to estimated positive contributions to employment that were too high. Most of the error (675,000 out of a total 824,000 jobs) occurred in the first quarter of this year. The birth/death model was adding significantly to payrolls when all other payrolls were falling. In reality the contribution from net births and deaths was in fact negative.

4. Manning told us that the faulty birth/death model was still being used for the months after March of this year. The implication was that the faulty birth/death model would continue to overstate payrolls and understate the payroll job losses in the months since March.

5. And, in fact, the BLS is doing just that. For the last three months they are assuming net birth/deaths have added 18,000 jobs a week. Last year over the same period they assumed it added 17,000 a week, the year before 18,000 a week, and the year before smack in the middle of the economic boom 18,000 a week.

6. It is obvious what BLS is doing. They are simply plugging in an extrapolated figure with zero adjustment for the most severe labor market contraction in three generations. And, worse yet, they know the birth/death number they are using is pure baloney.

7. NUTS!

8. Therefore, reality probably lies somewhere between the payroll survey monthly rate of job loss of 188,000 and the noisy household survey rate of job loss of almost 589,000. A best guess would be that jobs continue to be lost at a rate of 300,000 a month or more.

Payrolls were down 190,000. A slightly larger decline than the consensus. But prior payrolls were revised to show a lesser decline in August and September combined of 91,000. Payrolls with revisions declined only 99,000.

From a payroll survey perspective employment conditions are improving significantly. Not so from a household survey perspective.

The unemployment rate rose by .4%. I expected a rise, but only because I expected the sharp drop in the labor force in recent months to be partly reversed. In fact the labor force fell further by 31,000. The increase in the unemployment rate came entirely from another huge decline in the household measure of employment of 589,000. This followed declines of 785,000 in September and 292,000 in August. That is an average monthly rate of decline in employment of 589,000. That is as bad as it has been for the entire recession adjusted for population discontinuities.

The household survey of employment is a very noisy series. I was absolutely certain that, after the huge declines of August and September, we would see a much lesser decline in household survey employment in October. I thought that a decline of 200,000-300,000 would still signal serious employment weakness because of the huge declines in the prior two months.

No matter how noisy we think the household survey is, we have to take these household survey employment declines seriously. The three month decline may not be close to 1.8 million; it may be half that. It does not matter. A 300,000 a month rate of employment decline is very serious.

How can there be such a huge divergence between the household survey which now shows almost 600,000 job losses a month and the payroll survey which now shows average job losses of under 200,000 a month? Part of it, of course, is data noise. But part of it must be a continued overestimation of net positive job creation arising from the notorious birth/death model….

Therefore, reality probably lies somewhere between the payroll survey monthly rate of job loss of 188,000 and the noisy household survey rate of job loss of almost 589,000. A best guess would be that jobs continue to be lost at a rate of 300,000 a month or more.

Is this consistent with anything else? Yes. Though the manufacturing ISM showed a huge increased in its employment index, the non-manufacturing ISM showed a significant decrease to a low level. The vast majority of employment is in the non-manufacturing sector.

Also, if the rate of job loss was seriously contracting the work week should be rising. A move to a longer work week is often the first move by employers when labor conditions start to improve. The payroll survey shows a decline in the work week over the last three months and no improvement in the last month.

The latest initial and continuing claims suggest that there is some recent abatement in job losses. But they have probably continued at a significant rate and income destruction probably continues at a rapid pace….

As for the markets, they are so clueless at reading the fundamentals I have no idea how they will react to this data.

By George Washington of Washington’s Blog.

The Wall Street Journal admits this week that economists blew it:

The pain of the financial crisis has economists striving to understand precisely why it happened and how to prevent a repeat…

The crisis exposed the inadequacy of economists’ traditional tool kit, forcing them to revisit questions many had long thought answered, such as how to tame disruptive boom-and-bust cycles…
“We could be looking at a paradigm shift,” says Frederic Mishkin, a former Federal Reserve governor now at Columbia University.

That shift could change the way central bankers do their job, possibly leading them to wade more deeply into markets. They could, for example, place greater emphasis on the amount of borrowing in the economy, rather than just the interest rates at which borrowing is done. In boom times, that could lead them to restrict how much money various players, ranging from hedge funds to home buyers, can borrow

I have repeatedly pointed out the flaws in mainstream economics. See this, this, this, this and this.

But the Journal makes it sound like the policy-makers and economists who deployed faulty models were innocently ignorant of any larger truths:

The models “were not able to draw up the red flags,” says Tim Besley, a professor at the London School of Economics who served on the Bank of England’s policy-making committee until recently.

Barry Ritholtz has an excellent criticism of the article, pointing out:

There are many areas I would have liked to see the [journal's] article explore: The lack of Scientific Method, the mostly awful performance of economists, its misunderstanding of the value of modeling, the bias inherent in Wall Street variant of economics, and lastly, the corruption of economics by politics...

Let’s start with the basics. Hard “science” — Physics, Biology, Chemistry, and all variants thereto — begins humbly. They try to describe the universe around us by creating theories, and then testing them. These theorems are always preliminary. Even when testing validates them, Science is always prepared — even eager — to replace them with newer theories that are proven to be even more valid.

The humility of science begins with an admission: We know nothing. We seek to learn through experiment and logic, and constantly evolve more and more accurate explanations. Scientific belief evolves gradually over time. Nothing is assumed, presumed, or hypothesized as true. Indeed, research is a presumption that current theories are inadequate or incomplete. The practice of science is a an ongoing search for better explanations, more proof, further verification — for Truth.

Science is the ultimate “show me” state.

Economics has a somewhat, shall we call it, less rigorous approach. Indeed, the arrogance of economics is that it is the polar opposite of Science. It begins with a few basic assumptions, many of which are obviously untrue; some are demonstrably false.

No, Mankind is not a rational, profit maximizing actor. No, markets are not perfectly, or even nearly, efficient. No, prices do not reflect the sum total of all that is known about a given market, sector or stock. Those of you who pretend otherwise are fools who deserve to have your 401ks cut in half. That is called just desserts. The problem is that your foolishness helped cut nearly everyone else’s 401ks in half. That is called criminal incompetence.

Where was I? Ahhh, our sad tale of the practitioners of the dismal arts.

Starting from a false premise that fails to understand the most basic behaviors of the Human animal, economics proceeds to build an edifice of cards on a foundation of sand. (How could that possibly go astray?) Like a moonshot off by a few inches at launch, by the time the we reach further into time and space, the trajectory is off by millions of miles . . .

Economics … creates an illusion of precision where none exists. The belief in their models led to all manner of mischief, from subprime to derivatives to risk management…

The Behaviorists have been fighting the mainstream for decades now, trying to correct the errors of the basic building blocks of the dismal science.

But I would go further in my criticism of the economic profession by arguing that the decisions to use faulty models was an economic and political choice, because it benefited the economists and those who hired them.

For example, the elites get wealthy during booms and they get wealthy during busts. Therefore, the boom-and-bust cycle benefits them enormously, as they can trade both ways.

Specifically, as Simon Johnson, William K. Black and others point out, the big boys make bucketloads of money during the booms using fraudulent schemes and knowing that many borrowers will default. Then, during the bust, they know the government will bail them out, and they will be able to buy up competitors for cheap and consolidate power. They may also bet against the same products they are selling during the boom (more here), knowing that they’ll make a killing when it busts.

But economists have pretended there is no such thing as a bubble. Indeed, BIS slammed the Fed and other central banks for blowing bubbles and then using “gimmicks and palliatives” afterwards.

It is not like economists weren’t warning about booms and busts. Nobel prize winner Hayek and others were, but were ignored because it was “inconvenient” to discuss this “impolite” issue.

Likewise, the entire Federal Reserve model is faulty, benefiting the banks themselves but not the public.

However, as Huffington Post notes:

The Federal Reserve, through its extensive network of consultants, visiting scholars, alumni and staff economists, so thoroughly dominates the field of economics that real criticism of the central bank has become a career liability for members of the profession, an investigation by the Huffington Post has found.

This dominance helps explain how, even after the Fed failed to foresee the greatest economic collapse since the Great Depression, the central bank has largely escaped criticism from academic economists. In the Fed’s thrall, the economists missed it, too.

“The Fed has a lock on the economics world,” says Joshua Rosner, a Wall Street analyst who correctly called the meltdown. “There is no room for other views, which I guess is why economists got it so wrong.”

The problems of a massive debt overhang were also thoroughly documented by Minsky, but mainstream economists pretended that debt doesn’t matter.

And – even now – mainstream economists are STILL willfully ignoring things like massive leverage, hoping that the economy can be pumped back up to super-leveraged house-of-cards levels.

As the Wall Street Journal article notes:

As they did in the two revolutions in economic thought of the past century, economists are rediscovering relevant work.

It is only “rediscovered” because it was out of favor, and it was only out of favor because it was seen as unnecessarily crimping profits by, for example, arguing for more moderation during boom times.

The powers-that-be do not like economists who say “Boys, if you don’t slow down, that bubble is going to get too big and pop right in your face”. They don’t want to hear that they can’t make endless money using crazy levels of leverage and 30-to-1 levels of fractional reserve banking, and credit derivatives. And of course, they don’t want to hear that the Federal Reserve is a big part of the problem.

Indeed, the Journal and the economists it quotes seem to be in no hurry whatsoever to change things:

The quest is bringing financial economists — long viewed by some as a curiosity mostly relevant to Wall Street — together with macroeconomists. Some believe a viable solution will emerge within a couple of years; others say it could take decades.

Note: I am not necessarily saying that mainstream economists were intentionally wrong, or that they lied because it led to promotions or pleased their Wall Street, Fed or academic bosses.

But it is harder to fight the current and swim upstream then to go with the flow, and with so many rewards for doing so, there is a strong unconscious bias towards believing the prevailing myths. Just like regulators who are too close to their wards often come to adopt their views, many economists suffered “intellectual capture” by being too closely allied with Wall Street and the Fed.

As Upton Sinclair said:

It is difficult to get a man to understand something, when his salary depends upon his not understanding it.

By Richard Alford, a former economist at the New York Fed. Since them, he has worked in the financial industry as a trading floor economist and strategist on both the sell side and the buy side.

It has been frequently charged that the Fed, under Alan Greenspan and Ben Bernanke, kept interest rates too low for too long, contributing to bubbles in the stock, credit and real estate markets. The Fed has repeatedly denied that this is the case. The arguments, while presented with conviction, remain unsatisfying.

For example in a recent blog posting, an official at one of the Reserve Banks joined the chorus in arguing that monetary policy was not to blame. He presented a chart of the actual Fed funds rate and an estimate path for the Fed funds rates based on measures of inflation, actual output relative to potential output, and the lagged Fed funds rate for the period 1988-2009.

The estimated and actual rates never diverge by very much. (The author explicitly disavows calling his formulation a “Taylor Rule”. Perhaps it is because John Taylor has stated that the Taylor Rule correctly formulated indicates that the Fed funds rate was too low too long.)

The author then draws the following conclusion:

..whatever the underlying structure of policy decisions, after the fact the FOMC appears to have behaved in an extraordinarily consistent way over the period extending from the late 1980s. This observation, in turn, suggests to me that there was nothing all that unusual about monetary policy in 2003 once you account for the state of the economy. Which leads me to my main point…: If you are of the opinion that interest rate policy was good through the late 1980s and 1990s, then there seems to be a good case the FOMC was just sticking with “proven” success as it set interest rates through the dawning of the new millennium.

In its bare bones form, the argument is simply:

1. this policy regime was appropriate in prior years (late 1980s and 1990s);
2. the policy regime was unchanged;
3. therefore the policy regime must have been appropriate during the period in question (2002-2007).

I suggest that the Fed official talk with the fellows from LTCM. They back-tested their models during periods that include the late 1980s and early to mid 1990s and they did well—for a while. I suggest that the policymaker talk to the financial engineers who structured mortgage backed securities and portfolios based on the historically accurate premise that house prices had not fallen on a national basis since the Great Depression (as opposed to just the late 1980s and 1990s). They also did well –for a while. The list goes on.

The author does acknowledge that macroeconomics and policy has not kept pace with changes in financial markets:

…prior to 2007 it was not at all clear that detailed descriptions of how funds moved from lenders to borrowers or how short-term interest rates are transmitted to longer-term interest rates and capital accumulation decisions were crucial to getting monetary policy right. Models without such detail tended to deliver policy decisions not far from the sort depicted above, and, as I noted, they seemed to be working quite well in terms of macroeconomic outcomes.

However, the underlying argument is unchanged. This policy regime was consistent with “getting monetary policy right” in the past. Hence it cannot be responsible for poor outcomes in the present. Given the nature and the pace of recent change in:

1. the US financial sector,
2. the US external position and trade competitiveness,
3. the role of imported disinflationary pressures, and
4. the savings behavior of households

choosing a policy regime because it “got” it right in the late 1980s and 1990s is/was like trying to drive a car by looking through a telescopic rear-view mirror.

Furthermore, by what measure did policy get it right during the period 1988-2002? From 1996 to 2001, we had an economy supported by an unsustainable bubble in stock prices, growing external imbalances and a decline in the household savings rate while measured inflation was held down by imported disinflation. Toss out the Tech bubble years and the author’s base period is down to 1988-1995, which includes one recession. For much of the time in the expanded time horizon (1988-2009), the US economy was either in recession (1990, 2001, 2007), experiencing asset bubbles (1996-2000 and 2002-2007) which eventually burst causing economic dislocation, or enjoying a jobless recovery.

Throughout the discussion of the merits of Fed policy, I get the sense that the Fed wants to be Marked-graded-to-Model (of its own choosing) as opposed to the actual economic outcome. The Fed does appear to have done a credible job when the chosen metric is how closely the actual Fed rates tracks an estimated Fed funds rate (based on one or another variant of the Taylor Rule). However, when the metric is one that includes concerns such as sustainability of growth, external balance, and financial stability, as well as the output gap and inflation, it does not.

The Fed was quick to take credit for the “Great Moderation” and the longest economic expansion in US history, but now the Fed portrays itself as an innocent victim of circumstance. It is almost as if the Fed sees itself as a comic book super hero, endowed with powers that can only be used for good.

By George Washington of Washington’s Blog.

Financial insider and commentator Yves Smith wrote an essay last week entitled “MSM Reporting as Propaganda” arguing that the government has been using propaganda to make people think that things are getting better, no one is angry, and – therefore – no one should get upset:

The message, quite overtly, is: if you are pissed, you are in a minority. The country has moved on. Things are getting better, get with the program…

Per the social psychology research, this “you are in a minority, you are wrong” message DOES dissuade a lot of people. It is remarkably poisonous. And it discourages people from taking concrete action.

Is Smith right? And even if she is, isn’t “propaganda” too strong a word?

Think Positive

Sure, William K. Black – professor of economics and law, and the senior regulator during the S & L crisis – says that that the government’s entire strategy now – as during the S&L crisis – is to cover up how bad things are (”the entire strategy is to keep people from getting the facts”).

Admittedly, 7 out of the 8 giant, money center banks went bankrupt in the 1980’s during the “Latin American Crisis”, and the government’s response was to cover up their insolvency.

It’s true that Business Week wrote on May 23, 2006:

President George W. Bush has bestowed on his intelligence czar, John Negroponte, broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations.

I can’t deny that the Tarp Inspector General said that Paulson and Bernanke falsely stated that the big banks receiving Tarp money were healthy, when they were not.

Okay, the government and Wall Street have traditionally tried to dispense happy talk when there is an economic crash, and Arianna Huffington recently pointed out:

And I’ll give you that a recent Pew Research Center study on the coverage of the crisis found that the media has largely parroted what the White House and Wall Street were saying.

But that’s not propaganda . . . its just positive thinking, right?

The Other Guy

And the whole word propaganda is a Nazi, communist kind of thing which has no place in the same sentence as America. Right?

Granted, famed Watergate reporter Carl Bernstein says the CIA has already bought and paid for many successful journalists.

And sure, the New York Times discusses in a matter-of-fact way the use of mainstream writers by the CIA to spread messages.

True, a 4-part BBC documentary called the “Century of the Self” shows that an American – Freud’s nephew, Edward Bernays – created the modern field of manipulation of public perceptions, and the U.S. government has extensively used his techniques (but the BBC isn’t American, so it doesn’t count).

True, the Independent discusses allegations of American propaganda (but that’s a British paper, doesn’t count).

And (ho hum) one of the premier writers on journalism says the U.S. has used widespread propaganda.

And (are we still talking about this?) an expert on propaganda testified under oath during trial that the CIA employs THOUSANDS of reporters and OWNS its own media organizations (the expert has an impressive background).

And (I can’t believe we’re still talking about this) while the U.S. government has repeatedly claimed that it was launching propaganda programs solely at foreign enemies, it has actually used them against American citizens. For example:

• In 2002, the Pentagon announced that it was considering spreading false propaganda in the foreign press. However, the military has spread propaganda within the U.S. in an operation so aggressive that one participant, a military analyst, called it “psyops on steroids“

• Raw Story confirmed yesterday the use of propaganda on Americans

• The U.S. government long ago announced its intention to “fight the net”.

• As revealed by an official Pentagon report signed by Rumsfeld called “Information Operations Roadmap”:

The roadmap [contains an] acknowledgement that information put out as part of the military’s psychological operations, or Psyops, is finding its way onto the computer and television screens of ordinary Americans.”Information intended for foreign audiences, including public diplomacy and Psyops, is increasingly consumed by our domestic audience,” it reads.

“Psyops messages will often be replayed by the news media for much larger audiences, including the American public,” it goes on.***

“Strategy should be based on the premise that the Department [of Defense] will ‘fight the net’ as it would an enemy weapons system”.

And (when’s the next episode of American Idol on?) CENTCOM announced in 2008 that a team of employees would be “[engaging] bloggers who are posting inaccurate or untrue information, as well as bloggers who are posting incomplete information.”

And (who do you think will win the playoffs?) the Air Force is also engaging bloggers. Indeed, an Air Force spokesman said:

“We obviously have many more concerns regarding cyberspace than a typical Social Media user,” Capt. Faggard says. “I am concerned with how insurgents or potential enemies can use Social Media to their advantage. It’s our role to provide a clear and accurate, completely truthful and transparent picture for any audience.”

And (did you see that crazy photo?) it is well known that certain governments use software to automatically vote stories questioning their interests down and to send letters favorable to their view to politicians and media (see – as just one example – this, this, this, this and this). The U.S. government is very large and well-funded, and could substantially influence voting on social news sites with very little effort, if it wished.

The Bottom Line

Yeah yeah, people say this or that, whatever, I’m too busy to think about it.

Even if true, propaganda is too strong a word for attempts to convince people that important issues are boring, that no one else is angry about them, and that everything is normal.

Perhaps “herding the wayward sheep” would be better . . .

Submitted by Edward Harrison of Credit Writedowns

Why is everyone saying consumer credit is falling? It’s not. But, everywhere I look, everybody is saying it is.

I would like to be true to the data and not just take the government’s seasonally-adjusted numbers at face value.

Judge for yourself. Here’s the data:

This is what everyone is focused on – the seasonally-adjusted data. The part in red shows consumer credit down $12 billion.

But, what about the actual unadjusted data?

What do you know, it’s up $7 billion. It is indeed down $4 billion for revolving credit as banks are cutting credit card limits. But, non-revolving credit is up over $11 billion.  It was decreasing and is down 4.4% year-on-year (see the section highlighted in green above), but that ended this month.

Yes, I too believed that consumers were poised to begin deleveraging, but with stocks up 60%, interest rates at record lows, and house price declines stalled, why would you do that?

Conclusion: consumer credit is increasing, not decreasing. I wish people would actually look at the data.

The question you should be asking is not whether consumer credit is increasing, but whether it will continue to do so after August and cash for clunkers.

And I did a full review of the asset-based economy during economic turns yesterday. All indications are that the consumer is not deleveraging as I would have anticipated (see post here).

Sources

G.19 Current – Federal Reserve

G.19 Historical – Federal Reserve

An interesting post at VoxEU by Andrew K. Rose and Mark M. Spiegel does a series of analyses looking to explain how the crisis evolved internationally, but the obvious connections don’t provide an answer:

The 2008 financial crisis is sometimes characterised as one where financial difficulties in the US spread to the rest of the world. But is there clear evidence of such international contagion? This column reports research indicating that neither financial nor trade linkages to the US help explain the cross-country incidence of the crisis. If anything, countries more exposed to the US seem to have fared better….

The case for contagion seems superficially clear. In this column, we discuss our recent research that probes more deeply into the 2008 crisis. In particular, we ask if countries that were more heavily exposed to toxic US assets suffered deeper losses during the crisis of 2008.

Surprisingly, our answer is negative – countries that had disproportionately high amounts of trade with the US in either financial or real markets did not experience more intense crises. If anything, countries more heavily exposed to the US seemed to fare better than others. And our results are robust; we examine over 40 different linkages between countries, in both trade and capital. This negative finding makes us sceptical of the ability of “early warning systems” – such as the one discussed in the de Larosiere Report (2009) – to successfully predict the incidence of future crises across both countries and time.

A bit of further thought shows why this finding (or lack thereof) is not as surprising as it might seem.

There is evidently more to the research than their high level summary at VoxEU shows, but it does not appear that they found data on foreign country exposure to toxic assets; indeed, that information would take an extraordinary amount of effort to compile. How do you identify, say, which foreign banks hold collateralized loan obligations or CDOs that have tanked? You need to find which ones have done badly (already a huge task, this information is available only from dealers) and then you have to trace back ownership. Thus the researchers presumably could not develop the most relevant data.

And using US asset exposures as a proxy for toxic asset exposures is wrongheaded. Consider Japan and China. Both are huge trade partners of the US, and both have holdings heavily weighed towards US Treasuries and agencies. They were not buyers of exotic debt instruments. I believe the same is true of Taiwan.

Another factor this analysis fails to capture is the vulnerability of a country to financial crises. Relevant metrics would probably be private debt to GDP and size of the financial sector relative to GDP. Switzerland has limited trade relationships to the US, but has an outsized banking sector, and one that held a lot of dollar denominated assets that turned out to be rotten funded by dollar liabilities. If a country has a banking crisis in a country’s own currency is comparatively manageable (albeit painful and costly). But when you have a large external debt, it creates all sorts of financial instability and the issue of solvency (even for a supposedly rock-solid country like Switzerland) becomes a real concern.

So I have no doubt that contagion factors can be found, but they may not lie in clean data sets that economists like to use in regression analyses.

(I was going to take a week off, but Yves suggested I post this.)

By George Washington of Washington’s Blog.

We have to change our risk models, and not just defer to the big banks’ inaccurate models which got us into this mess.

Says who?

• Nassim Taleb:

I have been fighting risk models both as a Wall Street trader and as a professor and my worst nightmares were the results of regulators. It was they who promoted the reliance on ratings by credit agencies. The “value-at-risk” models regulators promoted made us take more risks…We replaced the heuristics of the elders with arrogant (and incompetent) beliefs, breaking, in the name of science, the chain of knowledge. Old, conservative bankers and traders have been replaced by keen young mathematical analysts, yet anyone who listened to a grandmother who survived the Depression would have been warned against debt and been better prepared than Ben Bernanke and Alan Greenspan, respectively chairman and former chairman of America’s Federal Reserve.

[And see this]

• A team of economics professors

• Paul Krugman

• Economist Robert Kuttner

• And many others

Today, Simon Johnson summarized the whole modeling issue very well:

Given that everyone is agreeing sophisticated risk models are worthless in crises, it seems particularly remarkable that regulators allowed some banks to use their in-house models in determining their own capital requirements – since one of the purposes of capital requirements is precisely to provide a cushion that protects banks (and their creditors, and taxpayers) in the event of a crisis. The obvious solution is that regulators should rely on cruder constraints, such as an absolute limit on leverage that banks cannot arbitrage around (one of the recommendations of Treasury’s recent white paper on capital requirements …), or periodic stress tests that estimate how bank asset portfolios will perform in a real crisis.

But there is a more interesting question to ask as well: why did VaR become so popular? It’s important to remember that competition among models is shaped by the human beings who create and use them, and those human beings have their own incentives.

David Colander made this point about economic models: the sociology of the economics profession gave preference to elegant mathematical models that could describe the world using the smallest number of parameters. “Common sense does not advance one very far within the economics profession,” he says.

A similar point can be made about VaR models. Sure, maybe all the financial professionals who design and work with VaR know about its shortcomings, both mathematical and practical. But nevertheless, using VaR brought concrete benefits to specific actors in the banking world. If common sense would lead a risk manager to crack down on a trader taking large, risky bets, then the trader is better off if the risk manager uses VaR instead.

Not only that, but imagine the situation of the chief risk manager of a bank in, say, 2004. As Andrew Lo has argued, if he attempted to reduce his bank’s exposure to structured securities such as CDOs, he would be out of a job; VaR gave him a handy tool to rationalize a situation that defied common sense but that made his bosses only too happy. And at the top levels, CEOs and directors who probably did not understand the shortcomings of VaR were biased in its favor because it told them a story they wanted to hear.

In other words, models succeed because they meet the needs of real human beings, and VaR was just what they needed during the boom. And we should assume that a profit-seeking financial sector will continue to invent models that further the objectives of the individuals and institutions that use them. The implication is that regulators need to resist the group think of large financial institutions. If everyone involved is using the same roadmap of risks, we will all drive off the cliff again together.

We ignore Johnson’s warnings at our own peril.

For background, see this, this, this and this.

By George Washington of Washington’s Blog.

Unemployment is disastrous on both the individual and societal level.

Individuals who look for work but can’t find it are miserable.  Indeed, most people who lose their job are unprepared for their circumstances.[1]

On the national level, high unemployment is both cause and effect concerning other problems with the economy. As we’ll see below, high unemployment results from a weak economy and – in turn – weakens the economy.

Until the causes of, and solutions to, high levels of unemployment are understood, we will not be able to solve the problem.

How High is Unemployment?

Before we can even start looking at causes or solutions, we have to understand what the current level of unemployment really is, and what the trends portend for the future.

Let’s use America as an example. With the largest economy in the world, it has often been said that “when America sneezes, the rest of the world catches cold”. And much of the rest of the world has adopted the “Washington Consensus” – America’s neoliberal view of economics.[2] Moreover, the rest of the world has been infected by many types of “toxic assets” invented in America, such as credit default swap derivatives[3], as well as Wall Street style banking strategies. So I will use the United States has a case example, but will also touch on global trends.

Official figures put unemployment in the United States somewhere between 9 and 10 percent. But the official figures use a very different measure for unemployment than was used during the Great Depression and for many decades afterwards.

Specifically, the official unemployment reports of the Department of Labor’s Bureau of Labor Statistics (BLS) provide conventional “U-3″ figures and various alternative measures including “U-6″. [4]

For example, as of December 2008, U-3 unemployment was 7.2 percent, while U-6 was 13.5 percent. [5]

U-6 is actually more accurate, because it includes those who would like full-time work, but can only find part-time work, or have given up looking for work altogether.

As can be seen by the December 2008 figures, U-6 unemployment rate can almost double the more commonly-cited U-3 figures.

But those in the know argue that the real rate is actually even higher than the U-6 figures.

For example, Paul Craig Roberts [6] – former Assistant Secretary of the Treasury and former editor of the Wall Street Journal – and economist John Williams both said in December 2008 that – if the unemployment rate was calculated as it was during the Great Depression – the December 2008 unemployment figure would actually have been 17.5%.

Williams says [7] that unemployment figures for July 2009 rose to 20.6% [8].

According to an article [9] summarizing the projections of former International Monetary Fund Chief Economist and Harvard University Economics Professor Kenneth Rogoff and University of Maryland Economics Professor Carmen Reinhart, U-6 unemployment could rise to 22% within the next 4 years or so.

As the New York Times pointed out in July[10] :

Include [those who have given up looking for a job and those part-time workers who want to be working full time] — as the Labor Department does when calculating its broadest measure of the job market — and the rate reached 23.5 percent in Oregon this spring, according to a New York Times analysis of state-by-state data. It was 21.5 percent in both Michigan and Rhode Island and 20.3 percent in California. In Tennessee, Nevada and several other states that have relied heavily on manufacturing or housing, the rate was just under 20 percent this spring and may have since surpassed it.

Indeed, the chief of the Atlanta Federal Reserve Bank -Dennis Lockhart – said in August 2009:

If one considers the people who would like a job but have stopped looking — so-called discouraged workers — and those who are working fewer hours than they want, the unemployment rate would move from the official 9.4 percent to 16 percent. [11]

Former Labor Secretary Robert Rubin notes:

Over the past three months annual wage growth has plummeted to just 0.7%. At the same time, furloughs — requiring workers to take unpaid vacations — are on the rise: recent surveys show 17% of companies imposing them. [12]

Temporary employment is still falling as well. [13]

And economist David Rosenberg points out:

65% of companies are still in the process of cutting their staff loads…

The Bureau of Labor Statistics also publishes a number from the Household survey that is comparable to the nonfarm survey (dubbed the population and payroll-adjusted Household number), and on this basis, employment sank — brace yourself — by over 1 million, which is unprecedented…[14]

In addition to the failure of official BLS unemployment figures to take into account discouraged and underemployed workers, many analysts argue that BLS’ “Birth-Death Model” severely understates unemployment during recessions. [15]

Many people – including economists and financial reporters – say that unemployment is much lower than it was during the Great Depression. What they mean when they say that is that current U-3 figures in America are under 10%, while unemployment hit 25% during the Great Depression.

But most people forget that the worst unemployment numbers during the Great Depression did not occur until years after the initial 1929 crash . Specifically, unemployment did not hit 25% until at least 3 years after the start of the Depression.[16]

As of this writing (2009), we are only a year into the current economic crisis. Therefore, we have at least 2 more years to go until we hit the same period that unemployment peaked during the Great Depression.

Indeed, former Secretary of Labor Robert Reich wrote in April that the unemployment figures show that we are already in a depression.[17]

And Chris Tilly – director of the Institute for Research on Labor and Employment at UCLA – points out that some populations, such as African-Americans and high school dropouts, have been hit much harder than other populations, and that these groups are already experiencing depression-level unemployment.[18]

Assuming that Williams, Roberts or Lockhart’s calculations of unemployment are correct (using the same methods of measuring unemployment as were used during the Great Depression), and depending on when we deem the current crisis to have commenced, then – as shown by the following charts – unemployment percentages may actually be worse than they were during a comparable period in the Great Depression:

[19 and 20]

[21]

We also know that, in terms of total numbers of unemployment people (as opposed to percentages), more people will be unemployed than during the Great Depression. [22]

What Are the Unemployment Trends?

If unemployment is anywhere near as bad as during a comparable period during the Great Depression, the obvious question is where the trends are heading.

It is well known among economists that unemployment is a “lagging” indicator. [23] In other words, there is a lag time. When the economy hits a rough patch, the economic weakness will not show up in the unemployment numbers until several months or years later.

For example, as Europe’s largest bank – RBS – warns:

Even if the economy starts to turn up the headwinds will be formidable,” [the company's CEO] warned. “The green shoots are short in duration and you need to be cautious about interpreting them. Even if growth returns, unemployment will rise for some time afterwards …[24]

Because of the lag time between conditions in the economy and unemployment, we have to ask the following two questions in order to forecast future unemployment trends:

1) How bad were conditions in 2008 and early 2009?

and

2) What will economic conditions be like in the future?

How Bad Did It Get?

Unfortunately, many experts – including the following people – have said that the economic crisis which started in 2008 could be worse than the Great Depression:

• Federal Reserve chairman Ben Bernanke said on July 26, 2009:
  

  A lot of things happened, a lot came together, [and] created probably the worst financial crisis, certainly since the Great Depression and possibly even including the Great Depression. [25]

• Economics professors Barry Eichengreen and and Kevin H. O’Rourke said that world-wide conditions are worse than during a comparable period during the Great Depression [26] (updated in June 2009 [27])

• Investment advisor, risk expert and bestselling author Nassim Nicholas Taleb said that the current crisis could be “vastly worse” than the Great Depression [28]

• Former Fed Chairman Paul Volcker believes the current crisis may be even worse than the Depression [29]

• Nobel prize winning economist Joseph Stiglitz said “this is worse than the Great Depression” [30]

• Economics scholar and former Federal Reserve Governor Frederick Mishkin said that conditions were worse than during the Depression [31]

• Well-known PhD economist PhD Economist Marc Faber believes this could be far worse than the Great Depression[32]

• Former Goldman Sachs chairman John Whitehead thinks that the current slump is worse than the Depression [33]

• Morgan Stanley’s UK equity strategist Graham Secker predicts economic collapse worse than the Great Depression [34]

• Former chief credit officer at Fannie Mae Edward J. Pinto said in January 2009 that the current housing crisis was worse than the Depression, and that current efforts to rescue the mortgage industry are less successful than those used during the 1930s. [35]

• Billionaire investor George Soros said in February 2009 that the current economic turbulence is actually more severe than during the Great Depression, comparing the current situation to the demise of the Soviet Union. [36]

What Will Economic Conditions Be Like In the Future?

As of this writing, the fact that unemployment will substantially increase is quite controversial. Most people still assume that the benefits of the government’s policies will soon kick in, the economy will recover, and then jobs will recover soon afterwards.

In order to accurately determine how bad general economic conditions – and thus unemployment – might be in the future, it is necessary to look at a variety of trends, including residential real estate, commercial real estate, toxic assets held by banks, loan loss rates, consumer spending, age demographics, the decline in manufacturing, and destruction of credit.

Residential Real Estate

Citigroup is projecting that unemployment in Spain will rise from its current 17.9% to 22% next year. [37]

Spain’s unemployment is largely driven by the bursting of its housing bubble. [38]

Housing bubbles are now bursting in China [39], France [40], Spain [41], Ireland [42], the United Kingdom [43], Eastern Europe [44], and many other regions. [45]

(And unemployment in Japan is apparently at the highest level since the government began collecting the data in 1953, a year after the U.S. military occupation ended.)[46]

Unfortunately, while the peak in subprime mortgages is behind us, many analysts say that Alt-A mortgage defaults have not yet occurred (as of this writing), but will not peak until 2010.[47]

Indeed, the crash in real estate and rising unemployment together form a negative feedback loop. As McClatchy notes, foreclosures rise as jobs and income drop. [48]

Former chief IMF economist Simon Johnson notes that a vicious cycle also exists between unemployment and property foreclosures:

Unemployment is always a lagging indicator, and given the record low number of average hours worked, it will turn around especially slowly this time. Until then, people will continue to lose their jobs and wages will remain flat, and any small rebound in housing prices is unlikely to help more than a few people refinance their way out of unaffordable mortgages. So unless the other part of the equation – monthly payments – changes, the number of foreclosures should just continue to rise.[49]

Indeed, the Washington Post notes:

The country’s growing unemployment is overtaking subprime mortgages as the main driver of foreclosures, according to bankers and economists, threatening to send even higher the number of borrowers who will lose their homes and making the foreclosure crisis far more complicated to unwind. [50]

Commercial Real Estate

Moreover, a crash in commercial real estate is now picking up speed. Unlike the subprime mortgage meltdown – which affected mainly the biggest banks – the commercial meltdown will apparently affect a huge number of small to medium-sized banks. [51]

On August 11, 2009, the Congressional Oversight Panel on the bailouts issued a report saying that small and medium sized banks are especially vulnerable, the report will say, in part they hold greater numbers of commercial real estate loans, “which pose a potential threat of high defaults.” [52]

That could spell real trouble for employment by small businesses since (1) smaller institutions are disproportionately responsible for providing credit to small businesses [53], (2) credit is essential for many small businesses, (3) commercial real estate is crashing even faster than residential [54], and (4) industry experts forecast that the commercial real estate market won’t bottom out for three more years.[55]

Indeed, largely because of the commercial real estate crash, the FDIC expects 500 banks to fail in the coming months. [56]

Unfortunately, the crash in commercial real estate is occurring world-wide. [57]

Toxic Assets

The Congressional Oversight Panel report also says that banks remain threatened by billions of dollars of bad loans on their balance sheets, more could fail if the economy worsens, and that – if unemployment rises sharply or the commercial real estate market collapses – the banking system could again crash:

The financial system [still remains] vulnerable to the crisis conditions that [the bailout] was meant to fix…

Financial stability remains at risk if the underlying problem of toxic assets remains unresolved.[58]

As Reuters notes:

The chairman of the congressional oversight panel, Elizabeth Warren, said no one even knows the value of the toxic assets still on banks’ books…”No one has a good handle how much is out there,” Warren said. “Here we are 10 months into this crisis…and we can’t tell you what the dollar value is.”[59]

Loan Loss Rates

Loan loss rates in could also be worse than the Great Depression, at least in the United States. Specifically, during the depths of the Great Depression, the loss rate which banks suffered on their loans climbed as high as 3.4% (it is normally well under 2.0%).[60]

Last month, banking analyst Mike Mayo predicted that loan loss rates could go as high as 5.5%, which is substantially higher than during the 1930s.[61]

But the Federal Reserve’s more adverse scenario for the stress tests – which everyone knows is too rosy concerning most of its assumptions – predicts a loan loss rate of 9.1%, nearly three times higher than during the 1930s.[62]

As US News and World Report wrote in May 2009:

For most of the past 50 years, the loss rate on all bank loans has stayed well under 2 percent. The Fed estimates that over the next two years the loss rate could reach 9.1 percent. You know all those historical comparisons that end with “the worst since the Great Depression”? Well, 9.1 percent would be EVEN WORSE than during the 1930s. Still looking forward to a soft landing or a quick recovery?[63]

Consumer Spending

Consumer spending accounts for the vast majority of the economy in the United States. The figure commonly cited is that consumer spending accounts for 70% of U.S. Gross Domestic Product. [64]. (Consumer spending has been a lower percentage of GDP in most other countries. [65])

But the economic crisis is driving consumer spending downward. Economist David Rosenberg [66] says that consumers have undergone a generational shift in spending habits, and will be frugal for a long time to come.[67]

The head of Collective Brands, Matthew Rubel, states:

Consumer spending as a percentage of GDP has moved down, will probably continue to move down through the end of year, and then normalize as we get into somewhere in early-to-mid next year, from our point of view.[68]

The chief economist of IHS Global Insight, Nariman Behravesh, says consumer spending will decline to 65 percent of GDP:

With individuals more focused on saving than spending, Behravesh said retail consumer spending as a percentage of GDP is likely to fall from 70 percent to 65 percent. “It will take a while, maybe 10 years,” he said. “Correspondingly other countries are going to have to shift in the opposite direction to rely more on their own consumers rather than the U.S. consumers.”[69]

Jason DeSena Trennert, Chief Investment Strategist for Strategas Research Partners, says:

Consumer spending as a percentage of GDP is going to go in one direction for a long time — lower.[70]

Time points out :

Economist Stephen Roach, chairman of Morgan Stanley Asia, says that “there is good reason to believe the capitulation of the American consumer has only just begun.” U.S. consumer spending as a percentage of GDP reached 72% in 2007, well above the pre-bubble norm of 67%. Using that as a gauge, Roach says that only 20% of the potential retrenchment of spending has taken place, even after the dramatic decline at the end of 2008. “The imbalance that contributed to the crisis — overconsumption and excessive savings — cannot continue,” says Ajay Chhibber, director of the Asia bureau at the United Nations Development Program in New York City. “The model where you stimulate and [then] go back to the old days is gone.”[71]

The Wall Street Journal notes:

“Economists also see an upturn in U.S. household saving as the beginning of a prolonged period of thrift…..”[72]

Demographics

Financial analysts who have studied U.S. demographics – like Harry Dent and Claus Vogt – point out that the U.S. population is aging:

United States Population Pyramid for 2010

United States Population Pyramid for 2020

United States Population Pyramid for 2050

[73]

Vogt argues that an aging population within a given nation is correlated with a decline in that country’s economy. [74]. Certainly, a population with less working-age people and more dependent elderly people will experience a drag on its economy.

Dent argues that one of the main drivers of a country’s economic growth is the number of people in the country who are in their peak spending years.

For example, Dent says that in the U.S., 45-54 year olds are the biggest spenders, because that is when – on average – they are paying for their kids’ college, paying mortgage on the biggest house they will own during their life, etc. Dent argues that the American economy will tend to grow when the number of 45-54 year olds grows, and to shrink when it shrinks.

As the charts above show, the number of 45-54 year olds in the U.S. will shrink considerably in the year ahead.

Decline in Manufacturing

As everyone knows, the manufacturing has shrunk in the United States and the service sector has grown. Even in a manufacturing center such as Detroit, manufacturing jobs have been declining for decades:

[75]

Indeed, according to professor of economics Dr. Mark J. Perry, manufacturing jobs have dropped to their lowest level since 1941, and are now below 9% of the workforce for the first time. [76]

Wayne State University’s Center for Urban Studies argues:

For each job lost in the manufacturing industry, more spinoff jobs are lost than would be in other sectors. Each manufacturing job helps support a larger number of other jobs than do most other sectors. [77]

That means that the ongoing reduction in manufacturing jobs will adversely affect unemployment for the foreseeable future.

Destruction of Credit

The amount of credit outstanding has been reduced by trillions of dollars in the past year.

For example, the amount of consumer credit outstanding has plummeted:

Banks have become tight-fisted about lending, and this will probably not change any time soon. As the New York Times wrote in an article from October 2008 entitled “Banks Are Likely to Hold Tight to Bailout Money”:

“Will lenders deploy their new-found capital quickly, as the Treasury hopes, and unlock the flow of credit through the economy? Or will they hoard the money to protect themselves?

John A. Thain, the chief executive of Merrill Lynch, said on Thursday that banks were unlikely to act swiftly. Executives at other banks privately expressed a similar view.

‘We will have the opportunity to redeploy that,’ Mr. Thain said of the new capital on a telephone call with analysts. ‘But at least for the next quarter, it’s just going to be a cushion.’

***

Lenders have been pulling back on credit lines for businesses, mortgages, home equity loans and credit card offers, and analysts said that trend was unlikely to be reversed by the government’s money.

Roger Freeman, an analyst at Barclays Capital, which acquired parts of the now-bankrupt Lehman Brothers last month [said] ‘My expectation is it’s quarters off, not months off, before you see that capital being put to work.’ ”[78]

And another New York Times article included the following quote:

“It doesn’t matter how much Hank Paulson gives us,” said an influential senior official at a big bank that received money from the government, “no one is going to lend a nickel until the economy turns.” The official added: “Who are we going to lend money to?” before repeating an old saw about banking: “Only people who don’t need it.”[79]

Reading between the lines, the bank officials are saying that they will not lend freely until the economic crisis is over.

As WLMLab Bank Loan Performance points out, outstanding loans in the United States have dropped $110 billion dollars quarter-over-quarter. [80]

McClatchy notes:

Over the course of 2008, the nation’s five largest banks reduced their consumer loans by 79 percent, real estate loans by 66 percent and commercial loans by 19 percent, according to FDIC data. A wide range of credit measures, including recent FDIC data, show that lending remains depressed.[81]

Indeed, total seasonally adjusted consumer debt fell $21.55 billion, or at a 10.4% annual rate, in July 2009 alone. credit-card debt fell $6.11 billion, or 8.5%, to $905.58 billion. This is the record 11th straight monthly drop in credit card debt. Non-revolving credit, such as auto loans, personal loans and student loans fell a record $15.44 billion or 11.7% to $1.57 trillion [82]

In addition, the securitization market has largely collapsed, which in turn has destroyed a large proportion of the world’s credit. As noted in an article in the Washington Times:

“Before last fall’s financial crisis, banks provided only $8 trillion of the roughly $25 trillion in loans outstanding in the United States, while traditional bond markets provided another $7 trillion, according to the Federal Reserve. The largest share of the borrowed funds – $10 trillion – came from securitized loan markets that barely existed two decades ago. . . .

Mr. Regalia [chief economist at the U.S. Chamber of Commerce] said … 70 percent of the system isn’t there anymore,’ he said.”[83]

The reason that seventy percent of the system “isn’t there anymore” is because the traditional bond markets and securitized loan markets (part of the “shadow banking system”) have dried up. As the Washington Times article notes:

“Congress’ demand that banks fill in for collapsed securities markets poses a dilemma for the banks, not only because most do not have the capacity to ramp up to such large-scale lending quickly. The securitized loan markets provided an essential part of the machinery that enabled banks to lend in the first place. By selling most of their portfolios of mortgages, business and consumer loans to investors, banks in the past freed up money to make new loans. . . .

“The market for pooled subprime loans, known as collateralized debt obligations (CDOs), collapsed at the end of 2007 and, by most accounts, will never come back. Because of the surging defaults on subprime and other exotic mortgages, investors have shied away from buying the loans, forcing banks and Wall Street firms to hold them on their books and take the losses.”

Senior economic adviser for UBS Investment Bank, George Magnus, confirms:

The restoration of normal credit creation should not be expected, until the economy has adjusted to the disappearance of shadow bank credit, and until banks have created the capacity to resume lending to creditworthy borrowers. This is still about capital adequacy, where better signs of organic capital creation are welcome. More importantly now though, it is about poor asset quality, especially as defaults and loan losses rise into 2010 from already elevated levels.[84]

And McClatchy writes:

The foundation of U.S. credit expansion for the past 20 years is in ruin. Since the 1980s, banks haven’t kept loans on their balance sheets; instead, they sold them into a secondary market, where they were pooled for sale to investors as securities. The process, called securitization, fueled a rapid expansion of credit to consumers and businesses. By passing their loans on to investors, banks were freed to lend more.

Today, securitization is all but dead. Investors have little appetite for risky securities. Few buyers want a security based on pools of mortgages, car loans, student loans and the like.

“The basis of revival of the system along the line of what previously existed doesn’t exist. The foundation that was supposed to be there for the revival (of the economy) . . . got washed away,” [economist James K.] Galbraith said.

Unless and until securitization rebounds, it will be hard for banks to resume robust lending because they’re stuck with loans on their books.[85]

Not only has the supply of credit been destroyed, but the demand for many types of loans – such as commercial real estate loans – is also drying up.[86]

So there is simply much less credit flowing through the economic system than there was prior to 2007.

The New Normal – Lower Economic Activity

As chief economist for the International Monetary Fund, Olivier Blanchard, said:

This recession has been so destructive that “we may not go back to the old growth path … potential output may be lower than it was before the crisis.” [87]

All of the above trends force many economists to conclude that economic activity as a whole will be lower for many, many years. In other words, they say that “The New Normal” will be a much lower level for the economy.

Pimco CEO Mohamed El-Erian says elevated unemployment and record wealth destruction will keep growth at 2 percent or less for years. [88]

As Bloomberg writes:

The New Normal theory predicts that the recession will leave unemployment, forecast to reach 10 percent for the first time since 1983 early next year, higher for years. [89]

Indeed, the “overhang” of inventory [90]- that is, the inventory of unsold goods – in everything from housing [91 and 92] to cars [93] to consumer electronics [94] means that the newly reduced consumer demand is meeting up with very high levels of supply. This is a recipe for unemployment.

Many economists also point out that the length of time people are remaining unemployed is skyrocketing. As the Washington Post notes:

Another disturbing development was that the number of people out of work for 27 weeks or longer reached a record 5 million, accounting for a third of the unemployed. That suggests to some economists that those job losses were caused by structural changes in the economy and that many of those people won’t be called back to work once the economy picks up. The longer people are out of work, the harder it becomes for them to find jobs and the more likely they are to exhaust savings or lose their homes to foreclosure. [95]

The following chart from the St. Louis Federal Reserve Bank shows that people are staying unemployed much longer than they have in any previous economic downturn since 1950:

[96]

As David Rosenberg writes:

The number of people not on temporary layoff surged 220,000 in August and the level continues to reach new highs, now at 8.1 million. This accounts for 53.9% of the unemployed — again a record high — and this is a proxy for permanent job loss, in other words, these jobs are not coming back. Against that backdrop, the number of people who have been looking for a job for at least six months with no success rose a further half-percent in August, to stand at 5 million — the long-term unemployed now represent a record 33% of the total pool of joblessness. [97]

[98: for graphical updates on the state of the economy, see charts from the Cleveland Federal Reserve Bank posted at http://www.clevelandfed.org/research/data/updates/index.cfm?DCS.nav=Local]

Another Trend: Increased Productivity Means Less Jobs

All of the aforementioned economic trends point to lower levels of job creation, and thus higher unemployment.

In addition, the chief economist for MarketWatch, Distinguished Scholar of Economics at Dowling College (Irwin Kellner) points out that worker productivity is rising, and that increased worker productivity means less new people will be hired. [99]

Other Theories Regarding the Causes of Unemployment

The main cause of unemployment today is the economic crisis. For example, a report from the the National Industrial Conference Board pointed out in 1922 stated the obvious: depressions increase unemployment. [100]

The report also points out that seasonal variations, “immigration and tariff policies and international relationship” can affect unemployment figures. [101]

In fact, economists from different schools of thought ascribe different causes to unemployment. For example:

Keynesian economics emphasizes unemployment resulting from insufficient effective demand for goods and services in the economy (cyclical unemployment). Others point to structural problems, inefficiencies, inherent in labour markets (structural unemployment). Classical or neoclassical economics tends to reject these explanations, and focuses more on rigidities imposed on the labor market from the outside, such as minimum wage laws, taxes, and other regulations that may discourage the hiring of workers (classical unemployment). Yet others see unemployment as largely due to voluntary choices by the unemployed (frictional unemployment). Alternatively, some blame unemployment on disruptive technologies or Globalisation.

[102 and 103]

For example, many Americans believe that globalization has increased unemployment because “American jobs” have moved abroad. Certainly, the American government has encouraged multinational corporations based in the U.S. to move jobs overseas. But quick fixes may lead to new problems. For example, a new American protectionism could stifle trade, further weakening the American economy.

Similarly, some economists believe that inflation decreases unemployment. However, that is only true where the workers drastically underestimate the extent to which higher prices are decreasing the real value of their wages. Indeed, as the Cato Institute notes:

This reduction in unemployment cannot occur unless workers systematically underestimate the inflation rate. When workers are aware of the inflation rate and, for example, have their pay adjusted according to the cost of living, they will interpret wages properly and not be misled into thinking that a normal wage offer is a relatively high wage offer.

Rather than merely failing to decrease unemployment, inflation may actually increase the unemployment rate. Frequent concomitants of inflation, such as high interest rates and volatility and uncertainty in the financial and product markets, increase the risks inherent in business operations and thereby discourage the expansion of firms and the creation of jobs. [104]

Therefore, many “quick fixes” for unemployment may actually do more harm than good.

Isn’t the Government Helping to Reduce Unemployment?

The government has committed to give trillions to the financial industry. President Obama’s stimulus bill was $787 billion, which is less than a tenth of the money pledged to the banks and the financial system. [105]

Of the $787 billion, little more than perhaps 10% has been spent as of this writing. [106]

The Government Accountability Office says that the $787 billion stimulus package is not being used for stimulus. [107] Instead, the states are in such dire financial straights that the stimulus money is instead being used to “cushion” state budgets, prevent teacher layoffs, make more Medicaid payments and head off other fiscal problems. So even the money which is actually earmarked to help the states stimulate their economies is not being used for that purpose.

Indeed, much of the $787 billion was earmarked pork [108], not for anything which could actually stimulate the economy. [109]

Mark Zandi – chief economist for Moody’s – has calculated which stimulus programs give the most bang for the buck in terms of the economy:

[110]

But very little of the stimulus funds are actually going to high-value stimulus projects.

Indeed, as the Los Angeles Times points out:

Critics say the [stimulus money reaching California] is being used for projects that would have been built anyway, instead of on ways to change how Californians live. Case in point: Army latrines, not high-speed rail.

***
Critics say those aren’t the types of projects with lasting effects on the economy.

“Whether it’s talking about building a new [military] hospital or bachelor’s quarters, there isn’t that return on investment that you’d find on something that increases efficiency like a road or transit project,” said Ellis of Taxpayers for Common Sense.

Job creation is another question. A recent survey by the Associated General Contractors of America found that slightly more than one-third of the companies awarded stimulus projects planned to hire new employees. But about one-third of the companies that weren’t awarded stimulus projects also planned to hire new employees.

“While the construction portion of the stimulus is having an impact, it is far from delivering its full promise and potential,” said Stephen E. Sandherr, chief executive of the contractors group.

It’s unclear how many jobs will be created through the Defense Department projects. Most of the construction jobs are awarded through multiple award contracts, in which the department guarantees a minimum amount of business to certain contractors, and lets only those contractors bid on projects.

That means many of the contractors working on stimulus projects already have been busy at work on government projects.even the stimulus money which is being spent [111]

David Rosenberg writes:

Our advice to the Obama team would be to create and nurture a fiscal backdrop that tackles this jobs crisis with some permanent solutions rather than recurring populist short-term fiscal goodies that are only inducing households to add to their burdensome debt loads with no long-term multiplier impacts. The problem is not that we have an insufficient number of vehicles on the road or homes on the market; the problem is that we have insufficient labour demand.[112]

Donald W. Riegle Jr. – former chair of the Senate Banking Committee from 1989 to 1994 – wrote (along with the former CEO of AT&T Broadband and the international president of the United Steelworkers union):

It’s almost as if the administration is opting for a rose-colored-glasses PR strategy rather than taking a hard-nose look at actual consumer and employment figures and their trends, and modifying its economic policies accordingly.[113]

How Much Unemployment Do We Want?

On the one end of the spectrum, Article 23 of the United Nations’ Universal Declaration of Human Rights declares:

Everyone has the right to work, to free choice of employment, to just and favourable conditions of work and to protection against unemployment.[114]

In other words, the U.N. says that there should be essentially no unemployment for those who wish to work.

On the other end of the spectrum, some people – who make a lot of money during periods where the condition lead to high levels of unemployment – are comfortable with unemployment percentages reaching those in the Great Depression.

Societies should decide for themselves what level of unemployment they consider acceptable, and then demand policies which will accomplish that goal to the greatest extent possible. As discussed above, there are many factors which affect employment levels, and so solutions are complicated.

However, without an open and visible public policy debate about the issue, unemployment levels will either remain second order affects of policy choices concerning other elements of the economy, or will be decided behind closed doors by decision-makers who may or may not have the best public interest in mind.

Public Funding

As the above facts show, unemployment is a very serious problem in the United states, and world-wide. The policy responses of the U.S. and other Western governments has not been working. As discussed above, there is no simple solution.

Senator Riegle recommends a 4-part prescription, including:

Ensure that loans and credit facilities are readily available to the nation’s small and medium size businesses and manufacturers.

Many of the top economists argue that we need to break up the giant banks which are insolvent in order to save the economy.[115] Fortune[116], BusinessWeek[117] and Federal Reserve governor Daniel K. Tarullo[118] have pointed out that breaking up the largest, insolvent banks would allow more competition from small to mid-size banks, and that such banks may actually make more loans to small businesses. More loans to small businesses would lead to more employment by those many small businesses.

In addition, the U.S. has largely been financing job creation for ten years. Specifically, as the chief economist for BusinessWeek, Michael Mandel, points out, public spending has accounted for virtually all new job creation in the past 1o years:

Private sector job growth was almost non-existent over the past ten years. Take a look at this horrifying chart:

Between May 1999 and May 2009, employment in the private sector sector only rose by 1.1%, by far the lowest 10-year increase in the post-depression period.

It’s impossible to overstate how bad this is. Basically speaking, the private sector job machine has almost completely stalled over the past ten years. Take a look at this chart:

Over the past 10 years, the private sector has generated roughly 1.1 million additional jobs, or about 100K per year. The public sector created about 2.4 million jobs.

But even that gives the private sector too much credit. Remember that the private sector includes health care, social assistance, and education, all areas which receive a lot of government support.

***

Most of the industries which had positive job growth over the past ten years were in the HealthEdGov sector. In fact, financial job growth was nearly nonexistent once we take out the health insurers.

Let me finish with a final chart.

Without a decade of growing government support from rising health and education spending and soaring budget deficits, the labor market would have been flat on its back. [119]

Raw Story argues that the U.S. is building a largely military economy:

The use of the military-industrial complex as a quick, if dubious, way of jump-starting the economy is nothing new, but what is amazing is the divergence between the military economy and the civilian economy, as shown by this New York Times chart.

In the past nine years, non-industrial production in the US has declined by some 19 percent. It took about four years for manufacturing to return to levels seen before the 2001 recession — and all those gains were wiped out in the current recession.

By contrast, military manufacturing is now 123 percent greater than it was in 2000 — it has more than doubled while the rest of the manufacturing sector has been shrinking…

It’s important to note the trajectory — the military economy is nearly three times as large, proportionally to the rest of the economy, as it was at the beginning of the Bush administration. And it is the only manufacturing sector showing any growth. Extrapolate that trend, and what do you get?

The change in leadership in Washington does not appear to be abating that trend…[120]

So most of the job creation has been by the public sector. But because the job creation has been financed with loans from China and private banks, trillions in unnecessary interest charges have been incurred by the U.S.

Former Washington Post editor and author of one of the leading books on the Federal Reserve, William Greider, points out that governments actually have the power to create money and credit themselves, instead of borrowing it at interest from private banks:

If Congress chooses to take charge of its constitutional duty, it could similarly use greenback currency created by the Federal Reserve as a legitimate channel for financing important public projects–like sorely needed improvements to the nation’s infrastructure. Obviously, this has to be done carefully and responsibly, limited to normal expansion of the money supply and used only for projects that truly benefit the entire nation (lest it lead to inflation)…

This approach speaks to the contradiction House Speaker Pelosi pointed out when she asked why the Fed has limitless money to spend however it sees fit. Instead of borrowing the money to pay for the new rail system, the government financing would draw on the public’s money-creation process–just as Lincoln did and Bernanke is now doing.[121]

By creating the credit itself – instead of borrowing from private banks and foreign nations – the American government could finance the creation of new jobs without incurring huge interest charges owed to the private banks and foreign countries which lent America the money. In other words, the U.S. government would itself create the new credit, just as Lincoln did to finance the civil war.

By financing new projects with credit created by the government itself, America might be able to pick itself up by its bootstraps and put its people back to work.

The same may be true for other countries as well.

We’ve commented from time to time on dubious Chinese data releases. But this report from Foreign Policy reports on an interest aspect: that the statistics are not manipulated only in the normal bureaucratic manner (fudging them) but also by getting companies to change behavior so it can be tallied in a more flattering fashion.

The story contains some real bombshells: unemployment is likely 40 to 50 million, as opposed to the widely reported 20 to 30 million; the statistical manipulations are a surprisingly broad-based initiative.

From Foreign Policy (hat tip reader Michael):

In February, local Chinese Labor Ministry officials came to “help” with massive layoffs at an electronics factory in Guangdong province, China. The owner of the factory felt nervous having government officials there, but kept his mouth shut. Who was he to complain that the officials were breaking the law by interfering with the firings, he added. They were the law! And they ordered him to offer his workers what seemed like a pretty good deal: Accept the layoff and receive the legal severance package, or “resign” and get an even larger upfront payment….

Such open-secret programs, writ large, help China manipulate its unemployment rate, because workers who “resign” don’t count toward that number. The government estimates that roughly 20 million migrant factory workers have lost their jobs since the downturn started. But, with “resignations” included, the number is likely closer to 40 million or 50 million, according to estimates made by Yiping Huang, chief Asia economist for Citigroup. That is the same size as Germany’s entire work force. China similarly distorts everything from its GDP to retail sales figures to production activity. This sort of number-padding isn’t just unethical, it’s also dangerous: The push to develop rosy economic data could actually lead China’s economy over the cliff….

Pressure to distort or fudge statistics likely comes from up high — and it’s intense…

But local and provincial governmental officials are the ones who actually fiddle with the numbers… “The higher [their] GDP [figures], the higher the chance will be for local officials to get promoted,” explained [Gary] Liu.

The story then goes through a good list of distorted and certain to be exaggerated figures, then returns to an assessment:

Still, it is possible to infer the severity of the gap between economic reality and China-on-paper by looking closely at monetary policy. China’s state-owned banks dramatically increased lending in the first half of 2009 — by 34.5 percent year on year, to more than $1 trillion. This move seems intended to keep growth artificially high until exports bounce back. Most analysts agree that it is leading to large bubbles in the stock, real estate, and commodity markets. And the Chinese government recently announced plans to raise capital requirements — an apparent sign it sees the need to reign in the expansion.

For the long term, China is banking on its main export markets — in the United States, Europe, and Japan — recovering and starting to consume again. The hope is that in the meantime, rosy economic figures will placate the masses and stop unrest. But, if the rest of the world does not rebound, China risks the bursting of asset bubbles in property and stocks, declining domestic consumption, and rising unemployment.

That’s when the Wile E. Coyote moment could happen. Once Chinese citizens no longer believe that the economy is doing well, social unrest and more widespread worker riots — already increasing in scope and severity — are likely. That’s something that China will have a harder time hiding. And then we’ll know whether China’s statistical manipulation was a smart move or a disastrous mistake.

Although it should have been blindingly obvious, it never occurred to me that the cheerleading via distorted numbers was to promote social cohesion.

By Andrew Kaplan, a hedge fund manager:

It has become fashionable among equities managers of the bullish persuasion to argue that a strong recovery in GDP will occur in 2010 because the “structural adjustment period” of moving back to a more normal savings rate has been completed. We’ve gone from a savings rate of barely 1% in 2008 up to 4.2% in July (ok, so the argument sounded better when the number was 6.2% in May, but still…).

The story goes something like, “consumers took a little time to recognize that their home equity had disappeared, but now they’ve adjusted their savings rates toward the desired level to reflect the fact that they need to save a larger proportion of income for retirement…so this effect will no longer be a drag on growth in coming quarters.”

This is the kind of conventional wisdom which could only emerge among folks in the 99^th income percentile who spend their time primarily with other folks in the 99^th income percentile. You don’t have to look at the data (mortgage delinquencies, foreclosures, credit card defaults, bankruptcies) all that hard to see a very different picture. In fact, it is almost certainly true that the savings rate for 99% of the US population is negative. These people (a/k/a “all of us”) are drowning. And to the extent that our savings rate is less negative than it was one or two years ago, that simply reflects the reality of reduced home equity and unsecured credit lines rather than any conscious effort to reach a “desired level” of savings.

A little data might help here. Unfortunately, there really IS no good data on PCE (personal consumption expenditure) and savings stratified by income percentile. There are a couple of surveys, the triennial “Survey of Consumer Finances” by the Federal Reserve and the “Consumer Expenditure Survey” by the Bureau of Labor Statistics, but the self-reported data is laughable. For 2007, the Consumer Expenditure Survey showed a personal savings rate of 18.4%. In the same year, the Bureau of Economic Analysis, which calculates the savings rate as a residual from actual income and expenditure data, showed a savings rate of 1.7%. Either the Consumer Expenditure Survey does a poor job of sampling, or people who fill out surveys are really big liars.

Fortunately, there IS some pretty good data on income stratification in the United States, and a few assumptions can help shed some light. Economists Thomas Piketty and Emmanuel Saez have made careers of studying US income inequality using IRS data, which goes back to 1913. The most recent data available (for 2007) showed that the top 14,988 households (0.01% of the population) received 6.04% of income, the highest figure for any year since the data became available. The top 1% of households received 23.5% of income (the second highest on record, after 1928), while the top 10% received 49.7% of income (the highest on record).

The fortunate 14,988 had an average income in 2007 of $35,042,705. They had an average federal tax burden, according to Piketty and Saez, of 34.7%, leaving them after tax income of $22.9 million. If you assume a 50% savings rate among this group, you get total savings of $171.5 billion. This is nearly ONE HALF of the total savings for the entire country implied by a savings rate of 4.2% ($365 bn) reported in this month’s Bureau of Economic Analysis data.

I’ve never actually had an after tax income of $22.9 million, so I couldn’t say for sure whether a 50% savings rate is a reasonable assumption, but I’m going to go out on a limb and say that it is, just based on the pure physics of spending money. Buying cars, clothes, and fancy dinners, even at Masa, won’t get you there…the math doesn’t work. Buying a private jet could get you there, but most people, even rich people, don’t buy one of those every year. The only EASY way to spend more than 50% of $22.9 million on an annual basis is to buy lots of houses…but the definition of “personal consumption expenditure” used by the BEA specifically excludes purchases of real estate. They use an imputed rent calculation instead. So I’m going to stick with my 50% number.

If we expand our survey to the top 1% of all households, we find an average income of $1.36 million for 2007. These folks had an average federal tax burden of just under 33%, so their after tax income averaged $916 thousand. If you assume this group had a savings rate of 33%, you get total savings of $452 billion (remember, $171.5 bn of this comes from the top 0.01%, we’re assuming a savings rate of around 25% of after tax income for the “poorer” 99% of the top 1%) This is more than 100% of the personal savings of the entire population, according to the BEA data. It implies that 99% of the US population still has, on average, a negative savings rate of around 1.3%. If you subtract the next nine percent, which likely still has a positive savings rate, the data for the bottom 90% becomes even more depressing, implying a negative savings rate of close to 5%.