Why Are US Job Numbers Better Than Europe’s? Thank the Deficit!
Last Friday, Eurostat released the latest European unemployment data for November 2011. The results were horrific, with unemployment rates in Spain now close to 23 percent (as at November 2011 and rising) and Greece 18.8 percent (as at September 2011) and rising. Greece’s unemployment rate rose 4.8 per cent in the first 9 months of last year. By contrast, the US jobless rate dropped to a near three-year low of 8.5 percent.
Looking at the US data one certainly does not see a boom, but there is a pervasive pattern of improvement that is not consistent with anything seen in Europe. So why would the US data look better even though we are programmed for some fiscal restriction, the household savings rate is too low, the global economy has weakened, and there is no big increase in equity and home prices?
The answer could be very, very simple. Three years of “horrible” budget deficits in excess of 8 percent of GDP have managed to do something critical to help the economy. How? Mainly in the form of what economists call “automatic stabilizers” – things like unemployment insurance and food stamps that put money in the hands of consumers during a downturn. By running deficits, we have been able to put a floor on demand and generate at least a modicum of economic momentum, which is slowly leading to an improving job situation.
Of course, you wouldn’t know this if you turned on the TV.
When it comes to federal budget deficits there only appear to be two respectable positions in the mainstream media. The first is the “deficit hawk” position that argues that budget deficits are never acceptable because they only lead to complete crowding-out: every dollar of government spending is offset by a dollar of private spending. The second view—“deficit dove”--is that deficits are probably acceptable for the short run, and perhaps even necessary to save the economy from another depression. This view maintains that the benefits we receive today are partially offset by costs in the future when we will need to “tighten our belts” to repay the debt.
But neither view is correct: Right now, the US economy faces such strong headwinds that a huge fiscal expansion is required—and this will mean deficits even larger and perhaps more prolonged than those now projected. Contrary to the position of the fiscal deficit hysterics such as billionaire Pete Peterson and the Concord Coalition who endlessly repeat the fiction that deficits are always evil, it’s better to think of the deficits as the one thing which is saving us from the grim fate now experienced in Europe, where double digit unemployment is the norm virtually throughout the continent. And we don't have to worry about eliminating them in the future, as growth (with correspondingly higher tax revenues and lower social welfare payments) will take care of the "deficit problem," much as it did following World War II and also during the early 1980s.
Let’s be clear: I’m not a Pollyanna hailing the rebirth of the US economy. There have been over 15 million jobs lost since the financial crisis of 2008 and today’s growth is insufficient to bring up back to full employment. If you like, the US economy is the least ugly person at the dance, and a lot more fiscal stimulus likely necessary to turn the American economy into the belle of the ball.
How We Recovered From the Great Depression
We have had the biggest recession since 1932, but no strong recovery. By contrast, in the four years after 1932, the US economy had its strongest economic growth on record. Why? In the mainstream media, you’ll often hear that the slow nature of the current recovery is a consequence of the overhang of private debt and the unwillingness of banks to lend. But wait, in the early 1930s the ratio of private debt to GDP was higher than it is now because inflation-adjusted GDP fell by fifty percent in the Great Depression. Additionally, bank lending continued to contract until mid 1935. Yet the economy grew at a rate in excess of 10 percent of GDP in the first two years of the recovery.
And if you look at President Roosevelt’s fiscal stimulus, you’ll find that it only began after the recovery was well under way (Industrial production and other measures of economic activity were already rising by 1932). From that, we can conclude that the existence of shrinking debt and bank restraint affects the SPEED at which a recovery occurs and how long the recession lasts (because larger private debt burdens induced people to put off consumption or investment to pay off existing debts). But these factors are in themselves not always a sufficient barrier to a strong recovery unless you get the trends continuing. If private debt is reduced sufficiently and private savings begin to stabilize, then you can start to recover (which is what is happening in the US right now). And the public deficits are the reason why this is occurring, because PUBLIC deficits (as opposed to private) facilitate private sector debt deleveraging. Remember, unless some other sector can take up the slack (say, via higher exports) or the government increases its deficit spending (as with the federal budget balance of late) then the mere attempt by the domestic private sector to net save out of income flows, given the existing private debt overhang, can prove very economically disruptive.
Part of the explosive nature of the recovery in the early thirties can be attributed to the overshooting of the stock adjustment. In other words, the inventory of goods and stock of consumer durables and producer durables were cut to the bone relative to demand and output. Industrial production rose by 62 percent in the first year of that recovery, as the lean nature of all three led to a slingshot in the demand for goods. Additionally, after a year of recovery there was no doubt a big swing in public sentiment from extremely depressed levels. People began to feel more optimistic.
In this instance there has been a long lag. I think the eruption of systemic threats in the eurozone had a lot to do with this, but the adjustment process has still continued apace in the US. So now one has to ponder whether the improved numbers in the US, which are not dramatic but quite pervasive, isn't telling us that the adjustment is complete and sentiment is being healed by time and forgetfulness. If that’s true, then the US economy is going to do better than the consensus expects.
But as Jonathan Wilmot, strategist at Credit Suisse recently noted at the firm’s Global Macro Conference in Asia last week, the consensus on the US remains very negative. Why? Because economists, investors, market practitioners and the like remember Lehman Brothers and its aftermath and are looking for a repeat. This time they expect the repeat to occur in Europe. But such very unusual events don't tend to repeat, at least over the shortish run. And each time we get to the cliff's edge in Europe, the European Central Bank (ECB) steps in and writes the check to sustain the euro’s viability. It's not enough to prevent a recession in Europe (because, as noted above, the ongoing embrace of fiscal austerity is killing demand), but it's doing enough to prevent the euro from evaporating. The European Central Bank’s actions in respect of the eurozone are akin to watering a flower enough to keep it from withering and dying, but not enough to let it grow properly.
US Outlook is Good -- if We Can Reject Austerity
So let's go back to the US: What happens if the US neutralizes most of the programmed fiscal restriction and the US economy grows above trend? And what if the European economy has an overall muddle through recession which everyone now discounts and the Chinese put on the gas again (which I think they'll do because their economy is decelerating quickly)?
It seems to me that the US could still do better than the consensus, so long as it doesn't embrace the doomed fiscal austerity policies of Europe. And let’s celebrate this fact. America’s budget deficits are not an aberration.
If you look back to 1776, the federal budget has run a continuous deficit except for seven short periods. The first six of those were followed by depressions—the last time was in 1929 which was followed by the Great Depression. The one exception was the Clinton budget surplus, which was followed (so far) only by a recession. While one cannot rule out coincidences, seven surpluses followed by six and a half depressions (with some possibility for making it the perfect seven) should create some pause amongst our fiscal hawks pushing for budget cuts now. As counter-intuitive as it sounds given the prevailing "conventional wisdom," balancing federal budgets and pushing for surpluses weakens the economy.
In fact, each time the government tried to push its budget into surplus, a major recession followed which forced the budget right back into deficit as those automatic stabilizers kicked in. Eliminating the so-called "scourge of public debt" has been a disaster throughout our history, even as the "experts" continue to applaud it.
Deficits have certainly helped the US from falling into Great Depression 2.0. If our policy makers would stop treating these deficits as the economic equivalent of Norman Bate’s mother in the Bates Motel attic, then this might (emphasis on MIGHT) actually lead to some coherent policy making going forward.