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Richmans' Trade and Taxes Blog
9.1% unemployment shows that Obama's recovery & QE2 have failed
Howard Richman, 6/3/2011
This morning, the Bureau of Labor Statistics announced that unemployment rose to 9.1% in May, after a rise to 9.0% in April. With unemployment staying high, it is clear that the Obama recovery and Ben Bernanke's QE2 have both failed. And let's not forget the projected Unemployment Rate, shown in blue, that was made by President Obama's economic advisers based upon their expectations of how well his recovery plan would work.
Those who have been reading my postings should not be surprised. I predicted all of this. For example, I predicted the failure of Obama's recovery plan after I read President Obama's inaugural address. I wrote on January 23, 2009:
If Obama addresses the trade deficits, then his recovery plan should succeed. The hope generated by his presidency would be rewarded. And he would likely be considered one of the greatest economic presidents ever.
But if he doesn't take action to balance trade, his recovery plan will not work. He will need to borrow more and more for one stimulus package after another, just to keep unemployment low. Eventually this borrowing could destroy the U.S. government's credit rating and lead to a dollar collapse. That's when things would get really bad.
Key to my prediction was the idea that Obama wouldn't balance trade. I was correct. The only temporary improvement in the trade balance occurred during the fourth quarter of 2010, due to QE2. Except for that, the U.S. trade balance has worsened consistently ever since Obama's inaugural (2009-I on the graph). as shown in the chart below:
On September 9, 2009, I explained why Obama's recovery would fail in some detail. I wrote:
Some economists are predicting a normal recovery. Some are predicting a jobless recovery. I predict that there will be no recovery at all, other than a very temporary one caused by a blip in government spending.
Let me explain why in terms of the four factors that economists use to divide up the total spending in an economy (i.e., the "aggregate demand"). In order for a recovery to occur, the sum of these factors has to rise. Here's why I don't expect that sum to rise:
- Consumption. Wages and salaries won't be increasing, and people are too deeply in debt to spend more money without more income.
- Investment. None of the following types of business investment are likely to increase:
- a. Manufacturing investment won't increase because China, following a mercantilist policy, will keep the dollar pegged to a rate where they can prevent investments in American manufacturing from becoming profitable, and President Obama will continue to do nothing about this problem.
- b. Construction investment won't increase because of over-construction during the house price bubble and because house prices still have a way to fall.
- c. Retail investment won't increase because consumption won't be increasing.
- d. Energy investment in nuclear or fossil fuel energy sources won't increase because they will be discouraged by the Obama administration and the Democratic Congress.
- Government Purchases. Although government purchases and subsidies of unprofitable energy production will stay strong, the government can't increase its already huge deficit spending much more.
- Trade Surplus. An improving trade surplus (i.e. more exports or less imports) would help. But I expect the trade surplus to go the opposite way because many countries, including China, will manipulate their exchange rates to prevent American exports from increasing more than American imports, and President Obama will continue to do nothing about the problem.
I am not saying that there will never be a recovery, just that there won't be a recovery until our trade problem is solved. This prediction is not original with me. Economist John Maynard Keynes made the same prediction when he wrote in his magnum opus (The General Theory of Employment Interest and Money):
(A) favorable [trade] balance, provided it is not too large, will prove extremely stimulating; whilst an unfavorable balance may soon produce a state of persistent depression. (p. 338)
Keynes's solution was for a trade deficit country to subsidize exports and restrict imports in order to balance trade. But President Obama's economic advisors are all unilateral-free-traders, so they won't do anything to solve the problem. And the Democratic Congress is much too subservient to the Democratic administration to do anything on its own.
A currency crash could also provide a solution. After a dollar crash, Americans would have a much lower standard of living, but the American economy would grow rapidly, led by foreign and domestic business investments in America's manufacturing sector. The main task of the President would be to get the government out of the way of the recovery.
Thus, due to the incompetence of his economic advisors, President Obama's term will either be marked by recession and stagnation or by a dollar crash. In either case, he will be a one-term president.
I also predicted that the fall in house prices would resume, despite such foolish measures as subsidies for first-time buyers and the Federal Reserve buying over a trillion dollars worth of mortgage-backed securities. The actual course of house prices is shown on the chart below:
In fact, I predicted the resumed fall in house prices several times. For example, on October 16, 2009, I wrote:
Home sales declined in August, as did the average price at which houses were sold. An article in the Christian Science Monitor puts a positive face on the story. Here's a selection:
The median sales price of existing homes ... declined from $181,500 in July to $177,700 in August, according to a National Association of Realtors (NAR) report released Thursday....
Outside analysts downplayed the one-month decline. “We suspect it is just a temporary blip in the improving trend rather than a sign of renewed weakness,” wrote Paul Dales, an economist at Capital Economics, in an analysis....
I expected this decline, and I expect that house prices will continue to decline. The real blip was the temporary pause in the fall of house prices, bought at huge expense to taxpayers by the incompetent economists of the Federal Reserve and the Obama administration.
In November 15, 2010, I correctly predicted that the effects of the Federal Reserve's QE2 would either be temporary or disastrous, depending upon the actions of foreign central banks. I wrote:
“QE2” are the initials of the Queen Elizabeth 2, a great ocean liner which was the sequel of a great ocean liner. They are also the initials of “Quantitative Easing 2,” Federal Reserve Chairman Ben Bernanke’s second huge increase in the United States money supply. Although QE1 was a huge success, QE2 could end in disaster. If so, it may be renamed “Titanic2,” after another ocean liner, one that sank.
QE1 restored liquidity to the U.S. money supply during and after the October 2008 financial crash. The extra liquidity provided by the Fed let American banks lend short term so that businesses could meet payrolls and buy inventory. As part of the QE1 package, Bernanke even made currency swaps with fellow central banks, which made dollars available around the world to foreign businesses whose debt payments required dollars. QE1 was Bernanke at his best.
QE2 is designed to reduce American private savings and also to cause private foreign savings to flee from the United States. Its goal is to increase inflation from its current 1% to at least 2% or 3% while keeping short-term U.S. interest rates close to 0%, producing an “inflation tax” upon private American and foreign savers.
Bernanke hopes that reducing private American savings will increase American consumption and that sending private savings abroad will improve America’s trade balance. Indeed, the short-term result of QE2 will be beneficial. Consumption will increase and private savings will flee the country for better interest rates abroad. Already, the dollar has weakened versus most foreign currencies, which makes American products more competitive in U.S. and world markets.
But in the long term, Bernanke’s discouragement of American savings will reduce investment in America’s economic future and his decision to increase inflation will provide a new element of uncertainty in business decision making.
The effect upon the dollar can’t help much. It will either be temporary or disastrous, depending upon what foreign central banks do:
- Temporary Effect. If foreign central banks buy dollars with their currencies to prop up the dollar, as most Asian central banks are already doing so that their own products will be more competitive, they will drive the dollar back up, eliminating the positive effect upon America’s trade balance.
- Disastrous Effect. If foreign central banks don’t buy dollars, then the dollar will collapse, producing a severe cut in American living standards. The United States would experience inflation. Interest rates would skyrocket. The prices of foreign goods, including oil, would skyrocket.
QE2 is a sign of desperation. Bernanke would not risk a dollar crash if he thought that he had any other choice. But all of the major economic philosophies have been failing in recent U.S. economic history because of our failure to balance trade:
- Monetarism Failed. Alan Greenspan was an excellent Federal Reserve Chairman in that, unlike Bernanke, he kept the U.S. money supply growing on an even keel. But his failure to stem the foreign savings being forced into our economy by foreign governments that were seeking trade surpluses fed the house price bubble with low interest loans. The 2006 collapse of the house price bubble, in turn, started the Great Recession. Greenspan didn’t understand that economic stability requires balanced trade.
- Supply Side Economics Failed. President GW Bush’s attempt to grow the economy through huge tax cuts failed because he let the Asian governments manipulate the dollar’s exchange rate in order to keep their labor costs low to steal our industries. If he had required balanced trade, American businesses would have invested their profits in American factories. American workers who lost their jobs to imports would have taken even better paying jobs producing exports. Instead Bush presided over a decline in American median income.
- Keynesian Economics Failed. President Obama’s attempt to grow the economy through huge stimulus packages failed. An analysis of the data of the last two quarters shows why. During the second quarter, Obama’s “summer of recovery,” the growing trade deficit reduced economic growth from 5.1% to just 1.7%. During the third quarter it reduced growth from 4.0% to 2.0% (according to preliminary data). Our naïve president has relied upon diplomacy to change China’s policy. His failure at the G-20 last weekend shows that he is never going to be able to talk China into changing.
There has always been, and there will always be a way for a country with a huge trade deficit to get its economy moving. All it needs to do is balance trade. Doing so would provide an economic stimulus with legs. American consumption would increase because American demand would be producing American income, not Chinese income. American business investment would increase because businesses would be able to produce goods in the United States and still sell in China.
There is a very simple way to balance trade, a scaled tariff whose rate goes up as our trade deficit with a particular country goes up, down when the trade deficit goes down, and disappears when our trade deficit disappears. Such a WTO-legal tariff would force the trade-manipulating governments to take down their many, many barriers to American products, increasing American exports while decreasing American imports.
There are three pillars of economic stability: balanced monetary growth, balanced budgets and balanced trade. At the moment, the American political establishment is not doing any of them. The result could be catastrophic.
It turns out that the effects of QE2 are likely to be temporary, not a disaster. It boosted the growth in real GDP during the fourth quarter of 2010, but by the first quarter of 2011, that growth was already dissipating as shown in the graph below:
Foreign governments will now resume their currency manipulations, but Bernanke cannot continue QE2 due to the rising inflation that QE2 has already caused, shown in the graph below:
So there you have it. The failures of the policies recommended by Obama's advisers and by Ben Bernanke at the Federal Reserve have been predictable from the word go.
Macroeconomics is actually quite simple. There are three pillars required for long-term economic stability and growth: (1) balanced budgets, (2) balanced trade, and (3) balanced monetary growth. Obama's advisors thought that they could fix a problem caused by imbalanced trade through imbalanced budgets. Ben Bernanke thought that he could fix a problem caused by imbalanced trade through imbalanced monetary growth. Both failed. When one pillar is way out of balance, the solution to the economic problem is simple. Balance it!