Economists are warning of another U.S. recession and the Federal Reserve (FED) has stated the U.S. economy is “close to faltering” without additional support. Additional support really means expanding the money supply with another round of Quantitative Easing (QE) or in simpler terms – printing more money. This next next recession may be more problematic due to the other economic troubles that are going to accompany it. These troubles include:
1. The U.S. government is getting itself deep into debt and there is no political will to reign it in. The current debt level is over $15 T and has surpassed the country’s $14.9 T Gross Domestic Product (GDP). What is more distressing is the total unfunded liabilities (the real debt) which stands at over $54 T. This lack of fiscal responsibility is causing foreign investors to no longer consider U.S. Treasury Bills the safe investments they used to be. If foreign investors stop purchasing U.S. treasuries (this has already started to happen) the Fed will be forced to print more dollars to cover future deficit spending. Interest rates on Treasuries will also go up since they will have to pay higher yields to attract investors. As Treasury rates raise so do mortgage rates and other interest rates consumers use to purchase goods. This slows GDP growth.
The federal debt is not the only concern. State and municipal (local) government debt is currently $2.9 T and rising. These governments cannot print money to cover their deficits like the federal government does. This means that severe cuts will be needed to balance their budgets and maintain their credit ratings. This usually results in budget cuts in healthcare for the poor, elderly care, and in education. Even with cuts many states and local governments are already on the verge of bankruptcy and close to defaulting on their debts. Budget cuts alone may not be enough to keep state and local government’s solvent forcing them to issue more municipal bonds. The problem here is the same as with Treasuries. Large investors (mutual funds, insurance companies, wealthy individuals) no longer view municipal bonds as the tax free safe haven they once were and are shifting their holdings out of municipal bonds. This will require local and state governments to also raise interest rates on new bond issues to attract investors.
Growing federal debt represents another problem. The U.S. dollar is the world’s currency of choice for international trade. This provides the U.S. with a purchasing power advantage. To much debt combined with printing to many dollars has laready started country’s discussing the possibility of a different currency or basket of currencies as the currency of choice for world trade. If this were to happen the cost of foreign goods would increase dramatically.
The bottom line – interest rates which have been kept artificially low by the FED in attempts to stimulate the economy are going to rise soon. This makes purchasing goods with credit more expensive which decreases the U.S. consumers purchasing power, this in turn slows down economic growth.
The next problem is rising inflation. The consumer price Index (CPI-U), which is a measure of inflation, has risen to 3.8% in the past year. This CPI has been criticized as being misleading and not representative of real inflation. When the CPI is calculated, as was done in 1990, inflation is at 5.5%. If calculated according to 1980 methods it rises to over 10%. What is important here is the rising trend in American’s staples: food (groceries) 6%, gasoline 32%, heating oil 35%, electricity 2%, medical coverage 3%, clothing 4%, and housing 2%. Consider your expenses over the past two years. The real rate of inflation is rising and this means higher prices for goods and services.
Rising prices are not the only pinch on consumer pocketbooks. Wages have been stagnant since 2000. In fact median wage stagnation has become a way of life for most Americans. Wage stagnation is attributed to a decline of organized labor unions, erosion of minimum wage, globalization which encourages companies to take advantage of cheap overseas labor, and a trend away from manufacturing towards lower paying service jobs. Low income jobs now account for over 40% of all jobs. In addition, American’s no longer have access to easy credit and can’t borrow against their homes equity.
The bottom line – inflation is raising and goods and services are becoming more expensive while consumer wages remain stagnant. The result is that consumers will purchase less goods and services and will slow GDP even further.
Another critical component is unemployment which has remained above 9% for over a year. This figure is another government reported statistic regarded by many as inaccurate. It doesn’t include workers who’s unemployment benefits have expired but are still out of work, worker’s who are forced to accept part time work or short term contracts both without benefits and at a fraction of their usual salaries, self employed workers whose incomes have drastically decreased, or worker’s who could not get a job and have gone back to school incurring debt. When all factors are considered the true unemployment rate is probably closer to 16%+/-. Fewer Americans working means fewer Americans are able to purchase the same quantities of goods and services and this is slowing down GDP growth.
High unemployment also increases federal and state government spending which drives up the debt. Unemployment benefits exceeded $160 B with the brunt of it bared by the States. This has required many States unable to meet these payouts to borrow from the federal government. Today one in every six Americans relies on Medicaid. 44 million Americans are on food stamps and this includes one out of every four American children.
The bottom line – As the economy slows unemployment will continue to remain high and many companies will expect their workers to provide the same levels of productivity only with less people or fear loosing their jobs.
The next recession may not only impact the U.S. It may be a global recession. The European economies are on the brink of a debt crisis much worse than here in the U.S. Even private sector business activity in Europe has been falling. European countries in the past have successfully been able to rely on austerity measures which involve raising taxes while decreasing government spending, but with such deep debt levels and a number of country’s about to default on those debts even austerity measures are having little success. The U.S. Treasury recently issued a warning that the European crisis represents a significant risk to U.S. recovery due to the close integration between the U.S. and E.U. and that a severe crisis in Europe would further undermine U.S. consumer confidence and weaken demand. This would in turn slow down GDP and economic growth. There is also growing concern that a European debt crisis may lead to another global recession or worse a financial collapse similar to that experienced in 2008. Even manufacturing powerhouse China has seen three straight quarters of declining orders.
Europe’s austerity measures may be a precursor to what the U.S. may be forced to go through to meet international debtor expectations. Europeans are feeling the pressures of raising payroll taxes, increased retirement age pension cuts, broad cuts in social programs, and privatization of public services followed by higher prices for those services. These measures have driven thousands to the streets in protests.
In so much as a downturn in European economy can effect U.S. growth, a decline in the U.S. economy can also have a great impact on global markets. Consider that 70% of U.S. GDP is consumer spending and that the U.S. is responsible for more than 22% of global activity. Therefore 15% of global activity is directly tied to U.S. consumer purchases. The U.S. consumer’s purchasing capacity is decreasing and will likely continue to do so. This situation is pulling the world economic system down and is evidence of how interconnected the world is.
So what can be done to revitalize GDP growth or stifle a recession? The FED is urging Congress not to go the European route of austerity, at least not yet. The FED Chairman has come out requesting that lawmakers not cut spending too hastily in the short term despite public outcry to reign in the debt and international debtors seeking alternatives to both U.S. treasuries and the dollar. Instead they appear to want another round of Quantitative Easing.
If QE3 is enacted it will provide banks and financial institutions money in exchange for Treasury Bills, long term bonds, or perhaps it will be municipal bonds this time. The banks can then use that money to bolster reserves and lend or invest up to ten times that amount. This is the only trick the FED has left to try to jump start the economy. The FED’s main method of revitalizing the economy has been to lower interest rates, but it has already kept interest rates at near zero for years and while its been very lucrative for banks it has not resulted in economic growth for the country.
The problem is that QE1 (the bank bailouts) and QE2 (U.S. Treasury purchases) didn’t really work. In QE1he banks dumped their mortgage backed securities on the FED and didn’t invest the money back into main street America as promised. QE2 resulted in a great deal for Wall Street once again. Large banks and financial institutions used the cash infusions to replenish reserves and increase investing. However, those investments did not find their way into small and medium sized business which represent 85% of jobs. Instead banks invested in more profitable derivatives which contribute nothing to tangible growth and lent to large multi-national corporations with global exposure in the emerging markets of Asia. Those companies were deemed better credit risks despite the fact investment dollars and jobs were going overseas. One thing QE2 did manage to do besides improving Wall Street profitability was to drastically lower real Gross Domestic Product (GDP).
But are these the best solutions for the country or the best solutions for Wall Street? Dropping interest rates to essentially nothing and QE1 and QE2 did little to revitalize economic growth but it did provide massive profits for Wall Street. Austerity measures in Europe on the other hand are also having little effect and many proponents think it will do more harm than good with the final result being those countries on the brink of default will do so and require bailouts. Another option is debt forgiveness but no one seems to be mentioning this idea.
The U.S. may not be in a recoverable position and it wasn’t main street America who put us in this position it started with Wall Street and the Banks with their relentless drive for profits at any cost, even if it meant long-term economic collapse. This is not what capitalism is suppose to be about.
It appears the FED will take care of large banks and financial institutions which in turn will look out for large Multi National Corporations and wealthy investors. Main Street is going to have to stand up and find their voice.