Europe Crumbles Due to Lack of Demand

Europe's economy is crashing in such a way that even the least objective ideologues in Germany now must begin to feel uneasy.

It is not only Greece, but now Spain also (the country that had budget surpluses before 2008) crashing into unambiguous economic depression.  Domestic demand continues to crumble rapidly in Spain, so that one wonders if the entire economy there might sag into social chaos.

But the reality isn't that some countries are in serious straights while others nations are doing fine, so that the overall situation might be sanguine....

No.

Europe as a whole is in sharp decline.

Consider the straight dope -- even as The Economist scrambles to blame monetary policy (but not the Euro!) we see the starkness of the failure of austerity:

IT IS a car crash of a data release. One simply can't look away. Hard to know precisely which part of the euro area's latest unemployment report is the most grimly compelling. The overall rate, at 12.1%? In the spring of 2010 unemployment rates in America and the euro zone were effectively the same at about 10%. There is now a gap of 4.5 percentage points. Total unemployment? In the first three years of the downturn America did far worse than the euro area, adding some 7.5m workers to the unemployment rolls to Europe's 4.7m. Since then total unemployment in the euro area has risen by another 3.2m while America reduced the ranks of the jobless by 3.5m. The euro area now has some 19.2m unemployed workers.

The reality remains that Europe is crashing due to the pan-European trade imbalances created by the monetary union (which prevents natural price adjustment and easy rebounds by sinking economies) -- this increases the job strength in Germany, and that increase specifically comes from taking most available jobs away from the weaker economies via the Euro lock on relative prices.

What is the soundest, best economy in the world right now?  Clearly that of the U.S.

Why?  Demand -- people wanting to buy goods and services in sufficient amounts for an economy to function.  The U.S. has adequate domestic demand.

Economies depend on demand and production, equally.  But production exists around the world in abundance.

Demand is in short supply.

Unlike skating-on-thinning-ice Germany, deeply dependent on exports, or China, deeply dependent on exports and on financial bubbles, the U.S. in contrast has adequate demand at home and little financial froth.

The U.S. is stronger than Europe largely as a result of the just-in-time demand in the U.S. economy created by the stimulus of 2009-2010, and since then, due to a more cautiously gradual reduction in deficit spending than that of misguided Europe.

The U.S. and Europe both have similar overhangs of excessive private household debt weighing us down.  But Europe tried rapid deficit reduction by cutting spending -- which backfired and resulted in deficits as a % of GDP rising in many Europeans countries.   Because of weak demand, cutting government spending simply started downward spirals in European economies.  Not, of course, in the European country that has had an profound pricing advantage over the others for more than a decade, locked in by the common currency (the Euro).

At this moment, U.S. strength is the sole bright spot in the global economy.

While Germany has been like a fire burning down a house (Europe), the U.S. is like a massive motor humming along.

But will it keep humming?

As China and Germany continue to force unemployment on the rest of the globe by consuming so much less than they produce, their massive trade surpluses threaten to eventually sink us all, and only a radical change towards more domestic consumption in these two economies offers any long term hope of avoiding the specter of war.

Are We Inside a Great Depression?

There is much confusion in even the economics-following population about the current economic situation. Will this "recession" end? Is it just a deep recession? Should we cut back on federal spending? Richard Koo is good at explaining the actual (unusual) economic situation we are in. This is not what is understood as simply a deep recession (this is not like 1982) -- it is a different animal.

Koo explains some of the economics I illustrated in my recent post "The Savings Conundrum":

What is our real situation, and why the Fed alone can't reverse it (with any actions similar to those taken to date, and perhaps not even with broader or more extensive quantitative easing):



Roger Lowenstein lays out the big picture in more layman-like language in the NYTimes.

Throughout the Universe, and in our own Milkyway Galaxy, many black holes reside, sucking nearby matter and stars into their titanic masses. The point of no return for even light itself is called the event horizon. It is a radius beneath which light itself cannot escape the gravity of the black hole.

It appears we are at or just inside the event horizon of a great depression. Unlike Paul Krugman, I don't think this will be a "long depression" (long and shallow). Debt levels and world-wide frugality are sufficient to make this depression deep, or "great."

The key fact -- and why this incipient depression looks to be "great" -- is that practically all large economies are beginning to embrace frugality simultaneously. China is a huge saver to begin with due to culture (single children saving to support their parents and attract mates), and how could this culture change quickly? It will be many years before China begins to reduce its huge savings rate.

In short, without extraordinary measures, the world economy will spiral downward due to a savings-conundrum circular impoverishment. Of course, as this becomes more visible extraordinary measures will indeed be contemplated, and then enacted....

Only unconventional measures could propel us out of the normal gravitational result of worldwide, simultaneous governmental and household frugality.

I think we are heading towards extraordinary times and extraordinary new governmental responses. But....many won't comprehend the savings-conundrum, and will try to blame governmental spending for conditions -- similar to blaming your lifeboat for the sinking of the Titanic.

In the absence of extraordinary measures, the conditions that engender the rise of militant nationalism would arise, as they did in 1931-1933. Lest we forget, militant nationalism leads to aggression, and usually to war. Some wars become major wars. Major wars involve much deeper resources and a wider use of major weapons. That equates to a lot higher casualties. Millions of casualties are a plausible outcome.

Those are the stakes if no extraordinary economic measures are taken. We have taken extraordinary measures, both actions of the Fed and the Federal stimulus, and....more might prove necessary.

Prognostications On The Economy (update 6-26)

Most people reading this blog will have read some prognostications on the economic future of the next 1-2 years, talking of what will happen in 2010.

These longer-term forecasts are fantasies.

While the mainstream prediction of some economic stabilization this year followed by modest GDP growth and continuing job losses makes sense, even this middle-of-the-road 6-month forecast is similar in reliability to a 2-week weather forecast during the spring or fall.

It might happen that way.

Exactly like a weather forecast, and for precisely the same scientific reasons, economic forecasts are relatively useful for a short-term outlook, and less and less meaningful for a longer term outlook.

I'm quite deliberate in this choice of language. Just as randomness changes the weather progressively more over time versus any specific scenario, the same effect applies to large economies. But while long-term weather usually follows seasonal averages with moderate deviation in most years, the long-term economy has more randomness and higher deviations.

Right now the biggest unknown is future evolution of expectations and the consequent choices individuals will make in response.

This is not at all predictable.

We can predict some aspects of the economy, such as national housing price changes, due to the highly consistent effects of supply versus demand -- when the supply of homes for sale is significantly more than 6-7 months worth, prices fall. The effect of significant supply along with significant expected shadow inventory (those with houses not currently on the market who would like to sell, and are waiting for the recession to ease) practically guarantee further price falls in many areas, and on national averages.

But some critical economic factors in the broad economy are fully unpredictable. That is, the degree of unforeseeable change is very high.

The economy is, after all, the joint decision of all of us together.

We can en masse pull back on our spending out of fear of job losses, creating a self-fulfilling outcome of continuing high job losses.

Or we can en masse gain confidence in the economy, and thus feel more secure in our jobs, and spend a little more, creating a self-fulfilling outcome of reduced job losses, and even an improving economy.

The most crucial part of the stimulus program -- the American Recovery and Reinvestment Act of 2009 -- is how it affects general confidence in the economy.

This is because general confidence will determine changes in consumer spending of greater scope than the amount of actual stimulus spending.

A popular forecast like "weak growth of 0.5% in the 2nd half of the year" is only a guess.

Fortunately, one of the greater forces in the economy has changed direction.

We can all breathe a little easier to see this news today:

Consumer confidence extended its rebound in May, soaring to the highest level since last September as more shoppers are feeling the worst of the recession is behind them....

This is no small thing.

Sufficient confidence could give the actual stimulus dollars much more traction, leading to a very different economic outcome over time. How different? Well, long-term interest rates for instance depend on investor confidence in America, which in turn depends on the American economy, which itself depends on small changes adding up over time...

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Update 6-26

(Reuters) - U.S. consumer confidence rose in June to the highest since
February 2008, as expectations grew that the worst economic recession since the
Great Depression may be ending, a survey showed on Friday.

Today we also learned the savings rate has shot up to 6.9% for May from 5.6% in April. New unemployment claims are still very high, ticking back up a bit.

But of all the indicators, most key are confidence and actual consumer spending (up 0.3% month over month).

These two suggest some possibility of real stabilization, instead of a downward spiral. What's unknown is how many layoffs have been delayed on hope of a bigger rebound in spending. The next 2 months will decide if this stabilization is firm, or only a pause. But I'm cautiously hopeful that this stabilization can hold, so that the economy may be at the bottom here, instead of a worse scenario. It's not certain, but it's a good sign.

Obama's Opening Statement at Press Conference

Barak Obama 2/9/2009

"Good evening. Before I take your questions tonight, I’d like to speak briefly about the state of our economy and why I believe we need to put this recovery plan in motion as soon as possible.

I took a trip to Elkhart, Indiana today. Elkhart is a place that has lost jobs faster than anywhere else in America. In one year, the unemployment rate went from 4.7% to 15.3%. Companies that have sustained this community for years are shedding jobs at an alarming speed, and the people who’ve lost them have no idea what to do or who to turn to. They can’t pay their bills and they’ve stopped spending money. And because they’ve stopped spending money, more businesses have been forced to lay off more workers. Local TV stations have started running public service announcements that tell people where to find food banks, even as the food banks don’t have enough to meet the demand.

As we speak, similar scenes are playing out in cities and towns across the country. Last Monday, more than 1,000 men and women stood in line for 35 firefighter jobs in Miami. Last month, our economy lost 598,000 jobs, which is nearly the equivalent of losing every single job in the state of Maine. And if there’s anyone out there who still doesn’t believe this constitutes a full-blown crisis, I suggest speaking to one of the millions of Americans whose lives have been turned upside down because they don’t know where their next paycheck is coming from.

That is why the single most important part of this Economic Recovery and Reinvestment Plan is the fact that it will save or create up to 4 million jobs. Because that is what America needs most right now.

It is absolutely true that we cannot depend on government alone to create jobs or economic growth. That is and must be the role of the private sector. But at this particular moment, with the private sector so weakened by this recession, the federal government is the only entity left with the resources to jolt our economy back to life. It is only government that can break the vicious cycle where lost jobs lead to people spending less money which leads to even more layoffs. And breaking that cycle is exactly what the plan that’s moving through Congress is designed to do.

When passed, this plan will ensure that Americans who have lost their jobs through no fault of their own can receive greater unemployment benefits and continue their health care coverage. We will also provide a $2,500 tax credit to folks who are struggling to pay the cost of their college tuition, and $1000 worth of badly-needed tax relief to working and middle-class families. These steps will put more money in the pockets of those Americans who are most likely to spend it, and that will help break the cycle and get our economy moving.

But as we learned very clearly and conclusively over the last eight years, tax cuts alone cannot solve all our economic problems – especially tax cuts that are targeted to the wealthiest few Americans. We have tried that strategy time and time again, and it has only helped lead us to the crisis we face right now.

That is why we have come together around a plan that combines hundreds of billions in tax cuts for the middle-class with direct investments in areas like health care, energy, education, and infrastructure – investments that will save jobs, create new jobs and new businesses, and help our economy grow again – now and in the future.

More than 90% of the jobs created by this plan will be in the private sector. These will not be make-work jobs, but jobs doing the work that America desperately needs done. Jobs rebuilding our crumbling roads and bridges, and repairing our dangerously deficient dams and levees so that we don’t face another Katrina. They will be jobs building the wind turbines and solar panels and fuel-efficient cars that will lower our dependence on foreign oil, and modernizing a costly health care system that will save us billions of dollars and countless lives. They’ll be jobs creating 21st century classrooms, libraries, and labs for millions of children across America. And they’ll be the jobs of firefighters, teachers, and police officers that would otherwise be eliminated if we do not provide states with some relief.

After many weeks of debate and discussion, the plan that ultimately emerges from Congress must be big enough and bold enough to meet the size of the economic challenge we face right now. It is a plan that is already supported by businesses representing almost every industry in America; by both the Chamber of Commerce and the AFL-CIO. It contains input, ideas, and compromises from both Democrats and Republicans. It also contains an unprecedented level of transparency and accountability, so that every American will be able to go online and see where and how we’re spending every dime. What it does not contain, however, is a single pet project, and it has been stripped of the projects members of both parties found most objectionable.

Despite all of this, the plan is not perfect. No plan is. I can’t tell you for sure that everything in this plan will work exactly as we hope, but I can tell you with complete confidence that a failure to act will only deepen this crisis as well as the pain felt by millions of Americans. My administration inherited a deficit of over $1 trillion, but because we also inherited the most profound economic emergency since the Great Depression, doing too little or nothing at all will result in an even greater deficit of jobs, incomes; and confidence. That is a deficit that could turn a crisis into a catastrophe. And I refuse to let that happen. As long as I hold this office, I will do whatever it takes to put this country back to work.

I want to thank the members of Congress who’ve worked so hard to move this plan forward, but I also want to urge all members of Congress to act without delay in the coming week to resolve their differences and pass this plan.

We find ourselves in a rare moment where the citizens of our country and all countries are watching and waiting for us to lead. It is a responsibility that this generation did not ask for, but one that we must accept for the sake of our future and our children’s. The strongest democracies flourish from frequent and lively debate, but they endure when people of every background and belief find a way to set aside smaller differences in service of a greater purpose. That is the test facing the United States of America in this winter of our hardship, and it is our duty as leaders and citizens to stay true to that purpose in the weeks and months ahead. After a day of speaking with and listening to the fundamentally decent men and women who call this nation home, I have full faith and confidence that we can do it. But we're going to have to work together. That's what I intend to promote in the weeks and days ahead. And with that, I’ll take your questions."

China Should Press the Keynes Test Button, and Hold It Down (Update!)

A few months ago it became clear to me that China is one of the nations is in more profound danger from a general world economic recession.

Yes, not the U.S., China. China, with its big surpluses and large savings is actually under greater threat than the United States.

This is because, like the United States in 1930, China is the big export nation.

When consumer demand falls around the world, nations more reliant on exports, like China or Germany face a fall in demand for their output. But in China's case, exports are such a large part of all of its entire economy that the proportional effect is worse.

Now we are learning that this is happening more dramatically than officially reported.

Plunging exports. Factory closures. More than 20 million people thrown out of work. Official data showing that China's economy is cooling but still growing strongly obscure what economists say is a sharp recent decline that has inflicted obvious pain....

...experts say that compared to the previous three months — the system used by most other major countries — China's growth fell to as low as 1 percent or possibly zero....

Those who have followed the discussion on China know that it's widely thought that China needs to grow above 6% due to its large number of job seekers.

Why is China in so much trouble? Why can't it just rely on itself to grow?

China has an enormous savings rate, near 50%! This means that it produces about twice as much as its people consume.

Basically, in terms of sustainability, China has a huge consumption shortfall.

So China was already in need of Keynesian stimulus of certain kinds even before the sudden great crisis it is now beginning to face.

China consumes such a low amount of its production for several reasons, and some of these are key to what can be done to save China from enormous turmoil.

Part of the reason Chinese workers save so much is a sense of insecurity. They have insecurity about health costs, and insecurity about having something in their old age.

In China the culture requires children to care for their aged parents, but the One-Child Policy means that this care for aged parents will often fall on a single set of shoulders, or for instance four parents being cared for by one married couple.

One program to increase retirement security was founded in the U.S. during the Depression -- Social Security was created in 1935.

So one step China needs to do to help its citizens begin to support each others' jobs through adequate domestic consumer demand is to provide more of a sense of security against illness and old age. Feeling more secure, Chinese can then save a lesser amount and spend more. During a recession, these new social programs can be funded through deficit.

Social programs meant to increase a feeling of security, more doctors and health care investment, and more schools -- these are a few of the types of stimulus China needs now.

China needs to press the Keynes Test Button down even more firmly, and hold it down.

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Update: I just saw this great news. Very encouraging:

Earlier this month, Beijing announced it will spend $125 billion to build hospitals across China, as well as to expand medical insurance to cover 90% of China's 1.3 billion people by 2011. The government has also announced a significant expansion of its pension program....

It appears China is doing some good things in it's stimulus package. It's not yet clear if it is enough to accomplish the very needed effect of increasing feelings of security, and thus increasing Chinese consumer spending significantly. We should watch for the outcome over the next 6 months.
...

November 2009 Update: Reuters lays out the current situation.

How Obama's Middle Class Tax Cut Will Save Jobs

Debate has intensified in the last few days about whether the Obama tax cut proposals in the stimulus package will be effective as a stimulus.

Among the majority that believe a stimulus package will indeed create and save some jobs on net versus no stimulus, the big issue is whether the stimulus size is enough to counter the large fall in consumer demand, and thus prevent higher and higher joblessness.

Keynesian stimulus in a nutshell is that government spending can increase demand in the economy to replace the fall in demand during a recession, saving jobs and creating jobs.

Several important side debates have been ongoing, and let's quickly dispose with a couple of those and get back to the main question of this post.

Objection A) Government spending does not create new jobs, since it relies on taxing or borrowing which in turn removes money or available investment and discretionary funds from the general economy -- simply shifting spending and investment from one place to another without a net increase.

For investing, this is called crowding out, and it certainly does happen when an economy is running at or near full steam, so that resources (machines, workers, money) are being fully or almost fully utilized, so that all new output of the economy requires new investment dollars. In that situation, private investment competes for those new dollars with government. But when an economy has much slack, as ours does now, so that more money is sitting in money market accounts and short term treasury bills, there is plenty of available money for government borrowing and investing, and still plenty left for any private borrowing and investing the private sector chooses. A similar situation applies to spending -- government spending does not compete so much with private spending during a recession -- concrete prices are down sharply, for instance, so government infrastructure spending on concrete will not be competing much with private demand for concrete to a level that would strain available output.

Objection B) Government spending/investing is top-down, and is thus less informed/knowledgeable than private spending/investing -- less effective at producing the goods and services people actually want for their lives and standard of living.

Example -- Joe would rather buy a new car instead of paying more taxes (or having future taxes) for more city bus service.

This again, as above, is true during a time of economic expansion, but is it true during a time of recession? Currently consumers who have jobs have sharply pulled back in spending, and are saving on the whole, which of course has led to a sharp drop in consumer demand, and thus more and more job losses. Consumers are choosing that they don't want as many consumer goods and prefer instead to pay off their credit cards, or build up their emergency fund.

As they save, more money is available for investing also, and some of it flows into safe US Treasuries. When the Government spends more now, it is not removing money from current consumer spending.

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Ok, now let's consider the Obama Middle Class Tax Cut (MCTC) as a stimulus....

We know that tax rebates of a size like that of summer 2008 are much smaller than average consumer credit card debt, and it's little surprise that much of that rebate was saved (or paid against debt), and yet helped the economy in a dramatic way not widely understood. (see link)

We can surmise that much of the coming MCTC will also be saved, at least for a while.

Until when?

Well, that's an individual level decision.

For someone who's been paying off credit card debt for example, they may continue paying it off at the same rate, or even add in the extra take-home pay from the tax cut and make even larger payments (saving all the tax cut). Until....

Until they have paid off the credit cards to zero.

Then what happens?

If you could imagine celebrating upon paying off a card or the last card, I bet you are like most people.

Might you go out to eat? Might you finally get your car repaired? Might you stop putting off that gym membership?

Yes, when consumers have less debt, they will respond by spending more, resulting in more jobs. Some will spend more, some less, but overall spending will increase in response to debt going down (or savings up). Poorer families will spend more, and the sad truth is many "middle class" families are practically poor.

Even while consumers spend less in 2009 with the new tax cut than they did in 2008, the issue is how much less. A tax cut will make a difference in consumer spending, immediately and progressively, both. Many jobs will be saved, adding to the positive effect of those newly created.