Over the last few months the American media has been reporting that the economy seems to be recovering across the board. The stock market has risen almost 50% on these news, anticipating a full-blown recovery.
I have argued before that the supposed recovery is only an illusion, and I will continue to explain why below. I would also like to remind readers that this year’s pattern in the stock market is actually very similar to the pattern during the Great Depression (I won’t go into that further right now, but I recommend reading John Kenneth Galbraith’s “The Great Crash of 1929).
News stories tend to be self-reinforcing. Journalists feed on each other’s sentiments and the reactions from readers. That is why you get news cycles that eventually peter out, while others take their place. In yesterday’s New York Times, Robert Schiller makes the connection between news cycles and the stock market in the article An Echo Chamber of Boom and Bust.
In my view, what Schiller argues is a somewhat exaggerated view on the impact of news cycles on the stock market, but I think the Schiller’s thesis is nevertheless relevant at this point in time.
Journalists in the mainstream media are generally painfully ignorant of economics as a subject. On the CNBC website, I went through all the profiles of the journalists that I regularly see on the network, and only ONE person, Michelle Caruso-Cabrera, has any sort of degree in economics (she is, by the way, a border-line fascist, so her “insight” should be taken lightly). The so-called “chief economics reporter”, Steve Liesman, seems to have no education whatsoever in economics.
Without really knowing what they’re talking about, journalists have over the last 6 months or so all jumped on the recovery story bandwagon. I’m not sure how it started, but it might have been because of the stimulus money, the supposed optimism of the Fed and other government officials, but the recovery story in its essence is this:
The economic crisis is leveling out
“Leveling out” is a term that usually implies that the worst is over and that a change in direction is about to come. However, I would argue that it definitely does not have to mean that, and in the case of this crisis, does not mean that.
By far the most important measure of how well an economy is doing is employment. The “real unemployment rate” in the U.S. is currently between 16% and 18%. That is basically the percentage of people of working age who don’t have jobs (and who don’t study, are housewives or are on disability). That is in my mind the only relevant figure. One of the most important factors in the “recovery story” is that job cuts are leveling out. In other words, companies are currently cutting jobs at a slower pace.
As the economic crisis has been going on for over a year, this makes perfect sense. What companies have been doing is that they’ve been picking low-hanging fruit. They’ve been laying off staff-members without whom they can still function, in order to preserve cash. They’ve gotten rid of an extra secretary, some superfluous salesmen, and they’ve stopped having donuts delivered every morning.
When companies have gotten rid of all their non-essential spending, they couldn’t possibly get rid of more spending at the same pace without drastically changing their business model and becoming an entirely different company (although this has happened as well). That job cuts are leveling out is an economic inevitability.
To illustrate this, I would ask you to think of the U.S. economy as a regular guy. This guy loses his job. This is what he will probably do:
1. He’ll stop going as much to restaurants
2. He’ll stop taking expensive vacations
3. He won’t buy a new car
What this guy is doing is picking low-hanging fruit. He is cutting down on non-essential things, but, for now, he won’t do something radical like selling his house. As a result of cutting down on expenses, he now has more money than he would have had if he had kept going as if nothing happened, but that does not mean that he is on his way to recovering his old life-style. He has not gotten a new job.
In order for our guy to keep cutting down on expenses, he would have to do something more radical, like selling his house and moving into an apartment. He’s very reluctant to do that, because that would radically change his life-style.
Just like the guy has not gotten a new job, and keeps cutting down on expenses, U.S. companies don’t have any new or improved revenue streams. Demand is not up, domestically or abroad. U.S. exports are not very successful, judging by the trade deficit. For U.S. companies to start hiring again, and for the guy to get a job again, the money has to come from somewhere. you can’t just will it to happen, or magically create it.
The important thing to remember is that companies are still cutting jobs, at a pace that would have been utterly frightening only three years ago. This means that, if anything, demand for goods and services will keep going down and down and down. This will force companies to cut even more jobs, and the cycle continues.
So I ask again: what has improved? A leveling out is not an improvement. This is the basic thing that U.S. journalists do not seem to understand. Journalists have been jumping for joy, saying that the car industry is coming back as a result of the “cash for clunkers program”. But again, where’s the money coming from? It’s coming directly from the government, so the “improvement” is just an illusion.
When the government hires someone, it is not “job creation”, and when the government spends money, it cannot be counted as economic improvement. Government spending can do all sorts of things, but it is a type of economic activity that must not be confused with the market. With respect to the “clunkers” program, government spending is a zero-sum game.
In conclusion: how do you know when the economy is improving? Let me present a few alternatives:
1. You export your way out of the crisis, like Sweden and South Korea did in the 1990s. You sell more abroad than you buy from abroad = more money for the country.
2. You inflate a new bubble of some asset class and try to convince people that the price of this asset class will continue to go up forever. It seems to work for about 5 years and then do a lot of damage, while the elite has gotten richer. This is the traditional approach in the U.S., and the one that seems to be in the works right now.
3. A massive technological leap forward radically improves productivity, like it did during the industrial revolution, and to a smaller extent, in the 1990s with the PC revolution.
4. You permanently re-align the economy at a lower place with lower amounts of consumption compared to before, as Great Britain had to do when the empire slowly crumbled over a few decades. This is also a possibility for the U.S..
Moreover, I advise that the winner-takes-all voting system should be destroyed.