The Retail Sales Gap Is The Housing Gap

Atif Mian and Amir Sufi pondered why spending hasn't caught up to trend.

How would spending catch up to trend when employment hasn't caught up to trend?

And why would we expect employment to catch up when home construction lurks below the 1982 recession levels let alone below trend?

And even if employment were caught up, we're not going to have as much retail sales of home furnishings and such household goods until we have as many new homes to furnish.

Notice how in the early 1980s, home construction started up before employment. Just like how in 2006 home construction started slowing before employment ... and then started plummeting before employment.

Retail sales include paint, furnishings, and lots of other household goods. So really, is it any surprise that retail sales haven't recovered to trend but rather have only stopped dropping?

By and large, the home is where the retail sales live.

And why would a home builder ramp up construction when employment is low? Why is it again that we haven't restored the CCC and WPA this time around to get people working?

What Came First: The Decline In Housing Or The Mortgage Crisis?

We're awash in a great sea of complicated answers to the question of what caused the Lesser Depression. Why? The story's rather simple.

For those who would say it all comes down to deregulation, the repeal of Glass-Steagall, and sub-prime loans, please answer this: How could a collapse in loans that comes well after the sharp drop in housing starts supposedly reach back in time and cause that preceding sharp drop in housing starts? Or how could failures of financial institutions travel time to kick off the decline in housing starts before they started failing?

The delinquency rate on single family residential mortgages averaged 2.2% between 1991 and 2007. Let's presume that wasn't a time of extraordinary caution and thus that 2.2% represents a reasonably ordinary rate of delinquencies. That rate dipped below 2 in 2003 and didn't get back up to 2 until the fourth quarter of 2006. Delinquencies didn't climb past 2.2% until the 2nd quarter of 2007, over a year after housing starts began plummeting. It seems quite clear that since there was no rash of delinquencies until well after housing starts crashed, we can't reasonably blame the decline in starts on the delinquencies. In other words, failing sub-prime loans simply don't work as an explanation without time travel.

Bank failures run a similar course. None in 2006 while housing starts drop sharply. Three in 2007. But 25 in 2008. Housing starts fell off the cliff long before banks started failing.

But then, what did go along with the housing starts decline? Why did they stop starting so many? Could it be that folks stopped being willing to pay ever higher prices?

Yep. In early 2006, housing prices tapered, peaked, and then started dropping a bit. And then they went flat for a while. Sellers resisted selling for less than they'd hoped a few months earlier. It's easy to understand reluctance to drop prices when it had so recently been a sellers market. But before long, prices joined in at the same angle of descent they'd set up in housing starts. Of course those two declines would feed into each other. With prices no longer rising and worse declining, it just doesn't make sense to build as much.

And what happens when we don't build as many houses? There's a bit of lag in effect. After all, once a start happens there's usually a few months of building. But as some months go by with a continuing sharp drop in house component orders and furniture sales, we get a decline in employment.

And once we have a decline in employment, fewer people can afford houses and fewer people can hold off on selling houses ... at any price.

In short order, not long after employment started down from the October 2006 peak, the bottom fell out from under house prices after March 2007.

Which brings us to the 2nd quarter of 2007. Remember that? That was when delinquencies started up past the norm for the preceding decades. So here's the question: did all this happen because collapsing sub-prime loans hopped a ride on Dr. Emmett Brown's DeLorean back to before the home prices, housing starts, and unemployment all started down? Or should we perhaps consider that maybe reality actually went in chronological order?

What came first? Home prices stopped rising and housing starts fell. Then unemployment. And we don't get into issues with mortgage-backed securities and complex derivatives until after those three got together. Can someone show us a working time machine or reference to all of this in Nostradamus? If not, no matter how much sub-prime loans and Glass-Steagall's repeal might have made the aftermath worse, it might make sense to presume they didn't have a thing to do with causing the whole mess.

Government As The Homeowner, Revisited: To Scrap Or To Invest?

Consider a homeowner who owes a typical mortgage on a house and makes just enough to keep up with the bills and maybe every once in a while treat the family to something nice like a dinner out or a trip to the zoo.

Does it make sense for that homeowner to sell the car he uses to get to work in order to pay down the mortgage faster?

How about if he skips paying for the annual licensing for his field of employment (required for his career) to pay down the mortgage faster?

In order to pay down that mortgage faster, does it make sense for that homeowner to stop buying food for the kids, getting reasonable check-ups and other medical attention as needed, and keeping the house warm enough that the pipes won't freeze?

Should the homeowner cut out all trips to the library for books for the kids so as to save on gas and send bigger mortgage payments? How about toys? Should the homeowner never buy a toy again until the mortgage is payed off, even if it's a just started 30 year mortgage and he has a newborn with no toys beyond a single teething ring?

Does any of that really, truly make sense?

How about investments? Should the homeowner stop contributing a modest sum to his retirement plan and an education savings plan for his kid? Even if both of those investments are expected to have a return higher than the interest on the mortgage?

And if the homeowner can reasonably expect to get significantly higher pay from investing in his career, what then? Let's imagine this homeowner could put $1,000 on his low interest home equity line and get training and certification that on average increases a certified individual's pay by $1,000 a year. Would it be more sensible, rational, and responsible for the homeowner to get this certification or to avoid taking on a little bit more debt?

Our government is this homeowner. Our debt is this manageable mortgage.

When we're at full employment -- unlike now -- there would be no certification we could expect to be a safe bet to increase our income steadily. But we're not there. Not even close.

When we're well below full employment on account of a consumer demand shortfall -- like now -- just about any additional spending we have the government do can typically be expected to add to commerce and help push us that little bit closer to full employment. That means higher revenues. And that's without even focusing it into the most useful spending, which we can and should do to get the most bang for the buck by spending on adding to infrastructure, R&D, and other investments known to build the most revenue.

It should already be an obvious choice. But unlike the homeowner, the government gets an additional win by investing that spending in increasing revenue. Since additional employment means less unemployment, medicaid, and other liabilities, the government reduces its costs by increasing its revenue. That's not just a win-win ... it's a no-brainer. It's stunningly obvious. We should be investing in raising our revenue by engaging some short term spending (preferably including long term investments in that short term spending).

Now if only the budget cutters in Congress could see that.

What Does The Sequester Mean? Unemployment.

What does the sequester mean? In a word, unemployment.

By most estimates, the sequester will reduce 2013 GDP growth from what would be somewhere around 3% to somewhere around 2%. That might not sound so bad. After all, it's still growth, right? One might think that if one is not familiar with Okun's Law. We need some growth in the economy to deal with growth in population, productivity, and other factors.

How much growth do we need to break even? Around 2.7%.* That's roughly the rate of economic growth we need just to keep a steady rate of unemployment. When we're not already at full employment -- and we certainly aren't likely to see full employment in 2013 -- any growth rate higher than what's needed to break even will translate to a reduction in unemployment. And should we drop to a growth rate below that break even point, then expect bad things to happen to the unemployment rate.

Remember what the common estimates were for GDP growth without the sequester? 3%. That would mean that if it weren't for the sequester, then we could expect a slight drop in the unemployment rate over 2013 due to just enough jobs being added to see some improvement.

And then there's the sequester. With estimates of the sequester slashing growth down to 2%, that means for 2013 we're likely to be below the break even point in growth. Rising unemployment looms on the horizon.

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* Estimates vary, among other reasons because the current steady-state figure can vary a bit with various conditions, but 2.7% is in the rough ballpark.

Jobs Versus Budget Cuts: It's One Or The Other

So many still seem to be missing this basic point:

"Right now the central challenge is to reignite the economy — getting jobs back, improving wages, and restoring growth.  

Deficit reduction moves us in the opposite direction. That’s because most consumers (whose spending is 70 percent of economic activity) are still losing ground, and businesses won’t expand and hire without more consumers." 

- Robert Reich in "The Economic Challenge Ahead: More Jobs and Growth, Not Deficit Reduction"

At least, so many among the Republican movers and shakers and apparently in the Oval Office too. Why? One can only presume that they're still taking it on faith that reducing the deficit is the most important thing ever, despite all the mountains of reason to believe otherwise.

One data point in that mountain, as Reich puts it,

"Likewise, cuts in government spending, such as occurred in the fourth quarter of 2012, cause the economy to contract — as it did in the fourth quarter."

In order to move the country in the right direction, policy needs to get the basic problem correct. So long as they figure deficit reduction via budget cutting is the order of the day, they'll continue to hurt. Everything. Including the deficit.

"For 60 years (!) the pattern has held. When unemployment drops, the deficit as a percentage of GDP drops. When unemployment rises, the deficit rises." 

- Joe Weisenthal in "There's Only One Way To Fix The Deficit — And Actually It's Totally Painless"

Sure, we could possibly have jobs despite their budget cutting. After all, we've had some recovery so far, if a rather anemic one. But that's despite their budget cutting. The whole economy -- including the debt/deficit picture -- would be better off if deficit hawks weren't hamstringing us with their fixation on budget cutting.

Fiscal Conservatism And Necessity

We're in a depression. To many, that's stating the obvious. But it seems not quite everyone realizes just yet.

GDP depressed below normal levels from 2008 through this writing

Our commerce has been significantly below capacity for several years. By the end of 2008 the quarterly output gap exceeded even the previous record (from 1982) for output gaps since 1949. We've seen the main characteristic factors of depression beyond just the raw output gap: increased unemployment, tight credit for consumers and small business, and bank failures (though many of the potential failures were averted). And as anyone familiar with Irving Fisher's work should know, we'd surely have had significant deflation from the paying down of private debts were it not for a series of Fed actions to mitigate deflationary forces.

Deficit hawks ignore the reasons for our deficits in recent years. Depressions increase short-term costs. People out of work utilize the safety net when they wouldn't otherwise. We have a severe short-term increase in costs. At the same time, depressions also reduce revenue. We bring in less tax money because fewer people are getting paid, and often smaller real wages.

There's one clear answer to get rid of deficits: get people back to work. Rev up the economy back to potential. Close the output gap. Until we do that, we'll continue to have increased costs and reduced revenues.

In our attempts to close that output gap, today's fiscal conservatives hamstring us with massive state budget cuts to avoid the temporary tax increases and/or bond issuance needed for dealing with the downturn. Their unwillingness to raise revenue means lots of layoffs, slowing down our economy while hurting the quality of services that we the people want. Many of us would willingly pay more in taxes to keep quality of service through an economic downturn. Many of us would be more than willing to pay more in taxes to keep investing in the sort of growth-spurring government measures that can get us back to expansion. But fiscal conservatives will brook no such sensibility. So instead we get slower growth and less prosperity. Like our slow recovery? Thank a fiscal conservative. Like our rising tuition costs for students? Thank a fiscal conservative. Like our broken roads increasing business costs? Thank a fiscal conservative. Like fewer research patents being licensed to domestic businesses than we'd otherwise have over the coming years? Thank a conservative.

This impact is nothing new. We had deficit hawks and credit growth hawks to thank for the recession of 1937-38 when attempts to balance the budget and tighten monetary policy put a crimp in recovery from the Great Depression. We had sharp cuts in the name of balanced budget zeal to thank for the recessions and increased unemployment under Eisenhower. Time and again, we keep having to re-learn the lesson that sharp cuts hurt even when they're earnestly meant to help.

We're long overdue to stop letting fiscal conservatives shape the narrative. We need to stop worrying about balancing the budget when we're in the midst of a downturn. When the economy's roaring at full steam, then we can afford to mess about with budget balancing. Until then, we can't afford their cuts.

One needs to already be in good shape to recover from a deep, large, sharp cut. Until we've eliminated the output gap, we need more recovery efforts ... not more cuts.

A More Important Deficit: The Jobs Deficit

Yes, the jobs scene is getting better. But it's obviously not back where it should be yet, and for more than one reason.

From "Closing America’s Jobs Deficit", Laura Tyson reports that

"Public-sector demand has also contracted, owing to state and local governments’ deteriorating budgets. As a result, public employment, which usually rises during recoveries, has been a major contributor to high unemployment during the last three years. Despite a modest uptick in the last three months, government employment is 569,000 below its June 2009 level – a 30-year low as a share of the adult civilian population. According to Hamilton Project calculations, if this share were at its 1980-2012 average of about 9.6% (it was actually higher between 2001 and 2007), there would be about 1.4 million more public-sector jobs and the unemployment rate would be around 6.9%."

This may not be stunning news to those of us who've already been lamenting that aspect of layoffs stunting our recovery, but it's certainly worth highlighting again ... especially that we would have an unemployment rate somewhere around a full point lower if it weren't for the public sector layoffs. Obviously, if it weren't for contractionary fiscal policy (govt budget cuts), we'd have a far better employment situation.

And what is a certain party calling for? More contractionary fiscal policy.

Tyson also note some interesting points about the jobs that are out there, the differences in unemployment for those with less education versus those with more education, and that:

"... recent study by McKinsey suggests that the gaps in educational opportunity and attainment by income impose the equivalent of a permanent recession of 3-5% of GDP on the US economy."

Unemployment and Party Policies: There's a Correlation, But What's the Causation?

Can we conclude failed / succeeded party policies from the following chart? Or did the policies change too much from administration to administration even within parties to attribute this trend to a policy set typical of either party?

This being unemployment, down is good ... a reduction in unemployment. The chart starts with the first President whose full term is entirely within the standard BLS/FRED  "unrate" data. Figures are calculated by starting with the first full month of the administration and going to the first full month of the next administration or to the latest available month in the case of the current administration.

As a group since Eisenhower, Republican Presidents averaged a 2.05 point increase in unemployment per administration. Meanwhile Democrats averaged a 1.42 point reduction in unemployment per administration.

From all that I've seen beyond just this chart, I'm tempted to say that this chart illustrates the economic impact mainly of two things: Republican drives to cut spending to balance the budget and Democratic drives to strengthen the safety net resulting in more fuel to the consumer engine. However, I hesitate to state that as a definitive explanation at this point. It's more of a rough hypothesis.

When It Went Wrong

When did things start down? Where was the bump in the road that triggered the Great Recession? In this election season, that question matters in the short term for trying to choose the folks most likely to not send us back down the same path. Partisans from both major parties would love to tell us things when wrong under the other party's watch, but only one side can say it accurately. So when did it start?

To begin answering that question, we can't just look at GDP or unemployment alone. While those may tell us when things really got bad, they don't tell us when the problem started. To get a better idea of when the problem started requires focusing further back than when it became obvious to everyone. The overall economy was hammered by a financial crisis, but that financial crisis didn't just spring up on its own. The financial crisis was triggered by a stumbling housing market. So when did housing tumble off the cliff?

Housing fell off a cliff in 2006; in 2007/8, it was just still falling from 2006.

Building permits peaked on September 2005 and then proceeded to fluctuate through January 2006. Housing starts peaked in January 2006. Then after January 6th, both building permits and housing starts tumbled off that cliff, followed soon after by residential construction. Between the January 2006 peak and the start of the 110th Congress in January 2007, housing starts dropped by 38% and residential construction dropped by 15%. The housing industry was collapsing throughout 2006 and bringing layoffs starting with housing and spreading into related domestic industries such as window and cabinet making. Following on housing's decline, manufacturers new orders hit choppy waters in 2006, . By the end of 2006, the effects weren't yet enough to seriously shake unemployment or turn GDP negative, but the decline did start to show in other measures and a slackening of quarterly GDP growth. The annual growth in consumption per capita for 2006 started back down from what we'd seen in 2005.

Demand/person slowed down in 2006 ... before getting to an actual drop.

Put it all together it's really only a technicality that the recession didn't hit until late 2007. In fact, the economy was already in rough shape in 2006, with really lousy growth evident over the 2nd and 4th quarters of 2006, to the point of quarterly GDP growth just barely staying out of negatives.

2006 wasn't technically recession; but it was darn close.

Clearly, the first wave of what became the Great Recession was well under way during the watch of the 109th Congress (2005-2006) under President Bush II, even though we hadn't reached technical recession yet. What happened during the 110th Congress was just that it became clear that the problem -- which was already under way -- was spreading from housing into finance and from there to everything else. The curtain covering over the problems was pulled away in 2007-2008, but the trouble was there before the curtain pulled away. Republicans held majorities in both Houses of the 109th Congress, as they had for almost all of the time since 1995 (except for a slim Senate flip in part of the 107th Congress). By 2006, Republican policies had held sway in both the executive and legislative for years and they were still in control. While there's room for debate as to how much involvement government had in the creating or allowing the mess, the weight of evidence says that if one were going to blame governance, the party to blame for that mess is Republican.

Unemployment Rate Changes Put In Perspective

Let's put the levels of unemployment at this point in the Presidential cycle into perspective.

The above chart tracks the point changes  in the unemployment rate since the first full month of each of  the current and previous Presidents' terms. For President Obama, the numbers show unemployment brought back down to where it was as his watch was just getting started. For President Bush II, the numbers at the equivalent point in his first term show unemployment significantly worse than where it was as his watch was just getting started.

When Republicans Were Great: The Once and Future GOP?

Where would you guess the following quote came from?

"We are proud of and shall continue our far-reaching and sound advances in matters of basic human needs—expansion of social security—broadened coverage in unemployment insurance —improved housing—and better health protection for all our people. We are determined that our government remain warmly responsive to the urgent social and economic problems of our people."

If you guessed the 1956 Republican Party Platform, congratulations! Once upon a time, Republicans stood for far-reaching advances in matters of basic human needs. Once upon a time, Republicans stood for expansion of social security. Once upon a time, Republicans stood for broadened coverage in unemployment insurance. Once upon a time, Republicans stood for improved housing. Once upon a time, Republicans stood for better health protection for all our people. Once upon a time, Republicans stood for being warmly responsive to the urgent social and economic problems of our people.

Over the past several decades, the "Reagan Revolution" political dogma stamped out what was left of those golden days when traditional, proven, sensible, responsible, balanced policy drove the Republican party. The party leadership and much of its base turned against the policies that built our economic strength on a larger middle-class as the engine of commerce. At this point, Republicans stand for ignoring basic human needs. Current Republicans stand for privatizing social security and turning seniors over to the topsy-turvy stock market as fodder for those who would like nothing better than to gamble with those funds. Now Republicans stand in the way of extending unemployment insurance. Today's Republicans seek every opportunity to repeal better health protection for more of our people. Contemporary Republicans stand for leaving the urgent social and economic problems of our people to the whims of the short-sighted, momentary-profit-driven market. And if answering their social and economic problems should happen to be thought unprofitable in the short-term, post-Reagan Republicans see no reason not to sacrifice the long term good of the people.

It doesn't have to be that way. Obviously. The Grand Old Party really was grand before the Reagan Revolution. It could be again. All it would need to do is rediscover traditional American values -- the old-school Republican values -- and repudiate the "starve the beast" platform of ever lower taxes in an effort to force abandonment of social and economic progress. Balancing the budget in the average year isn't bad and was even embraced in the 1956 platform too, but today's GOP pitches snake oil when it claims the only way to balance the budget is to cut. The party used to know better. There are values it should rediscover from it's past, such as:

• "Republican action created the Department of Health, Education and Welfare as the first new Federal department in 40 years, to raise the continuing consideration of these problems for the first time to the highest council of Government, the President's Cabinet."
• "The Republican Party will renew its efforts to enact a program based on sound principles of need and designed to encourage increased state and local efforts to build more classrooms."
• "Stimulate improved job safety of our workers, through assistance to the States, employees and employers;"
• "Protect by law, the assets of employee welfare and benefit plans so that workers who are the beneficiaries can be assured of their rightful benefits;"
• "Assure equal pay for equal work regardless of Sex;"
• "Provide assistance to improve the economic conditions of areas faced with persistent and substantial unemployment;"
• "We have supported the distribution of free vaccine to protect millions of children against dreaded polio."
• "Republican leadership has enlarged Federal assistance for construction of hospitals, emphasizing low-cost care of chronic diseases and the special problems of older persons, and increased Federal aid for medical care of the needy."
• "We have asked the largest increase in research funds ever sought in one year to intensify attacks on cancer, mental illness, heart disease and other dread diseases."
• "We have supported measures that have made more housing available than ever before in history, reduced urban slums in local-federal partnership, stimulated record home ownership, and authorized additional low-rent public housing."
• "We shall continue to seek extension and perfection of a sound social security system."

Traditional American values. Every one of them. Those are values the Republican party once knew. The heartless ideologues of the Reagan Revolution have lead the GOP astray. But parties change. There's still time for the GOP to reclaim those traditional values and learn to rediscover the art of appropriate taxation instead of always starving our government and undermining its work of building infrastructure, commerce, and a growing, prospering middle class. Building a safety net under our people, working to lift up the least affluent, and strengthening the middle class leads to strong, lasting, stable prosperity for us all. Wealth grows best on a diet of steady commerce from a rising middle class. To get there, we must pull our heads out of the hole that is cutting at all costs. Budgets must be balanced by growth ... not by slash and burn. As the 1956 GOP platform quoted President Eisenhower, "America does not prosper unless all Americans prosper. Government must have a heart as well as a head."

SOTU: Guns vs Jobs

Some, including Mayor Bloomberg and the Brady Center to Prevent Gun Violence, were disappointed that there was no overt mention of gun control in the 2011 State of the Union.

They missed the point. Apply some perspective.

Yes, gun control is a big issue. Yes, it's ridiculous to fail to restore restriction on the size of gun ammo magazines back down to a sane level as per the collective failure that's been going on since the assault weapon ban expired.

But the President of the United States can't ignore the big picture. We're living in a time of high unemployment. Too many people call for massive cuts that would likely throw us into an avalanche of crushing unemployment. Too many people call for insane moves like blocking the debt ceiling that would likely jam the entire world economy into a tailspin. These economic issues have the potential to bring widespread violence through collapse if the President doesn't talk them down from that fiscal ledge. If we went there, it would not be the first time that unemployment heated anger to boil over. The first priority of the President of the United States must be to keep our economy from grinding to a halt. Everything else depends on this. All the refinements of civil society to protect this or restrict that depend on our economy running at least well enough to keep our civil institutions going.

Gun control -- even the most sane and obvious restrictions like a cap on magazine size -- can be a very contentious and partisan issue.  Maybe he could have pulled it off.  But were the President to go there in the State of the Union, it would risk focusing his entire message on that issue.  Yes, it's important.  But even bigger concerns loom over our Union.  We have 535 members of Congress who can worry about championing all of the secondary and tertiary issues.  When the basic stability of the nation is at stake, the President needs to be focused on the jobs that make it possible to keep our society together.

Govt And Job Creation

Someone said, "It's not congresses job to create jobs, the market creates jobs."

It is the govt's job to stabilize job creation. Too much growth can be bad (bubbles, inflation). Too little growth is very bad (unemployment, etc.). When the market is over-performing, we need the government to step in and put on the brakes with rate increases and such to limit inflation. When the market is under-performing -- such as now -- we need the govt to step in and do everything it can to accelerate the economy.

The only time the govt should avoid having an impact is when things are humming along at a healthy pace. We're not there right now.

Someone replied, "I disagree, the free market manages job employment, the bubbles and depressions are caused by the government dicking around with the market. Just like how the government pushed sub-prime lending and artificially dropped interest rates, which helped lead to the housing crisis."

History does not seem to agree. When left to itself, the free market has shown itself to be perfectly capable of creating its own bubbles and depressions (see the "Panic of 1857" for starters, but there are plenty of others).

While it seems convenient to blame the govt for "pushing" sub-prime lending, plenty of get-rich-quick lenders were perfectly happy to gamble before getting any "push" from the government. All many of them needed to dive in head first was to see the pool and get the government to step out of the way ... to deregulate and/or avoid sufficiently regulating new products such as CDOs. Indeed, Fannie and Freddie did not lead the charge into risky lending. Fannie and Freddie came late into that game, after the private lenders were aggressively pushing them to the sidelines of the lending market with their sub-prime feeding frenzy. Fannie and Freddie might have been better off staying on the sidelines, but that wasn't the conventional wisdom at the time. Those voices in the wilderness calling out for caution were marginalized by the private sector zeal for profit. Claiming that they only did it because the government was pushing them is like saying a football team would sit in the bleachers for the entire game if the cheerleaders didn't call out for them to score.  Did govt missteps make it worse?  Probably.  That doesn't mean the private sector wouldn't have formed the bubble on their own.

Yes, the government can take the wrong steps and bungle into making matters worse. But that doesn't change the fact that -- whether specific administrations and Congressional sessions do it well or not -- it is the govt's job to strengthen and stabilize the economy, which generally means job creation.

Should you need proof of the govt working to create jobs in our early history: Among the more obvious examples from way back in history to gain any sort of current renown is the 1798 "Act for the Relief of Sick and Disabled Seamen" passed by the 5th Congress (featuring Thomas Jefferson as President of the Senate) and signed by President John Adams. The primary point of the law was to encourage the growth of American commerce (jobs and wealth) by reducing the loss of that specific labor pool to poor health. It also served as an incentive to join that labor pool by making it easier to get health care as a member thereof. More mariners meant more commerce. More commerce meant more American jobs. Voilà. Good job, 5th Congress.

Plan For Growth

"It takes as much energy to wish as it does to plan." - Eleanor Roosevelt

We have uncomfortably high unemployment. We want that to come down. We also have an uncomfortably high deficit. That needs to drop too. What we need is a plan. One that can do both. One that can work.

Our new House majority has loudly pushed focusing on the deficit with budget cuts. The trouble, as I've previously shown and discussed in relation to specific budget cutting figures, is that any significant budget cuts are very, very likely to steer us into far higher unemployment. That would further reduce tax revenues and make the deficits worse. So that just won't work. We can't get rid of the deficit by chopping growth and making the deficit worse.

What can we do?

Well, what happens if we maintain the status quo? What happens if we proceed with spending at the exact dollar amount it is now, keep tax rates exactly where they are, and manage to keep the pace of growth at the roughly 3% estimated for 2011? (Note that spending is scheduled to shrink in 2012 with the expiration of stimulus programs and the winding down of expensive wars. So this assumes we actually spend more than is currently expected for some of these years.)

Deficit/surplus assuming budget holds steady, 3% GDP growth, and revenue stays at the current 14.81% of GDP

Interesting. We'd have a surplus by 2029 at that rate and could start reducing our debt. That's without budget cuts. That's even assuming more spending for at least one of those years than is currently projected. We'd all love to see that budget gap closed sooner, but that's going in the right direction.

OK, how can we speed that up? What happens if we go back to the 30-year average of revenue as a percentage of GDP starting in 2012 but keep all else as before, with spending staying at the 2010 dollar level and a 3% GDP growth rate?

Deficit/surplus assuming budget holds steady, 3% GDP growth, and revenue goes back to 18.2% of GDP in 2012

A bit better. That'd have the surplus and its potential paying down of the debt begin in 2022. But let's try for more. What happens if we go back to the 30-year average of revenue as a percentage of GDP starting in 2012, keep spending at the 2010 dollar level, and find some way to increase our growth rate over 3%? For the sake of charting, let's imagine we get it up to 4% in 2012, peak at 5% in 2013, and then manage 4% thereafter.

Deficit/surplus assuming budget holds steady, but revenue goes back to 18.2% of GDP and avg. 4% GDP growth from 2012

That's more like it, don't you think? If we could achieve an average 4% GDP growth over that time, we could be seeing revenue eclipse spending in 2019, assuming we keep spending at the dollar amount from 2010 and return revenue back to the 30-year average of 18.2%. That's just 8 years from now. I don't know about your kids, but that's even before my older daughter will start college.

That's fairly vague, I'll admit. I've left a lot of room for what exactly those efforts to increase the rate of GDP growth might be. Where to get the money? I'm not a defense expert, but even some conservatives are suggesting we have some fat to trim in the defense spending. Imagine if we took those proposed cuts on spending beyond what the Pentagon actually needs to do its job and transferred that money into real job creation programs.

Off the top of my head, I can come up with several ways we could be doing more to create jobs through our Federal govt:

1. a reborn national Civilian Conservation Corp chartered for 5 with potential to renew
2. repairs to all of our crumbling bridges (and maybe revamping some roads too)
3. high tech research towards "green" energy and products

The first two of these would easily pay off right away. We've got a lot of unemployed construction workers, and it shouldn't take a terrible lot of retraining to put a lot of them to work in a CCC or on improving our transportation infrastructure. The research part might take a bit longer to get going, but the pay-out would go even further. Well beyond when we might have brought our unemployment down using a CCC and beefed up infrastructure projects, we could be benefiting from jobs and sales in exporting of green tech, just like we've benefited from Defense Department and NASA research in our computer industry. That's investing prudently in a future for our children.

It's time.

GOP Seeks Lower GDP

Sen. Rand Paul

Sen. Richard Shelby (R-AL) feels we can cut 30% across the board. Or maybe 10%. According to Ben Armbruster of ThinkProgress, "It is unclear which reduction figure, 10 percent or 30 percent, he is officially advocating." On ABC's "Top Line", Rep. Michele Bachmann (R-MN) says that she's found "about $450 billion worth of cuts." That'd be around 12%. Sen. Mike Lee (R-UT) has talked about cutting the budget by 40%. Sen. Rand Paul (R-KY) strikes it at a balanced budget, which means roughly 33%.

As previously detailed, when we cut the budget to avoid borrowing, those cuts don't come from nowhere. They come out of spending, reducing demand, lowering our nation's GDP. In good times, that's fine. When GDP growth is high enough, we can afford to cut. But we can't afford to drop our growth below around 2.5%. Otherwise we get rising unemployment. One would hope that these members of Congress understand national budgets, have done the math, and wouldn't propose a drop that would take us below 2.5% GDP growth, right?

So what would each of those figures mean? We can plug these into a rough formula. Some of the lower estimates figure the government around a 25% share of GDP. To give these members of Congress the most benefit of the doubt, we'll go with this low estimate. So when you cut government spending by a percentage, you effectively cut the GDP (or more precisely lower the percentage change in GDP) by roughly 1/4 of the percentage by which government spending was cut. Applying Okun's Law (or Okun's Rule of Thumb), we can expect roughly a 1% drop in employment per 2% reduction of the GDP growth below 2.5%. It's a rough figure, but it tells us more or less what we should expect.

Govt budget cut % / 4 = -% GDP impact

Our baseline is 3%. Why? That's a typical estimate for our GDP growth for 2011. Since the stable point for unemployment is around 2.5%, we might theoretically be able to take about a 0.5% drop in GDP without adding more to the unemployment roster and reducing our payroll tax revenue (thus increasing the deficit).

Let's start with the most modest of these, Sen. Shelby's 10% (assuming he didn't really mean 30%).

10% budget cut / 4 = 2.5 % GDP impact

est. 0.5 % GDP meaning 1% added to unemployment rate

Well, that's not very pleasing. So what do we get from the others?

Rep. Backmann's 12%:

12% / 4 = 3%

est. 0% GDP meaning 1.25% added to unemployment rate

Sen. Paul's 33%:

33% / 4 = 8.25%

est. -5.25% GDP meaning 3.875% added to unemployment rate

Sen. Lee's 40%:

40% / 4 = 10%

est. -7% GDP meaning 4.75% added to unemployment rate

So just how much unemployment do they suppose we can handle? Either the answer is above, or they just don't realize that their slash and burn plans would raise unemployment. Even the most modest of them would cause unemployment to rise at this point of not particularly fast growth.

Meanwhile, each of these increases in unemployment would mean fewer people on payrolls. That means less income tax revenue. Since a drop in revenue doesn't generally cause our costs to drop, that means that assuming we went with Sen. Paul's balanced budget, we'd build ourselves a brand new deficit because of that extra almost 4% tacked onto the unemployment picture. So to use Sen. Paul's "ironclad" balanced budget rules, we'd have to make further cuts. Assuming nothing else rescued our GDP from outside, that'd mean a further drop in GPD and more unemployment. Let's not do that. Not now. Not while we don't have enough growth to afford cuts.

The Cost of Cuts

To break even on employment, we need around 2 or 3% growth in GDP.

"Putting this in our current context we can see that growth has to do two things. First it has to cover, or absorb, growth in the workforce due to population changes. A good rule of thumb in the US is that GDP needs to rise by about 2.5% for unemployment just to stay even with such changes." from "Sticky unemployment – Okun’s Law" by Peter Radford

Our GDP, the amount of goods and services we produce, comes from the amount that is spent on American goods and services ... the supply rises and falls to meet the demand. Of that spending (or demand), private sources (individuals and corporations) spend only a portion of the total that makes up the GDP. The government also spends, and that spending makes up a portion of the total demand for goods and services.

Supply doesn't discriminate. Supply is blind to the source. It doesn't care whether the demand comes from private or public sources. No matter what portion of the demand comes from each, supply doesn't care about anything other than the total. If the total demand rises, supply will meet it and require more workers to do so. If the total demand falls, supply will meet it and require fewer workers to do so.

Government's share of GDP has mostly risen over the years, although not in an exactly straight line. Some hate this fact; but whether you call it positive, negative, or neutral, there it is. Government's shared of GDP has been estimated at 25% (or even 43.85% by one source) for 2010. For the sake of avoiding any exaggeration of the impact of government spending cuts, let's go with that smaller 25% figure. At 1/4 of GDP, a 10% cut in government spending would mean about a 2.5 % reduction in GDP. Let's simplify the numbers so that is easy to see. Imagine if we had a total GDP of 100 million dollars and 25 million of that were from the government:

100 - (25 * 0.10) = 100 - 2.5 = 97.5

So there you have it, a 10% cut in govt spending would shrink our GDP by 2.5%. Of course, this assumes that what we're cutting is to make up for deficit spending, i.e. govt foreign borrowing. Considering that the main reason there's talk of cutting government spending in the US is to reduce foreign borrowing, that seems a safe assumption. Borrowing brings in money from outside, so a reduction in debt-based spending does not get offset inside the system. If we had a balanced budget and were cutting spending in order to lower taxes, the offset might just be shifted from public to private spending. But that's not where we are. We're looking at cuts to reduce the amount of GDP we cover by bringing in money from outside, which means we'd reduce the total spending in the system, the total demand, the total GDP.

But what does it mean to have a cut in government spending reduce our GDP? This brings us back to that minimum GDP growth of about 2.5% in order to keep employment stable. Estimates vary, but many forecasts for 2011 US GDP growth are around 3%. So if we cut our government budget by about 10%, that'd subtract 2.5% and give us a GDP growth of about 0.5%, which is roughly 2% below the level needed to sustain stable employment. That means we'd have rising unemployment. Of course, rising unemployment lowers payroll tax revenues. Dropping payroll tax revenues increase the deficit. Deficit increases make people think about cutting more from the government spending. See how this could spiral?

To balance the 2011 budget, we'd need to cut government spending by about $1.27 trillion. The total spending for 2011 at this point is estimated around $3.83 trillion. This means that we'd need to cut the budget by around 33% in order to balance revenue with spending.

Assuming the lower 25% share of GDP, thus less impact, a 33% drop in government spending strictly to avoid taking on more debt would slash 8.25% from our GDP.

100 - (25 * 0.33) = 100 - 8.25 = 91.75

Downward spiral

Pulling 8.25% from our GDP growth would leave us with a GDP growth of around -5.25 for 2011, which is a severe contraction. Remember that we need around 2.5% growth to keep unemployment stable and higher than that to see a reduction in unemployment. So with a -5.25% contraction in GDP, unemployment would go up, up, and up some more. That rising unemployment would promptly lower our revenue (and increase our costs for the unemployed) and give us a deficit again. That deficit might make people cut more, which would lower our GDP further and bring more unemployment.

"What you see is that unemployment tends to fall when growth is high, rise when it’s low or negative. You also see that growth has to be fairly fast — more than 2 percent — just to keep the unemployment rate from rising. Why? Well, productivity is rising, so that you can produce any given level of output with fewer workers; so output has to rise to keep employment from falling. And the working-age population is growing, so you need positive employment growth just to keep unemployment from rising." from "Growth and unemployment" by Paul Krugman

Bad recipe. Clearly, we can't cut our way out of this deficit. We have no choice but to find a way to grow. If we had high GDP growth (like 7%), we could to cut meaningful amounts (like maybe 10%, assuming 7% GDP growth), and still have rising employment, reducing unemployment. Rising employment would also mean more payroll tax revenues, thus lowering the deficit directly. Growth such as this is the only way to spiral upwards. During slow growth, cuts force a downward spiral.

We can't afford cuts. We have to find a way to grow.

Austerity in Modern History

"Those who cannot remember the past are condemned to repeat it" - George Santayana

On the Dylan Ratigan show, Mark Ames, founder of exiledonline.com, describes what happened in the Weimar Republic when they implemented the measures that the GOP are currently pushing in America::

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"The incoming Republican congress is promising to deliver a megadose of austerity this year and the media and financial elites are telling us we need a major dose of austerity for our own good, whether we like it or not. But what none of the dictionaries or politicians or financial experts are telling us us is that austerity's been tried before -- many times, which might make you think "Oh great, so it's been tried and it works, right?" And that's where things get a little tricky. For example, one of the most infamous austerity programs was tried out in Germany in 1930 by Chancellor Bruning, one of those fiscal responsibility buffs who was sure that the answer to Germany's economic problems was to balance the budget and strengthen the currency by slashing unemployment benefits, pensions, and wages, hiking taxes, and sticking to the gold standard. The result: unemployment exploded, riots in the streets, the collapse of democracy, and the rise of Adolf Hitler. The rest is history. But hey, at least he got that deficit under control."

(Ames also added a further example that he witnessed first hand, the total collapse of the Russian economy in the 1990s after they implemented austerity measures.)

Republicans are fond of referring to the Weimar Republic whenever they're fear-mongering about inflation and advocating the ransacking of our social safety net. What they don't mention -- perhaps cannot remember -- is that the Weimar Republic coped with its inflation and stabilized its currency. It was not their hyperinflation that caused the demise of the Republic by descent into fascism.

Not that inflation was nothing. The hyperinflation was painful. And it was used politically. But the Republic survived the inflation itself, handled the situation, and got on with life after the hyperinflation with a currency that had been mostly stable for years after the reset of 1923/1924 established the Reichsmark. They didn't just achieve stability. The prosperity of the Roaring Twenties ran beyond the United States. In the latter 1920s, Germany also boomed after the hyperinflation under the Weimar Republic.

Then the Great Depression hit, giving the Nazi party more discontent with which to work. Then Chancellor Brüning slashed and burned what remained of the German economy with austerity programs. In theory, austerity was meant to deal with the financial problems of debt and the Great Depression while avoiding a return to inflation. But it was those austerity efforts and their side effects that collapsed the Weimar Republic and the launched Germany into fascism.