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Morning Jay: Make No Mistake: the Economy Is Problematic for Obama

6:00 AM, Apr 6, 2011 • By JAY COST
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A media meme has developed about the economy and the 2012 election: if Barack Obama gets the unemployment rate at or below 8 percent, he will be well positioned to win reelection. To that end, the press greeted last Friday’s jobs report (the addition of 216,000 jobs, and unemployment falling to 8.8 percent) as though it was the first sunbeam of Morning in America, Version 2.0.

 As usual, we can head to the New York Times for the spin:

[A]s the unemployment rate ticked down, the hopes of Mr. Obama and his party ticked up: perhaps by the approaching election year they could claim vindication for the stimulus policies Democrats have enacted, or at least dodge the sort of blame that Republicans so effectively stuck them with last November in the midterm elections.

At the same time it has given Democrats new ammunition to argue that Republican efforts to cut spending could hurt the recovery just as it is gaining traction, and that forcing a government shutdown could put more people out of work.

The reality for the president, however, is much more complicated than the White House or its media boosters would have us believe.

When we abandon the quick-and-dirty methodology the MSM uses to analyze economic (or, for that matter, any) data, and instead look at matters in historical context, we see an economy that is at one of its weakest point since the end of World War II. As proof of this, consider the following chart. It tracks the actual performance of GDP from 1948 to the present, against a hypothetical scenario in which the economy grew at 3.43 percent every year. Why 3.43 percent? That is the average annual rate of growth in the economy between 1948 (the first year of postwar growth) and 2007 (the year before the current slowdown).

Any time we’re above the dotted line, it means we’ve grown faster than 3.43 percent per year up to that point. Any time we’re under it, it means we have grown slower than 3.43 percent up to that point. As we can see, for most of the postwar period, economic contractions did not knock us off a very robust growth rate. However, the economy has been in a relative wind-down for a decade, due to the fact that the recovery between 2001 and 2007 saw only one year of growth that was greater than 3.43 percent. Now, with the latest recession we have fallen significantly off the long-term trend line, and with growth expected to come in under 3.43 percent in the next two years, we’re going to fall even farther.  

This precipitous decline in the economy comes despite the fact that the federal government has pumped an unprecedented amount of cash into the private sector over the last three years. Obviously, the 2009 stimulus bill was the most notable such example, but there has been much more than that. The extraordinary extensions of unemployment benefits were stimuli. So was the increased level of domestic discretionary spending approved by the Democrats in the last Congress. So was the deal in December on cutting the payroll tax. Additionally, the progressivity of the income tax has been a kind of stimulus – as people’s incomes have fallen, the percentage of that income that has gone to the government has fallen as well. All in all, we have seen the federal government spend more than any point in decades, take in less, and run an unprecedentedly large budget deficit to finance the whole operation:

This does not exhaust the limits of federal stimulus. The Federal Reserve has kept interest rates at an extraordinarily low level for over a year now, as the following graph demonstrates.

On top of all this, we have the Fed’s program of buying assets – typically referred to as quantitative easing. This is from Reuters last week:

The Federal Reserve's balance sheet grew to another record size in the latest week as the central bank bought more bonds in an effort to support the economy, Fed data released on Thursday showed.

The purchases were part of its $600 billion quantitative easing program, dubbed QE2, with the goal to stimulate investments and economic activity.

The balance sheet, a broad gauge of Fed lending to the financial system, expanded to $2.606 trillion in the week ended March 30 from $2.585 trillion the prior week.

So, the federal government and its central bank have taken on a massive, unprecedented project of fiscal and monetary stimulus – something that we all know is unsustainable over time – and what will be the result? According to Wells Fargo, we can expect an average growth rate of 2.5 percent in 2011 and 2.9 percent in 2012, both of which are well under the historical trend.

Not only that, but we have a recovery that average people are still not really participating in. Consider, for instance, the unemployment rate. The headline number showed downward movement last month, from 8.9 to 8.8 percent. However, unemployment is calculated in a somewhat counter-intuitive way. If you do not have a job and are not looking for one, you are counted as being out of the workforce, and therefore not unemployed!

To appreciate the effect this has on the unemployment rate, consider the following graph. It tracks the nominal unemployment rate (what the Bureau of Labor Statistics publishes every month) versus what I’d call the “shadow” rate. The shadow rate is calculated by assuming that a constant percentage of adults are actually in the workforce – 66.2 percent, to be precise, which is the average number during 2007.

Notice how the two lines mirror each other closely for most of the 2000s. This is because the labor force participation rate was pretty constant, right around 66.2 percent. Starting in the middle of 2009, however, the shadow rate zoomed past the nominal rate because the participation rate declined as people gave up looking. Today, the percentage of adults who are counted as being in the labor force is just 64.2 percent, the lowest since the mid-1980s

This will either be a political problem for the president, or a huge economic problem for the country. If people start returning to the work force, then the nominal number and the “shadow” number will move closer together, suggesting that the nominal number will tick up or remain flat for some time, and thus give the president some bad press. If that doesn’t happen, if the long-term result of this recession is a smaller labor force, then that is bad news for economic growth (sooner or later you need more workers for more output) as well as the deficit (how much in taxes do non-workers pay?).

Most voters, of course, are employed, meaning that their personal economic situation depends more on how much money they have in their pockets. This is often measured by “personal income per capita,” which has gone up since the bottom of the recession.

However, a big chunk of the subsequent improvement is due to those extraordinary government stimulus measures – like the extension of unemployment benefits and more people signing up for food stamps (see this graph for the detail on this trend – but beware that it is not for the faint of heart). Indeed, in 2007 (the last year before the recession), government transfer payments accounted for 14.2 percent of all personal income. In February of this year, they accounted for 17.8 percent.

It’s because of this extraordinary increase in government transfer payments that the income hole that developed after the recession has finally been filled. The following chart tracks this by presenting two lines. The first is nominal per capita income as it has been reported. The second is what it would have been if the government had not stepped in with these huge subsidies, and instead kept them in line with where they were in 2007.

This graph makes it clear that, were it not for unusually large government subsidies, the average American would have less money than he did in 2007. And remember, these are nominal dollars, meaning that we’re not taking into account inflation.

Indeed, the evidence suggests that real wages and salaries – in other words, the actual buying power of a paycheck – have been in a five-year slide:

In terms of purchasing power, today’s average paycheck is performing less strongly than it has at any point since 1998. And this is one area where the (real) unemployment, which is almost triple what it would be at so-called “full employment,” harms everybody, including those who have jobs. Put simply, it’s a buyers' market for labor these days, making it harder for the average worker to negotiate for a larger paycheck.

In fact, the supposedly “good” jobs report that came out last Friday had wages flat in the month-to-month, while nearly half of the jobs came from low paying sectors – retail trade, leisure/hospitality, and temporary services. Meanwhile, construction jobs are at a 15-year low while manufacturing jobs have not been this scarce since World War II.

So basically, here is where we are. Policymakers have spent the last three years tossing not millions, not billions, but trillions of borrowed dollars at the output gap in the American economy. And what is the result? A fair measurement of unemployment comes in higher than anything we’ve seen since the Great Depression. Real wages are in decline. Food stamp enrollment is at an all time high. Jobs are coming back, but at a painfully slow rate and without very good pay. Growth for this year and next are expected to come in below the historical trend. We’ve created a huge budget deficit, as we’ve borrowed from future generations to cover the output gap from the last couple years. And let’s not forget this one (not that we ever could!):

On top of all this, we see policymakers increasingly divided. We are well aware of the policy split in the Congress, and between Congress and President Obama. However, it appears that the Federal Reserve Board is increasingly uncertain of how to approach policy from this point forward:

A quiet day on Wall Street left stock indexes little changed after minutes from the most recent meeting of the Federal Reserve's policy committee showed few signs that the central bank plans on making changes to its stimulus program. Trading volume continued to be light.

The minutes, from the Fed's meeting on March 15, confirmed that members of the central bank are split about whether it needs to tighten credit later this year to ward off inflation. All of the committee's members agreed that the economy is improving.

Is this confusion any surprise, really? Let’s be honest. Most of the so-called experts were caught totally flat-footed by this contraction. Check out, for instance, the prognostications of the Wall Street Journal's experts in August, 2008; on average, they forecast a growth rate of 1.9 percent for 2009 (it finally came in at -2.6 percent). Most of them thought the recession wouldn’t be as bad as it has been; in December, 2008 they forecast that unemployment would be 8.1 percent (it came in at 9.9 percent). Lately, the experts have been revising their latest forecasts downward, sometimes drastically. It is hard to believe that any of them really understand why we're in the shape we're in, or what to do about it.

That includes, the president, whose prescription for "Winning the Future" is eeriely familiar to Lyle Lanley's.

So, for those analysts in the press who think that Obama will win in 2012 if incomes are still being propped up by massive (deficit financed) government spending, real salaries are declining or flat, unemployment is far above the historical trend, good paying jobs are scarce, the deficit is at an all time high, and the president has no real idea about what to do (except, of course, high speed rail), I have only this to say: you might want to think twice before you place that wager. This president is not yet out of the woods on the economy. Not even close.

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