Is end-of-the-recession optimism misleading?

BusinessWeek's August 24 cover blares: "The Case for Optimism." As magazines and papers hemorrhage ink in their cheerleading for a supposed end to the recession, it seems like time to take a step back and ask if these are merely "feel-good" features, or if there is any substance to the notion that "the worst is over," the recession is done, and "green shoots" are taking root in key places.

Ultimately, it seems like skepticism is in order, as the rousing optimism neglects to mention a few grim realities. To begin with, while many have noted that the jobless rate has declined, they seem less inclined to point out that this is because the work force shrank. This is typical smoke-and-mirrors statistics: as people lose extended unemployment benefits, they are classified as "discouraged" and are no longer counted in the "headline" unemployment number.
Unemployment has fallen by 267,000 to 14.5 million, while employment has fallen by 155,000. The labor force declined by 422,000 as "discouraged workers" dropped off the statistical count, which means the jobless rate declined because people dropped out of the work force, not because they got jobs.

Added to this, structural unemployment is skyrocketing. The number of people who've been out of work longer than six months rose by a record 584,000 to five million, accounting for more than a third of all unemployment for the first time on record.

And then, there is the unpleasant fact that everyone seems to have forgotten: we need to create 130,000 jobs a month just to stay even with population growth. So while "only" 250,000 jobs were lost last month -- never mind that a big chunk of employment was linked to the "cash for clunkers" giveaway -- we are still 380,000 jobs short of a return to a positive employment scenario. And we need much stronger growth to get back to lower unemployment. According to the Economic Policy Institute, the nation needs to create seven million jobs to return to pre-recession employment levels.

Of course, the recession extends beyond unemployment; for that matter, so does the bad news. The interest on all the debt the nation is taking on to bail out bankers and "stimulate" the failed credit-bubble model of expansion will place a drag on growth far into the future. At the end of March of 2009, Bloomberg reported that "The U.S. government and the Federal Reserve have spent, lent or committed $12.8 trillion, an amount that approaches the value of everything produced in the country last year." This amount "works out to $42,105 for every man, woman and child in the U.S. and 14 times the $899.8 billion of currency in circulation." The nation's gross domestic product was $14.2 trillion in 2008.

Even with today's dirt-cheap interest rates, the Federal government spends over $400 billion a year on interest. If interest rates rise, the interest could soon approach Pentagon spending ($707 billion a year) or Medicare and Medicaid ($742 billion a year).

Given the general trend of this piece, it almost goes without saying, but I'll say it anyway: interest rates are set to rise. There's nothing fancy here -- even the Fed economists understand this. As the Seeking Alpha blog notes, "In a 2003 paper, Thomas Laubach, the US Federal Reserve's senior economist, calculated the impact on long-term interest rates of rising fiscal deficits and soaring national debt The study is damning because Mr Laubach was the Fed's economist at the time, going on to become its senior economist between 2005 and 2008, when he stepped down. As a result, the doubling in rates is the US central bank's own prediction. +3.5 percent because of rising deficit."

Suddenly, the positive feedback/runaway debt scenario looks not just plausible but inevitable: if interest on the national debt rises as tax revenues plummet, then the only way to pay the interest is to borrow more, increasing the interest due. It's worth noting that that the stimulus deficit is 13 percent of the entire U.S. GDP. Five percent is widely considered unsustainable, and Argentina defaulted when its deficit hit 3 percent of GDP.

And what about paying it back? Well, tax revenues are tanking. Government revenue is at its lowest level since the Depression, and most states are on the verge of bankruptcy. Since they cannot be manipulated like unemployment, tax revenues and sales taxes are far more accurate measures of economic activity. Raising taxes is politically risky, leaving only one other way to continue funding deficit spending: print and borrow. This, of course, raises interest rates.

It also doesn't help that accounting and reporting rules are still not fully transparent. The U.S. financial markets remain a hall of mirrors in which accounting tricks can create billions in profits. In this context, it's worthwhile to remember Citicorp's phantom profits in March, which launched the stock market rally.

Speaking of accounting, reporting, and tax revenues, it's worth noting that commercial Real Estate is at risk. Even fancy accounting might not save banks when the tsunami of bad CRE loans hits in the coming months. Anyone want a faded-glory, half-empty, money-losing mall or three?

Part of the downfall in commercial real estate lies with consumers. While many analysts have assumed that consumers are retrenching for a few short months until the economy turns around, the reality seems to be that they are changing generationally. Consumer credit (revolving and non-revolving) dropped at a 4.9 percent annualized rate in June, double the expected pace, indicating that consumers are heavily shifting toward saving. Total outstanding consumer credit in June was $2,485 billion, $70 billion less than the $2,556 billion in June of 2008.

This is a major, systemic change: in the last decade of credit-fueled prosperity, consumer credit grew every month like clockwork. $70 billion isn't much, but it's the start of a trend which essentially dooms consumer-based, over-leveraged economies like the U.S. to years of (at best) meager growth.

This move toward saving is hardly surprising. For many consumers, their major investment -- housing -- still shows few signs of turning around. Residential housing is not healed; it's still bleeding profusely. Almost one-third of home loans under water. No collateral (as in, no housing equity) means that consumers cannot borrow more money, even if interest remains at absurdly low rates (and it won't).

Perhaps statistically, the recession is "getting less worse," but that is not the same as setting the foundations of robust, sustainable recovery in jobs, tax revenues and consumer collateral.

Charles Hugh Smith writes the Of Two Minds blog and is the author of numerous books, most recently "Survival+: Structuring Prosperity for Yourself and the Nation."
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