[Noozhawk’s note: This is the first in a two-part series. Click here for the second part.]
There are 15.1 million workers unemployed in America. Another 9 million are working temp for economic reasons, and another 2.5 million are marginally attached or discouraged from the work force. That is about 26.6 million people in trouble. We can argue about the “true” number of unemployed, but for the purpose of this article, the fact that it is high under any measure is sufficient.
The labor participation rate, which shows what percentage of the work force is engaged in employment, has been steadily dropping for 10 years:
It hovered at about the 60th percentile for many years (1948 to 1970), and then it took off in 1970 and peaked at 67.1 percent from 1997 to 2001, when it started declining to its present level.
Thus, it seems that we have been going backward for the past 10 years after rising rather steadily for 30 years.
What has happened during the past 10 years? We have experienced two business cycles as a result of the Federal Reserve’s money manipulation. The dot-com boom result in the dot-bomb bust of 2001 to 2004 and stubborn but moderate unemployment. In our current cycle, unemployment has risen sharply since late 2007. These two unemployment cycles have lasted longer than any other post-World War II cycle.
This chart illustrates the problem:
Note the duration of the brown line (2001) and the red line (2007). Just from looking at this chart, it’s obvious that these recent cycles have been more difficult for the government and the Fed to “stimulate” into jobful recoveries. The depth of our current recession is unprecedented for the period following WWII.
The big questions: Why does unemployment persist? What is different about this cycle that makes it worse than others?
One answer is that many jobs created during these booms aren’t coming back. Another answer is that a lack of “real capital” will hinder robust job growth.
The dot-com boom tricked those involved in it that they were experiencing a “new paradigm,” or a world where profitability mattered less than “concept,” where buzz meant more than feasibility.
Tremendous amounts of capital poured into dubious companies. The Geek Moment was at its all-time high, and they poured into Silicon Valley to make their overnight fortunes. That ended as soon as Alan Greenspan wrote “irrational exuberance” on the blackboard 100 times. What had made sense during the heat of the moment didn’t look so good when the Fed’s juice ran out. It was like a game of musical chairs, but in this game half of the chairs were taken away when the music stopped. Those jobs disappeared never to come back.
Just look at the brown line again on the spaghetti chart: It took 47 months for employment to get back to positive job growth.
The crash of 2008 was the biggest credit bubble the world has ever seen. New Fed money flows somewhere during booms, and this time it was into housing. It was so vast that the spillover poured into commercial real estate, leisure and hospitality, autos, consumer goods and student loans. As we are finding, this boom spread to most of the Organization for Economic Cooperation and Development economies, which make up 34 of the world’s more prosperous economies,. Fake wealth from new credit instruments spread worldwide as investors jumped lemming-like into the pool.
Credit bubbles never last. When the frenzy created by easy money starts to spin out of control, the Fed regains some sanity and stops “printing money” by raising interest rates. Then things fall apart. This is the inevitable bust phase of the cycle.
This time we were hit really hard since the Fed’s monetary expansion was immense. All jobs related to residential real estate have been severely impacted: workers in the construction industry, building materials jobs, developers, real estate salespeople, escrow and title workers, the real estate finance sector including home mortgage brokers, banks that financed mortgages, high-end employees in structured financing departments in very large banks, investment houses, and hedge funds. The spillover wealth effect of the boom that had pumped up the auto, retail and leisure, and hospitality industries hit these industries hard in the bust phase.
We all understand this effect of economic busts: Businesses go bankrupt or cut back, workers are laid off and banks suffer huge losses. Then things are supposed to get better, and after some passage of time we continue growing. But that isn’t happening and hasn’t been happening for the past 10 years if one measures employment and the labor participation rate. I don’t put any faith in traditional measures of economic recovery by the National Bureau of Economic Research, the arbiter of when recessions start and end. I don’t accept that there is a “recovery” when unemployment is close to 10 percent of the work force.
The reason employment has been declining for the past 10 years and what is significantly different from past cycles is that these boom-bust cycles have been destroying real capital on a massive scale.
The perceived prosperity of the boom was false, supported only by the Fed’s creation of fiat money and credit. When the veil of fiat money was lifted, we discovered the ashes of projects that were a waste of the capital invested in them. If you destroy enough capital in an economy, then fewer jobs are created because fewer businesses are able to expand and grow. It is my belief that this has happened on a massive scale in the past 10 years.
Another way of saying this is that quite a bit of the perceived expansion of the economy for the past 10 years was a waste of money. There is a technical term for this in economics, called “malinvestment” of capital. Let me explain this concept and how it works.
First, a couple guidelines. If the Fed or any central bank could create wealth (capital) by printing money, then we would all be rich. They can’t. The only way capital is created is through the production of goods from which some profit is derived and saved. Government can’t create wealth because it produces nothing. Only the private economy can do that.
What printing money can do is destroy capital.
How? By creating money out of thin air. Here’s how it works.
Let’s say you are a developer of residential housing. You’ve been looking at a piece of property for a 100-home project and you pencil it out to discover that it doesn’t make sense. Let’s say that a year later you look at the property again, but the Fed has been printing money for the past year and as a result price inflation has driven housing prices up. You think you can now sell the homes for $250,000 rather than the $220,000 you had projected last year, and now the project looks feasible to you. You think you can make 15 percent profit on the project. You go to your bank and borrow 70 percent of the money for the project, say $15 million. For the other 30 percent, or $6.25 million, you get 90 percent of it from a big pension fund and put up 10 percent of the money yourself.
The bank extends the loan and the Fed creates it out of thin air. By a few keystrokes, the bank has another $15 million on its books and credits your account by that amount. It is brand-new money, freshly “printed” by the Fed. All the bank needed was $1.5 million of uncommitted Tier 1 capital to make this happen. You now go out and build the project with the new money and bid away building materials from others and pay with checks that are deposited into the suppliers’ bank accounts. What have you done? You have gotten something for nothing. You have bought goods for free because the money is a fiction of a keystroke.
Other builders see this new activity (assume you aren’t the only one doing this) and they see prices of homes rising and do the same thing. All prices are going up as new money bids away scarce resources. As we get farther away from the bank’s injection of new money, the lowly consumer earns no more money but prices are going up and he has to pay more. He’s getting screwed and you’ve gotten something for nothing.
It takes you two years to build the project. But by then the Fed sees that prices are spiraling up and up and they raise interest rates to slow the creation of money. Mortgage rates increase, and for a while home prices also continue their rise. But now fewer folks are buying homes because they can’t afford them: it only worked with cheap mortgage rates. Now buyers can’t afford to buy your homes, and your sales slow down. Maybe you’ve sold half of them but the rest lay idle. You know that you wouldn’t make any money until the sale of the last 15 homes. At this point, you haven’t made enough back to pay off the bank or the pension fund, or take money home for yourself.
The economy slides into recession and more and more housing projects are going belly up. You can’t sell a thing. After another year of trying to work things out with your lender, the bank forecloses and takes back the 50 unsold homes. It sells the homes at wholesale prices and has lost about $4 million. The pension fund lost its entire $5.6 million, and you’ve lost $550,000, and the bank and the pension fund are going after you personally for repayment. You go bankrupt and they get nothing.
This is exactly what happened during the Great Recession. I speak from experience.
— Jeff Harding is a principal of Montecito Realty Investors LLC. A student of economics, he has a strong affinity for free-market economics. This commentary originally appeared on his blog, The Daily Capitalist.