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Monday, November 19 , 2018, 6:18 am | Fair 48º


The Daily Capitalist: Why Unemployment Will Remain High for Years, Part II

The government and the Fed continue to pursue policies that exacerbate the problem

[Noozhawk’s note: This is the second in a two-part series. Click here for the first part.]

Your project wouldn’t have happened had the Federal Reserve not created money out of thin air. Because of fiat money creation, it did happen. As a result, real capital — the $6 million from you and the pension fund — was “malinvested” in a project that wasn’t economically viable from the start.

If you magnify this worldwide, as the bust spread throughout the residential markets, and then the banks, and then mortgage backed securities and other derivatives, and the credit default swaps, and the rest of the complex financial instruments, trillions upon trillions of dollars of real capital were lost. To this day, no one really understands how much capital was and is still being lost.

Why aren’t jobs being created?

First, many of those jobs related to the housing boom have disappeared and won’t return. Developers have quit or have gone bankrupt. Mortgage financing is a shadow of the former market as new home building is at historic lows. All the related services have cut back. Small-business bankruptcies are historically high.

Second, it is my belief that the rate of home ownership will drop to near its historical level. From 1970 to 1995, the home ownership rate was 64 percent to 65 percent of American families. Starting in 1995, they shot up, reaching a high of more than 69 percent in 2004 and 2005. Now they have settled back close to 67 percent and are still heading south. I believe they will settle around the 66 percent level. Also, demographics suggest that we will not return to the heady levels of new home construction found during the boom. Assuming the economy recovers to a steady 3 percent to 3.5 percent GDP growth, it will not be sufficient to recreate jobs in the housing market to their boom levels.

Third, and most important, there is only one way to create jobs, and that is through business formation and expansion, and we don’t yet have enough new capital to create such growth. New capital can be created only through production and savings. And that won’t happen until the private sector has first sufficiently deleveraged (reduce debt incurred during the boom). Again, if the fix was as easy as the Fed creating more money out of thin air, we wouldn’t be in a recession to begin with.

Why have we been going backwards for 10 years? Because the dot-com bust, although smaller in scope, also was destructive of real capital. The Fed’s attempt from 2001 to 2004 to revive the economy through the creation of fiat money (M1 up almost 30 percent from 2001 to 2005) caused the false boom in housing and that it why we are where we are today. With each cycle, fiat money only serves to destroy more capital.

Now it is happening again with ZIRP and QE I and II. Except that this time there is a difference: We’ve wiped out too much capital, and we haven’t yet generated enough new real capital to drive growth. Attempts to flog the economy with fiat money will only lead to one thing, and that is stagflation. Stagflation was the curse of the 1970s and early 1980s when we had high inflation and stagnant economic growth.

How much real capital exists in the economy? The real answer is that we don’t know, and it is not possible to measure it from existing data. Instead, economists look at the effects of a lack of real capital in order to determine if real capital is growing or shrinking. Austrian theory economist Frank Shostak suggests that the state of bank credit (lending) may be a reasonable proxy for measuring the effect of a lack of real capital (savings).

“As long as the pool of real savings (capital) holds up, commercial banks are likely to cooperate with the Fed’s monetary pumping and convert it into a stronger money-supply rate of growth.

“However, if the pool of real savings is in trouble, banks are likely to ignore the pumping by the Fed. Why is that so?

“A fall in the pool of real savings means that less real wealth can be generated. This in turn means that the quality of banks’ assets is likely to come under pressure. Obviously, this leads to the curtailment of credit and the curtailment of the expansion of credit out of thin air.

“All this puts pressure on the rate of growth of the money supply. When the damage to the pool of real savings is severe, this is likely to be mirrored by a much more severe curtailment in credit expansion by banks.”

And that is where we are today. While there has been some improvement in bank lending, it has failed to significantly increase the money supply through the expansion of bank credit. As this chart shows, total commercial loans have collapsed resulting in the current so-called “credit freeze.”

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What this tells us is that despite the Fed’s attempt to increase money supply, banks aren’t lending. Almost all of the increase in money supply (using Austrian theory definitions) is coming from quantitative easing (the Fed’s direct injection of fiat money into the economy).

This suggests that the state of real capital is weak and economic growth will be hindered, which in turn will not create enough new jobs to put a significant dent into the unemployment rate.

This is a terrible prospect for the millions of unemployed Americans who need jobs. Yet our government and the Fed seem oblivious to the issue and still pursue policies that exacerbate the problem. They fail to see the scope of what they have done. This is no ordinary recession. The boom phase was unprecedented in history. Easy money led to a worldwide frenzy of malinvestment that is still in the process of being unwound. The more the government and the Fed interfere with the corrective process, the longer the misery of unemployment.

Current Fed policies are doomed to failure. This time instead of fiat money induced fake growth we will have fiat money induced stagnation and inflation.

What our leaders are doing to American workers is shameful and cruel. They seem to hate workers because they are doing everything they can to prevent job formation. I can’t predict when we will see healthy job growth again because I can’t predict what the government and the Fed will do. But based on the unprecedented loss of real capital, it could be another five or six years. In the meanwhile, unemployment will remain persistently high.

— 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.

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