The Obama Administration’s Bad Remedies

We have to face facts: The economic situation in the United States is dire for long-term structural reasons. In the first place, many American households are in a very shaky financial position. In 2010, 10 percent of American mortgage holders will default on their loans. There will be 4 million families who will have their homes seized by the bank. For the 11 million families who owe more on their homes than they are worth, it means that it’s in their interest to default. The very slow rise in real estate prices, which have declined by 30 percent since the beginning of the recession, does not significantly improve the situation. This means that American households are unable to restore their credit, and housing starts have stagnated at a very low level (500,000 per year vs. 2.2 million before the recession). Americans’ creditworthiness depends heavily on their wealth, and their real estate and financial wealth has decreased by 30 percent with the recession. Households will need many years to recover financially.

The second serious problem is the steep decline in the job market. The unemployment rate is 9.6 percent, but more than 9 million Americans who are working part-time say they are looking for full-time jobs. The unemployment rate in a broader sense is over 15 percent. This is due to the fact that American businesses are trying to increase their productivity drastically (by 5 percent per year), skewing their revenue at their employees’ expense to return to pre-recession profit levels. This results in weak job creation, weak salary income and, ultimately, a decline in productivity.

Finally, the third serious problem is the need to get households and businesses out of debt. Lowering the burden of debt, which could take several years, requires an increase in savings and a decline in spending by households and businesses.

Therefore, the most likely scenario for the American economy for the next two or three years is one of modest growth (about 2 percent per year), continuing high unemployment and continuing serious financial problems for many households. For the Obama administration, as well as for the Federal Reserve, this prospect is untenable; there have been recent announcements of new economic policies, such as the new stimulus bill ($200 billion in tax incentives for investments, $100 billion in tax credits for research, an extra $50 billion for infrastructure …) and an even more expansionary monetary policy.

The problem is that these new stimulus measures are ineffective and possibly even dangerous. American households and businesses want to get out of debt. Even though banks have more cash assets than ever, there has been no upswing in the credit market, due to lack of borrowers. American banks already have access to $1.05 billion dollars in cash reserves, and the credit market is not rebounding. What good will it do the banks to have a cash surplus of $1.2 or $1.3 billion? Giving businesses investment incentives in the form of tax credits will not be very effective in a situation where capacity utilization rates are low (75 percent on average instead of 82 percent) and where businesses do not need to invest. These tax incentives will have a “deadweight effect” and may simply push investments from 2010 to 2011 (as we have seen for the same reason with housing investments and car sales). The year 2011 will probably be a little better — 2012, not as good.

In the face of the American economy’s structural problems (debt reduction, households going broke, high unemployment), I fear that we might simply have to be patient and wait for employment and credit markets to naturally pick up, unhindered by excessive government deficits (probably 11 percent of GDP by 2011) and excess cash assets in the economy, which would only create a speculative bubble in asset prices.