Tuesday, Jun 18, 2024

Joblessness and European Debt Threaten the US Economy

The latest job and manufacturing statistics indicate that the US economy is still growing, but at a very slow pace. The extended high unemployment has undermined the confidence even of those American consumers who still have jobs, by undermining their ability to increase their incomes to keep up with inflation. While the job statistics for September and revised job numbers for July and August indicate that fears that the US is already in a double dip recession are premature, the long term trends indicate that, at best, we can look forward to continued slow growth, and a real danger that any further economic shocks could lead to a double dip recession in the first part of 2012.

Many economists fear that such a shock could come from Europe, where the leaders of Germany and France announced further meetings to come up with a unified strategy to deal with the renewed threat of a default by Greece on its bonds. As the Greek government continues to run up large budget deficits, the amount of money needed to prevent a default continues to grow, raising the issue of where the money will come from to prevent a default.


German Chancellor Angela Merkel is well aware that the opposition of German taxpayers is growing against providing any more money to the recently expanded central European bailout fund set up to save Greece and other troubled euro zone economies.


Meanwhile, French President Nicolas Sarkozy worries that French banks which hold many of the outstanding Greek bonds would not have enough capital to remain solvent if they are forced to take greater losses on those bonds as part of a new Greek rescue plan. He is pressing Merkel to give French banks easier access to the bailout fund, because he is worried that France could lose its triple-A credit rating if it must bail out its banks using only its own money.


On the other hand Germany is pushing for the Greek bondholders, including the French banks, to bear much more of the financial burden of rescuing Greece. They would force the bondholders to accept a much steeper reduction in the percentage of the principal amount of the bonds that would be required to be paid for their redemption than the current bailout arrangement.




Both Merkel and Sarkozy now agree that Europe’s largest banks will need much more capital to cover their losses on Greek and possibly other European government securities, and the current European bailout fund will need to be expanded, but they have yet to agree on a formula for where all the needed money will come from.


Following the most recent meeting between Merkel and Sarkozy, the German Chancellor said, “we are determined to do what is necessary to guarantee the recapitalization of our banks. We will make proposals in a comprehensive package that will enable closer cooperation between euro-zone countries.”


Sarkozy said that he and Merkel “determined to have a sustainable and comprehensive solution by the end of this month,” before the summit of the Group of 20 global economies is held in Cannes, France, on Nov. 3-4.




Meanwhile, fears grow that Italy and Spain may also face great difficulties in the months ahead as hundreds of billions of dollars worth of their bonds become due for payment. The European Central Bank (ECB) has already had to intervene in the market to buy some of the newly issued Italian and Spanish bonds, because otherwise international investors are demanding much higher interest rates on those securities as compensation for the perceived increased risk of a default.


Further market intervention by the ECB will be necessary in the months ahead if Italy and Spain are to be able to roll over the maturing bonds by selling new ones. If they can’t, the size of the bailout which will be required to avoid a default on the sovereign debts of Spain or Italy will dwarf the Greek rescue package, and far exceed the capacity of the current European rescue fund.




The reason why this affects the US economy is that US banks and European banks are closely linked by complex financial relationships. This means that if a major European bank fails, the US banks doing business with it will take part of the losses. In addition, the US Federal Reserve has been lending dollars to these European banks, through a special line of credit set up with the ECB, which adds to the size of the US financial exposure to a Lehman Brothers-style failure by one or more of the European banks. In a worst case scenario, such a failure could trigger an international financial domino effect, freezing up international lending and security markets in much the same way that the Lehman Brothers failure did in 2008, triggering a worldwide financial crises.


Many prominent economists, including former Federal Reserve Chairman Alan Greenspan, warn that the dangers of another such crisis touched off by a European default or bank failure is very real, and that there are no easy solutions to the problem in sight. That is because, unlike the US, there is no single central financial authority in Europe with the ability to control both government and monetary policy comparable to the US Treasury and the Federal Reserve, which were able to respond to the 2008 crisis effectively, narrowly avoiding a total global economic meltdown. Instead, policy in the ECB and the euro zone countries requires forming a consensus among all 17 of the participating euro zone countries, which can be a long and complicated process, and which could be stymied by the refusal of even one of the 17 countries to go along.




The current meetings between Merkel and Sakozy are a positive sign. They indicate that the leaders of Europe’s two largest economies now recognize the seriousness of the danger. But there is still fear in the financial markets that Germany and France cannot move swiftly enough to put the necessary financial safeguards to prevent investor concerns over the possibility of a European default from reaching a tipping point, leading to a full scale panic, with disastrous results for the entire financial world.


That is why prices on US stock markets have been so volatile over the past month, with huge swings both up and down triggered by every new development in the European situation. Increasingly, the course of trading on the US markets each day is being determined by the patterns set by the leading European stock exchanges, with the widest swings usually seen in the prices for the largest European and US bank stocks.


There is not much that the US can do to help the Europeans deal effectively with the problem, which is as much political as it is financial. The US is also constrained by its own domestic financial problems, as the result of low growth, continued high unemployment, as well as the huge addition to the national debt due in part to Obama’s failed financial stimulus programs. This has constrained the political ability of the US government to launch further direct stimulus programs in order to create more US jobs and economic growth.


With the developing countries, such as China and Brazil, also now reigning in their overheated economies in order to prevent an outbreak of inflation, there is no apparent source of new demand anywhere in the world to stimulate fresh growth. These are the reasons why the economic outlook, both domestically and internationally, is so bleak.




One welcome recent ray of good news was the report that the US economy added 103,000 jobs in September, and that the no job growth estimate for the month of August was adjusted upward to reflect a net gain of 57,000 jobs.


However, economists noted that overall, the level of US job growth over the past two years has remained less than the minimum amount necessary, about 125,000, to absorb new workers joining the US labor force each month.


Economists also note that such swings in the monthly job are relatively insignificant, because they sometimes reflect one-time events in the labor market. For example, the original flat job growth estimate in August was probably influenced by a strike by 45,000 Verizon workers, and that same number should be subtracted from the job growth reported in September, which counted the striking Verizon workers who went back to work as new jobs.


While the national unemployment rate remained at 9.1% in September, unless the rate of new job creation picks up soon, economists expect that percentage to start climbing again soon.


The US has added an average of 96,000 net new jobs a month over the past six months, which is about 30,000 less than the number of Americans who join the labor force every month. If that trend continues for any length of time, the overall rate of unemployment is bound to rise.




White House officials cautiously welcomed the September job numbers as not quite as bad as had been feared. “The jobs numbers were better than projected, but nowhere near the type of job growth we need to reduce unemployment and start getting the long-term unemployed back to work,” said Gene Sperling, who heads the White House National Economic Council, who then made another pitch for congressional passage of Obama’s $447 billion jobs bill. Counterproductively, the jobs stimulus measure would be paid for by sharply higher taxes on those earning more than $1 million, which includes many of the entrepreneurs to whom the country is now looking to create most of the new jobs it needs.


On Capitol Hill, Republicans blamed Obama’s leadership for the high unemployment rate. House Speaker John Boehner said that the September jobs report “underscores the urgency for both parties to find common ground on common-sense solutions to create a better environment for private-sector job creation.”


“Our unemployment rate has been higher than 8 percent for more than 2½ years, far above what the Obama administration promised with the [original] ‘stimulus.’ For many groups, including teenagers, Hispanics and African Americans, the jobless rate is even higher. These sad numbers show that more Washington spending, threats of higher taxes on small businesses and excessive government regulations don’t create a healthy environment for job growth.”




There were other new economic statistics which reinforced the basic message of the September jobs report, including the indexes for both the manufacturing and service segments of the US economy. They were all consistent with continued slow growth of the economy as a whole, but little or no relief in sight for millions of unemployed workers and other US families which now find themselves in increasingly difficult economic circumstances.


The size of the problem can be better appreciated by looking at the overall rate of unemployment, which has been stuck above 8 percent since early 2009, and where the US job market stands now compared to where it was before the last recession started in December, 2007.


Through September, the economy had recovered only about 2 million of the 8.75 million jobs lost as a result of the 18-month long recession that ended in June 2009. That means that about 6.75 million US jobs have disappeared completely, while millions of others have been replaced by lower-paying jobs. Unemployed workers who have had to take those jobs have had to accept a significant cut in pay and reduced household income.




That reduction in income for millions of American households, even in those where the breadwinners are still working, has helped to make this recovery feel so different from previous ones. Another complicating factor is that millions of American homeowners are effectively trapped in their homes because their mortgage loans are underwater. That is especially true for those families who bought their homes in the years before the nationwide real estate bubble burst in 2007, and paid substantially more for their homes than they are worth on the market today.


This means that homeowners in this position do not have any equity left in their homes that they can borrow against to tide them over in an emergency. For the same reason, most cannot qualify to refinance at today’s record low mortgage interest rates, which recently dropped below 4 percent for a 30-year fixed-rate loan for the first time ever.


These fixed mortgage rates have tracked the recent slide in 10-year Treasury bond interest yields to below 2%, due to growing concern by investors that Europe’s debt crisis is worsening and the US economy may slide back into a double dip recession. The Treasury bonds are still seen as the safest place for investors to park their money, which has allowed those holding them to demand higher prices for them when they sell them in the bond market. Because the interest rate on the face value of the Treasury securities is fixed when they are first issued, as their market value climbs above their face value, the effective interest rates which they pay their new owners goes down.




Falling housing prices also have an effect on the job market. Ordinarily, job seekers are free to relocate from areas where new jobs are scarce to areas where there are more employment opportunities. But any worker who owns a home bought in recent years will likely have to sell it for less than he paid for it, and take a substantial loss, if he wants to relocate to take advantage of a job offer in another part of the country. If the mortgage is underwater, meaning that the owner owes more money on the loan than the house is worth, if he sells the house, the bank might still go after him to try to collect the difference between the outstanding balance on the mortgage and the house’s sale price.


Taken all together, this explains why so many American middle class families feel that they are in an economic trap, and incapable of breaking out. Because jobs are generally so scarce, most workers are in a very weak bargaining position with their employers when they seek a raise.




The situation is even more dire for those increasing number of American workers who have been unemployed for long periods. In September, the number of people who have been unemployed for more than six months rose by 208,000, to 6.2 million. A broader measure of the unemployment rate, which included those who have given up looking for a job out of frustration or who are working part time but want full-time work, rose in September to 16.5 percent, from 16.2 percent.


The average length that a typical worker has remained unemployed has grown steadily since the recession started. In December, 2007, it was 16.6 weeks. In June 2009, when the recession technically ended, it was 24.1 weeks. More than two years into this recovery, in September, it had increased to 40.5 weeks, the longest in more than 60 years.


The problem facing many of these unemployed workers is that their former jobs are gone for good, either because their companies were closed or merged, or their jobs were outsourced by their employers to cheaper labor overseas, often to China. It is particularly acute for older workers who lost their jobs when nearing retirement age, and those workers whose job skills have become obsolete, or are no longer in demand. There is also the unprecedented phenomenon of a growing number of younger workers, including recent college graduates, who cannot find employment commensurate with their training and skills.




To help them through this difficult period in their lives, the federal government has repeatedly extended unemployment benefits in hard hit job markets to as long as two years. For many of these workers, unemployment benefits are not nearly enough for them and their families to maintain their prior standards of living. Even after drastically economizing on their household expenses, many do not have enough income to make ends meet.


There are now many workers who have been out of work so long that they exhausted their two years of eligibility for unemployment benefits.


Those fortunate enough to have retirement accounts have been forced to dip into those savings, and, in many cases, wipe them out completely. Those who do not have those resources have had to take more drastic measures. Many younger workers and their families have been forced to abandon their own homes and move in with their parents. Others have had to seek help from charities, such as local food banks which have reported a record demand from families made destitute by the unemployment of their breadwinners.




The economic crisis in the lives of millions of American families, and its full extent has been revealed by a shocking statistic.


According to a private study by two former Census Bureau employees, between June 2009, when the recession officially ended, and June 2011, the inflation-adjusted median US household income fell by 6.7 percent, to $49,909. That is more than twice as much as the 3.2 percent that median income fell during the recession from December 2007 to June 2009.


The full 9.8 percent drop in family income from the December 2007 to this past June, is the largest in several decades, and according to the authors of the study, represent “a significant reduction in the American standard of living” over that period.


During that period, the number of people who were not working or who dropped out of the US labor force has risen; while the hourly pay of those who do have jobs has failed to keep pace with inflation, including sharp increases in the prices of gasoline and many basic food products.


By contrast, during the 18 months of the recession itself, hourly wage gains actually outpaced inflation.


Another contributing factor to the decline in family income is that many of the workers who have changed jobs during the period had to take a cut in pay in order to get their new job. According to a study by Henry Farber, a Princeton University economist, workers who lost their jobs during the recession and have since been rehired are making an average of 17.5 percent less than they did before.




Farber told the New York Times that this is why he feels the current economic period is “fundamentally different” from all other post World War II recessions and recoveries. In fact, he says “ I do not think the recession has ended. Job losers are having more trouble than ever before finding full-time jobs.”


These statistics help to explain why so many Americans agree with Farber and are convinced that the recession never ended, because judging by their particular economic circumstances, it didn’t. It also explains why so many voters have grown so bitter and angry at the inaction of their elected political leaders to respond effectively to the very real economic crisis impacting their lives every day.


The jobs reports in recent months also show that the government employment sector has been a big part of the problem, rather than a solution. For example, in September, state and local governments struggling with their own budget deficits, due in part to reduced collections of real estate taxes since the US housing bubble burst, eliminated another 35,000 jobs, and the federal government owned US Postal Service cut 5,000 jobs. Here, too, there is no relief in sight. Most state and local governments are still projecting budget deficits for their next fiscal year, which means that the job cuts will continue. Due to the widespread substitution of email and text messages for “snail mail,” the US Postal Service is now facing a major reduction in the volume of first class mail, resulting in billions of dollars in operating losses over the next few years. This has prompted plans to close hundreds of local post offices around the country and stop Saturday delivery service, eliminating the jobs of tens of thousands more postal workers.




While the jobs picture remains bleak, economists still take some solace in the fact that many sectors of the US economy are growing, and corporate profits are up. Unfortunately, because of the uncertain financial outlook, and the generally anti-business policies and attitudes of the Obama administration, US business leaders have been reluctant to re-invest those profits to create more new jobs.


However, looking at the US economy in isolation, it is possible that if general business activity picks up further in coming months, the most lagging sectors, such as housing, could finally bottom out and start to come around.


Unfortunately, the US economy is not in isolation. Its financial institutions remain threatened by the European debt crisis, which means that US business and investor confidence is unlikely to be restored before that crisis is resolved.




In a lengthy recent interview on the CNBC business channel, Alan Greenspan said that such a resolution will require a major debt restructuring, and that it is not clear that European leaders can accomplish that in the time available.


“I think it’s very dangerous,” Greenspan said in the interview, emphasizing that he believes that the threat of “contagion” from the sovereign debt crisis in Europe is “real and substantial.”


Greenspan explained that while the direct level of exposure by US banks to European sovereign debt is not high, he doubts that US banks and markets could survive a collapse of their European counterparts.


“This is an integrated system. The presumption that somehow the huge American banking system…is independent of Europe is, I think, just utterly unrealistic,” Greenspan said.


Greenspan cites rising productivity as one of several signs that the US economy is improving, albeit too slowly. But he insists that as long as Europe fails to solve its sovereign debt problems, the US recovery remains in jeopardy.




He sees no alternative to a restructuring of Greek debt, with current Greek bondholders, including the European banks, forced to accept a substantial reduction in the amount of principal they will recover when the bonds are redeemed.


But he is not optimistic that European leaders can solve Greece’s bond problem before it is forced into default. “The issue is one where [I think we must ask], are they broke? Yeah, I think they’re broke. Are they going to resolve the issue? In and of themselves I can’t see how.”


“Anyone who thinks that isn’t the case and that it won’t affect the US in a substantial way isn’t facing reality,” he said.


“If Europe wasn’t out there…we [the US] would not be having the threat to our overall economy,” Greenspan said. “The size of the problem coming from Europe – I don’t think it could be overestimated. Economists who feel comfortable [that] they can split the effects of Europe from the rest of the forces that generally impact the United States, haven’t been around very long, I’m afraid.”




Writing in the British publication, the Financial Times, Greenspan said that, “the euro zone is likely to need political unification to bridge the differences between the profligate south and the prudent north in order to save the euro. . . It may be that nothing short of a politically united euro zone, or Europe, will, in the end, be seen as the only way to embrace the valued single currency.”


Greenspan argues that the basic problem goes beyond just debt to the underlying differences between the informal culture of Southern Europe, typified by Greece, and the much more disciplined culture in Northern Europe, typified by Germany.


Greenspan says that since the euro was created in 1999, there has been a net transfer of goods and services from the north to the south of the continent, with northern Europe effectively “subsidizing southern European consumption.”


He noted that the northern states, historically, had high savings rates and low inflation, because their culture emphasizes long-term investment over consumption, while Greece has had a negative saving rate and excess consumption since 2003.


Greenspan concludes that Europe’s current financial problems have been generated by this culture clash. It also means that the euro zone will never achieve long term economic stability until all of the countries which use the euro adopt the same underlying attitudes and controls for spending, consumption, saving and investment.


The Washington Post and Bloomberg News contributed to this story



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