Recession and Depression

Posted by PITHOCRATES - June 25th, 2012

Economics 101

A Depression is an Exceptionally Bad Recession 

When campaigning for the presidency Ronald Reagan explained what a recession, a depression and a recovery were.  He said a recession is when your neighbor loses his job.  A depression is when you lose your job.  And a recovery is when Jimmy Carter loses his job.  This was during the 1980 presidential election.  Where Reagan included that famous question at the end of one of the debates.  “Are you better off now than you were four years ago?”  And the answer was “no.”  Ronald Reagan surged ahead of Jimmy Carter after that and won by a landslide.  And he won reelection by an even bigger landslide in 1984.

There are a couple of ways to define a recession.  Falling output and rising unemployment.  Two consecutive quarters of falling Gross Domestic Product (GDP).  A decline in new factory orders.  The National Bureau of Economic Research (NBER) in Cambridge, Massachusetts, officially marks the start and end dates of all U.S. recessions.  They consider a lot of economic data.   It’s not an exact science.  But they track the business cycle.  That normal economic cycle between economic expansion and economic contraction.  The business cycle has peaks (expansion) and troughs (contraction).  A recession is the time period between a peak and a trough.  From the time everyone is working and happy and buying a lot of stuff.  Through a period of layoffs where people stop buying much of anything.  Until the last layoff before the next economic expansion begins.

A depression has an even more vague science behind it.  We really don’t have a set of requirements that the economy has to meet to tell us we’re in a depression.  Since the Great Depression we haven’t really used the word anymore for a depression is just thought of as an exceptionally bad recession.  Some have called the current recession (kicked off by the subprime mortgage crisis) a depression.  Because it has a lot of the things the Great Depression had.  Bank failures.  Liquidity crises.  A long period of high unemployment.  In fact, current U.S unemployment is close to Great Depression unemployment if you measure more apples to apples and use the U-6 rate instead of the official U-3 rate that subtracts a lot of people from the equation (people who can’t find work and have given up looking, people working part-time because they can’t find a full-time job, people underemployed working well below their skill level, etc.).  For these reasons many call the current recession the Great Recession.  To connect it to the Great Depression.  Without calling the current recession a depression.

Whether Inventories sell or not Businesses have to Pay their People and their Payroll Taxes

So what causes a recession?  Good economic times.  Funny, isn’t it?  It’s the good times that cause the bad times.  Here’s how.  When everyone has a job who wants a job a lot of people are spending money in the economy.  Creating a lot of economic activity.  Businesses respond to this.  They increase production.  Even boost the inventories they carry so they don’t miss out on these good times.  For the last thing a business wants is to run out of their hot selling merchandise when people are buying like there is no tomorrow.  Businesses will ramp up production.  Add overtime such as running production an extra day of the week.  Perhaps extend the working day.  Businesses will do everything to max out their production with their current labor force.  Because expanding that labor force will cause big problems when the bloom is off of the economic rose.

But if the economic good times look like they will last businesses will hire new workers.  Driving up labor costs as businesses have to pay more to hire workers in a tight labor market.  These new workers will work a second shift.  A third shift.  They will fill a manufacturing plant expansion.  Or fill a new plant.  (Built by a booming construction industry.  Just as construction workers are building new houses in a booming home industry.)  Businesses will make these costly investments to meet the booming demand during an economic expansion.  Increasing their costs.  Which increases their prices.  And as businesses do this throughout the economy they begin to produce even more than the people are buying.  Inventories begin to build up until inventories are growing faster than sales.  The business cycle has peaked.  And the economic decline begins.

Inventories are costly.  They produce no revenue.  But incur cost to warehouse them.  Worse, businesses spent a lot of money producing these inventories.  Or I should say credit.  Typically manufacturers buy things and pay for them later.  Their accounts payable.  Which are someone else’s accounts receivable.  A lot of bills coming due.  And a lot of invoices going past due.  Because businesses have their money tied up in those inventories.  But one thing they can’t owe money on is payroll.  Whether those inventories sell or not they have to pay their people on time or face some harsh legal penalties.  And they have to pay their payroll taxes (Social Security, Medicare, unemployment insurance, withholding taxes, etc.) for the same reasons.  As well as their Workers’ Compensation insurance.  And they have to pay their health care insurance.  Labor is costly.  And there is no flexibility in paying it while you’re waiting for that inventory to sell.  This is why businesses are reluctant to add new labor and only do so when there is no other way to keep up with demand.

The Fed tries to Remove the Recessionary Side of the Business Cycle with Small but ‘Manageable’ Inflation

As sales dry up businesses reduce their prices to unload that inventory.  To convert that inventory into cash so they can pay their bills.  At the same time they are cutting back on production.  With sales down they are only losing money by building up inventories of stuff no one is buying.  Which means layoffs.  They idle their third shifts.  Their second shifts.  Their overtime.  They shut down plants.  A lot of people lose jobs.  Sales fall.  And prices fall.  As businesses try to reduce their inventories.  And stay in business by enticing the fewer people in the market place to buy their reduced production at lower prices.

During the economic expansion costs increased.  Labor costs increased.  And prices increased.  Because demand was greater than supply.  Businesses incurred these higher costs to meet that demand.  During the contraction these had to fall.  Because supply exceeded demand.  Buyers could and did shop around for the lowest price.  Without fear of anything running out of stock and not being there to buy the next day.  Or the next week.  And when prices stop falling it marks the end of the recession and the beginning of the next expansion.  When supply equals demand once again.  Prices, then, are key to the business cycle.  They rise during boom times.  And fall during contractions.  And when they stop falling the recession is over.  This is so important that I will say it again.  When prices stop falling a recession is over.

Jimmy Carter had such a bad economy because his administration still followed Keynesian economic policies.  Which tried to massage the business cycle by removing the contraction side of it.  By using monetary policy.  The Keynesians believed that whenever the economy starts to go into recession all the government has to do is to print money and spend it.  And the government printed a lot of money in the Seventies.  So much that there was double digit inflation.  But all this new money did was raise prices during a recession.  Which only made the recession worse.  This was the turning point in Keynesian economics.  And the end of highly inflationary policies.  But not the end of inflationary policies.

The Federal Reserve (the Fed) still tries to remove the recessionary side of the business cycle.  And they still use monetary policy to do it.  With a smaller but ‘manageable’ amount of inflation.  During the great housing bubble that preceded the subprime mortgage crisis and the Great Recession the Fed kept expanding the money supply to keep interest rates very low.  This kept mortgage rates low.  People borrowed money and bought big houses.  Housing prices soared.  These artificially low interest rates created a huge housing bubble that eventually popped.  And because the prices were so high the recession would be a long one to bring them back down.  Which is why many call the current recession the Great Recession.  Because we haven’t seen a price deflation like this since the Great Depression.

www.PITHOCRATES.com

Share

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

Scott Walker turns Deficit into Surplus without any Layoffs while Los Angeles Furloughs Teachers

Posted by PITHOCRATES - June 10th, 2012

Week in Review

Los Angeles turns to furloughs to delay layoffs.  Betting everything on yet another tax increase this November (see Los Angeles teachers and school district reach pact to spare jobs by Howard Blume posted 6/9/2012 on the Los Angeles Times).

The Los Angeles school district and the teachers union reached a tentative agreement Friday that would prevent thousands of layoffs in exchange for 10 furlough days, which would shorten the school year by a week.

Under the accord, teachers would lose pay for five instructional days plus four holidays and one training day, equivalent to about a 5% salary cut…

If voters turn down a tax increase for schools, L.A. Unified’s budget woes would worsen considerably, the superintendent said. The equivalent of three additional weeks of school would have to be sacrificed, Deasy said. A typical school year is 180 days…

If the governor’s tax initiative passes, union officials said any additional money must go toward reducing the number of furlough days. And if teachers take the furlough days and the district ends up with a year-end surplus, teachers would be reimbursed for the pay cut, the union said.

More than 9,000 teachers had faced being laid off as of June 30…

This year’s crisis followed a familiar recession-era pattern. In 2008, the district closed a $427-million deficit; in 2009, $838 million; in 2010, $620 million; in 2011, $408 million. In all nearly 8,000 employees were laid off over the last four years; many teachers have since been rehired or used as substitutes.

Scott Walker didn’t furlough or lay off any teachers in Wisconsin.  They all kept their jobs by pitching in a little more for their benefits.  Amazing how just that can turn a deficit into a surplus.

This brings us to what’s missing in this article.  Pensions and health care benefits.  Which have to be the reason for all of those deficits.  Because public sector pensions and health care benefits are busting budgets in cities and states throughout the nation.  Especially for those retirees.  Which is why in the private sector people don’t get pensions anymore.  They save for their retirement in a 401(k).  And pay a large portion of their health care benefits.  An alien concept to those in the public sector.  But one they will soon learn.  Because the people are tired of sacrificing their lives to pay more taxes to support a privileged class who can retire earlier.  And enjoy more generous benefits in their retirement while they work well into their 60s to pay for it.

www.PITHOCRATES.com

Share

Tags: , , , , , , , , , , , ,

Obama Says Judge him on his Dismal Keynesian Economic Record

Posted by PITHOCRATES - August 21st, 2011

Are you Better Off than you were 4 Years Ago?

People who live in economic houses made of cards shouldn’t blow too hard.  Or boast about future successes (see Obama: Judge me on economic progress by Richard Wolf posted 8/21/2011 on USA TODAY).

“Things would have been much worse has we not made those decisions, (but) that’s not that satisfying if you don’t have a job right now. And I understand that, and I expect to be judged a year from now on whether or not things have continued to get better.”

You shouldn’t boast about a successful track record before you have one.  That could come back to haunt you at the next election.  I mean, when your last three years or so in office haven’t been successful economically, why would you think year 4 would be any better?  In fact, the odds are good that someone will Ronald Reagan you if current trends continue.  When that candidate will ask the people, “Are you better off than you were 4 years ago?”

Businesses never, ever hire New Employees while the Economic Outlook is so Dismal

If the judges are American businesses their verdict is already in (see Moody’s chief economist: Lawmakers need to ‘get it together’ to save economy by Meghashyam Mali posted 8/21/2011 on The Hill).

Zandi pointed to positive signs for American businesses. They are “getting their cost structures down, getting their profitability up, getting their balance sheets in order,” he said.

While businesses are still reluctant to start hiring new workers, they had little reason to layoff employees, a sign we would avoid a second recession according to Zandi.

They’re doing things now that a business does during bad economic times.  Cut costs.  Increase productivity.  Avoid new debt.  Stockpile cash.  And never, ever hire new employees while the economic outlook is so dismal.

The Nice Thing about Bonuses is that you can pay your People Less 

And the bad jobs outlook isn’t just on Main Street America.  It goes all the way up to the fat cats on Wall Street (see Layoffs sweep Wall Street, along with low morale by Lauren Tara LaCapra posted 8/21/2011 on Reuters).

The planned cuts at Bank of America have pushed the number of financial sector layoffs this year to 18,252 — 6 percent higher than in the comparable period in 2010, according to Challenger, Gray & Christmas, an outplacement firm that keeps a daily tab on layoff announcements.

Some companies began the culling earlier this year — HSBC has already axed about 5,000 employees, with 25,000 more set to get pink slips by the end of 2012 — and others, such as Goldman Sachs, said that cuts will come by year’s end.

Even the Wall Street bailouts couldn’t save Wall Street.  Or all that quantitative easing.  The economy is tanking some three years later despite all of Obama‘s best efforts to stimulate a recovery.  In fact, it turns out that their best efforts are complicit in these Wall Street purges.

Changes in pay structures mandated in part by the Dodd-Frank financial reform laws have exacerbated the problem.

Banks that used to pay modest base salaries supplemented by opulent stock-and-option packages that encouraged meeting short-term performance goals now are weighting compensation toward base salary…

The shift erodes Wall Street’s former flexibility to lower end-of-year bonuses in bad times and forces a heavier reliance on layoffs.

The nice thing about bonuses is that you can pay your people less.  If you have a bad year, you don’t have to lay off your employees.  You just cut year-end bonuses.  Their base salaries are more than enough to live on.  And they are tickled pink to still have a job after a bad year.  Of course, when you remove bonuses from the picture that only leaves one way to cut costs to reflect declining business.  You have to cut people.  Which is never a good thing in a ‘relationship’ business.

It’s hard to build a level of trust and confidence in a relationship.  And the higher the dollar amounts the harder it is to build that trust and confidence.  It’s scary letting other people into your balance sheet.  Once you do you don’t want to see that person leave.  Because you don’t deal with a bank.  You deal with a person.  That person.  And when they leave there’s nothing but more uncertainty in an already uncertain economic climate.

Keynesian Economics was always about the Growth of Government

So it looks like the chances are good President Obama may get that question next year.  Because indications are that it won’t be better than when he took office in 2009 (see Mises on the Business Cycle by Dennis Sperduto posted 8/21/2011 on Ludwig von Mises Institute).

The economic and financial events of the last few weeks indicate that the economies of the United States and most of Europe remain quite weak, if not in outright recession. This situation comes after unprecedented fiscal and monetary “stimuli” by many governments that were strongly supported and recommended by the large majority of the economics profession, media commentators, and politicians. And of course, with economic conditions showing renewed weakness, the mainstream calls for additional stimuli of even larger magnitudes. The mainstream is unable or unwilling to abandon its Keynesian foundation, a system of thought that has been shown by many individuals associated with the Austrian School to be one of the great retrogressions in scientific economic thought in modern times.

Obama is a Keynesian.  His administration has adopted Keynesian policies.  And all of their Keynesian policies have failed thus far.  No matter how they try, try and try again, they will always fail, fail and fail again.  For Keynesian economics was never about economics.  Not to those in government.  For them it was always about the growth of government. 

Recessions never End because of Keynesian Stimulus, they End Despite Keynesian Stimulus

But the one flaw in their grand design is that the private sector funds everything.  Economic activity.  And government.  So the more government grows, the more wealth is transferred from the private sector to fund it.  Meaning that if the government grows the private sector must shrink.  For here it is simple zero-sum.  Which is why recessions never end because of Keynesian stimulus.  They end despite Keynesian stimulus.

So if the Obama administration moves forward with more of the same it should make the 2012 election come down to a simple question.  Are you better off than you were 4 years ago?  Even Obama is admitting that if things don’t improve over the next year he will be a one-term president.  And right now there’s nothing in the economic forecast that bodes well for a second term.  If he’s judged for his economic performance.  Which he is telling the voters to do in 2012.  As I’m sure they will be more than happy to oblige.

www.PITHOCRATES.com

Share

Tags: , , , , , , , , , , , , , , , , , , , ,

FUNDAMENTAL TRUTH #27: “Yes, it’s the economy, but the economy is not JUST monetary policy, stupid.” -Old Pithy

Posted by PITHOCRATES - August 17th, 2010

DURING UNCERTAIN ECONOMIC times, people act differently.  If business is down where you work, your company may start laying off people.  Your friends and co-workers.  Even you.  If there is a round of layoffs and you survive, you should feel good but don’t.  Because it could have been you.  And very well can be you.  Next time.  Within a year.  In the next few months.  Any time.  You just don’t know.  And it isn’t a good feeling.

So, should this be you, what do you do?  Run up those credit cards?  By a new car?  Go on a vacation?  Take out a home equity loan to pay for new windows?  To remodel the kitchen?  Buy a hot tub?  Or do you cut back on your spending and start hoarding cash?  Just in case.  Because those unemployment payments may not be enough to pay for your house payment, your property taxes, your car payment, your insurances, your utilities, your groceries, your cable bill, etc.  And another loan payment won’t help.  So, no.  You don’t run up those credit cards.  Buy that car.  You don’t go on vacation.  And you don’t take that home equity loan.  Instead, you hunker down.  Sacrifice.  Ride it out.  Prepare for the worse.  Hoard your cash.  Enough to carry you through a few months of unemployment.  And shred those pre-approved credit card offers.  Even at those ridiculously low, introductory interest rates.

To help hammer home this point, you think of your friends who lost their jobs.  Who are behind on their mortgages.  Who are in foreclosure.  Whose financial hardships are stressing them out to no ends.  Suffering depression.  Harassed by collection agencies.  Feeling helpless.  Not knowing what to do because their financial problems are just so great.  About to lose everything they’ve worked for.  No.  You will not be in their position.  If you can help it.  If it’s not already too late.

AND SO IT is with businesses.  People who run businesses are, after all, people.  Just like you.  During uncertain economic times, they, too, hunker down.  When sales go down, they have less cash to pay for the cost of those sales.  As well as the overhead.  And their customers are having the same problems.  So they pay their bills slower.  Trying to hoard cash.  Receivables grow from 30 to 45 to 90 days.  So you delay paying as many of your bills as possible.  Trying to hoard cash.  But try as you might, your working capital is rapidly disappearing.  Manufacturers see their inventories swell.  And storing and protecting these inventories costs money.  Soon they must cut back on production.  Lay off people.  Idle machinery.  Most of which was financed by debt.  Which you still have to service.  Or you sell some of those now nonproductive assets.  So you can retire some of that debt.  But cost cutting can only take you so far.  And if you cut too much, what are you going to do when the economy turns around?  If it turns around?

You can borrow money.  But what good is that going to do?  Add debt, for one.  Which won’t help much.  You might be able to pay some bills, but you still have to pay back that borrowed money.  And you need sales revenue for that.  If you think this is only a momentary downturn and sales will return, you could borrow and feel somewhat confidant that you’ll be able to repay your loan.  But you don’t have the sales now.  And the future doesn’t look bright.  Your customers are all going through what you’re going through.  Not a confidence builder.  So you’re reluctant to borrow.  Unless you really, really have to.  And if you really, really have to, it’s probably because you’re in some really, really bad financial trouble.  Just what a banker wants to see in a prospective borrower.

Well, not really.  In fact, it’s the exact opposite.  A banker will want to avoid you as if you had the plague.  Besides, the banks are in the same economy as you are.  They have their finger on the pulse of the economy.  They know how bad things really are.  Some of their customers are paying slowly.  A bad omen of things to come.  Which is making them really, really nervous.  And really, really reluctant to make new loans.  They, too, want to hoard cash.  Because in bad economic times, people default on loans.  Enough of them default and the bank will have to scramble to sell securities, recall loans and/or borrow money themselves to meet the demands of their depositors.  And if their timing is off, if the depositors demand more of their money then they have on hand, the bank will fail.  And all the money they created via fractional reserve banking will disappear.  Making money even scarcer and harder to borrow.  You see, banking people are, after all, just people.  And like you, and the business people they serve, they, too, hunker down during bad economic times.  Hoping to ride out the bad times.  And to survive.  With a minimum of carnage. 

For these reasons, businesses and bankers hoard cash during uncertain economic times.  For if there is one thing that spooks businesses and banks more than too much debt it’s uncertainty.  Uncertainty about when a recession will end.  Uncertainty about the cost of healthcare.  Uncertainty about changes to the tax code.  Uncertainty about new government regulations.  Uncertainty about new government mandates.  Uncertainty about retroactive tax changes.  Uncertainty about previous tax cuts that they may repeal.  Uncertainty about monetary policy.  Uncertainty about fiscal policy.  All these uncertainties can result with large, unexpected cash expenditures at some time in the not so distant future.  Or severely reduce the purchasing power of their customers.  When this uncertainty is high during bad economic times, businesses typically circle the wagons.  Hoard more cash.  Go into survival mode.  Hold the line.  And one thing they do NOT do is add additional debt.

DEBT IS A funny thing.  You can lay off people.  You can cut benefits.  You can sell assets for cash.  You can sell assets and lease them back (to get rid of the debt while keeping the use of the asset).  You can factor your receivables (sell your receivables at a discount to a 3rd party to collect).  You can do a lot of things with your assets and costs.  But that debt is still there.  As are those interest payments.  Until you pay it off.  Or file bankruptcy.  And if you default on that debt, good luck.  Because you’ll need it.  You may be dependent on profitable operations for the indefinite future as few will want to loan to a debt defaulter.

Profitable operations.  Yes, that’s the key to success.  So how do you get it?  Profitable operations?  From sales revenue.  Sales are everything.  Have enough of them and there’s no problem you can’t solve.  Cash may be king, but sales are the life blood pumping through the king’s body.  Sales give business life.  Cash is important but it is finite.  You spend it and it’s gone.  If you don’t replenish it, you can’t spend anymore.  And that’s what sales do.  It gets you profitable operations.  Which replenishes your cash.  Which lets you pay your bills.  And service your debt.

And this is what government doesn’t understand.  When it comes to business and the economy, they think it’s all about the cash.  That it doesn’t have anything to do with the horrible things they’re doing with fiscal policy.  The tax and spend stuff.  When they kill an economy with their oppressive tax and regulatory policies, they think “Hmmm.  Interest rates must be too high.”  Because their tax and spending sure couldn’t have crashed the economy.  That stuff is stimulative.  Because their god said so.  And that god is, of course, John Maynard Keynes.  And his demand-side Keynesian economic policies.  If it were possible, those in government would have sex with these economic policies.  Why?   Because they empower government.  It gives government control over the economy.  And us.

And that control extends to monetary policy.  Control of the money supply and interest rates.  The theory goes that you stimulate economic activity by making money easier to borrow.  So businesses borrow more.  Create more jobs.  Which creates more tax receipts.  Which the government can spend.  It’s like a magical elixir.  Interest rates.  Cheap money.  Just keep interest rates low and money cheap and plentiful and business will do what it is that they do.  They don’t understand that part.  And they don’t care.  They just know that it brings in more tax money for them to spend.  And they really like that part.  The spending.  Sure, it can be inflationary, but what’s a little inflation in the quest for ‘full employment’?  Especially when it gives you money and power?  And a permanent underclass who is now dependent on your spending.  Whose vote you can always count on.  And when the economy tanks a little, all you need is a little more of that magical elixir.  And it will make everything all better.  So you can spend some more.

But it doesn’t work in practice.  At least, it hasn’t yet.  Because the economy is more than monetary policy.  Yes, cash is important.  But making money cheaper to borrow doesn’t mean people will borrow money.  Homeowners may borrow ‘cheap’ money to refinance higher-interest mortgages, but they aren’t going to take on additional debt to spend more.  Not until they feel secure in their jobs.  Likewise, businesses may borrow ‘cheap’ money to refinance higher-interest debt.  But they are not going to add additional debt to expand production.  Not until they see some stability in the market and stronger sales.  A more favorable tax and regulatory environment.  That is, a favorable business climate.  And until they do, they won’t create new jobs.  No matter how cheap money is to borrow.  They’ll dig in.  Hold the line.  And try to survive until better times.

NOT ONLY WILL people and businesses be reluctant to borrow, so will banks be reluctant to lend.  Especially with a lot of businesses out there looking a little ‘iffy’ who may still default on their loans.  Instead, they’ll beef up their reserves.  Instead of lending, they’ll buy liquid financial assets.  Sit on cash.  Earn less.  Just in case.  Dig in.  Hold the line.  And try to survive until better times.

Of course, the Keynesians don’t factor these things into their little formulae and models.  They just stamp their feet and pout.  They’ve done their part.  Now it’s up to the greedy bankers and businessmen to do theirs.  To engage in lending.  To create jobs.  To build things.  That no one is buying.  Because no one is confident in keeping their job.  Because the business climate is still poor.  Despite there being cheap money to borrow.

The problem with Keynesians, of course, is that they don’t understand business.  They’re macroeconomists.  They trade in theory.  Not reality.  When their theory fails, it’s not the theory.  It’s the application of the theory.  Or a greedy businessman.  Or banker.  It’s never their own stupidity.  No matter how many times they get it wrong.

www.PITHOCRATES.com

Share

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,