The Real Crisis is Unemployment

Jul 11, 2011Marshall Auerback

A deal on the debt ceiling of the kind proposed by both parties will only make the jobs crisis worse -- and push deficits up.

"O, the heart's blood of a patriot! That's a fellow now that'd sell his country for fourpence-ay-and go down on his bended knees and thank the Almighty Christ he had a country to sell." - Irish proverb

We had a horrendous employment number last Friday. Leaving aside the headline details, (which showed unemployment rising from 9.1% to 9.2%), the household measure of employment fell by 445,000.

Okay, it's just one number. But this measure of employment, which is never revised, now shows no employment growth over the last five months and very negative employment growth over the last three.

But it gets worse: The work week was down one tenth. Overtime was down one tenth. The labor participation rate at 64.1% was the lowest since 1984. The broad U6 unemployment rate rose from 15.8% to 16.2%. In other words, several other employment indicators in this report confirm the deep disappointment in the payroll series and the much more negative message of the household series.

And the President's response to this disaster: Get a deal done on the debt ceiling!

"The sooner we get this done, the sooner that the markets know that the debt limit ceiling will have been raised and that we have a serious plan to deal with our debt and deficit, the sooner that we give our businesses the certainty that will need in order to make additional investments to grow and hire," Obama said.

He made his remarks just hours after the latest employment report was released.

And when they agree to the deficit cuts, then unemployment will fall...and I'll go on a diet by eating a bunch of Super Sized Big Macs.

Here's the problem: Nobody in Washington DC seems to understand that today's crisis of unemployment is all about a lack of effective demand in the US economy. The persistently high unemployment is about a lack of jobs, nothing more. It has nothing to do with the uncertainty over the debt ceiling negotiations, except to the extent that any future deal, which features the cuts mooted by both parties in the press, will create an even greater shortage of spending power in the economy. Furthermore, as Bill Mitchell has argued, "the financial nature of the crisis...means that any revival of private spending will be slow to return. So private firms and households are first of all going to try to reduce their debt levels to restore some security to their balance sheets."

This isn't your run of the mill recession; it's Japan's "balance sheet recession" writ large.

Yet President Obama maintains that cutting spending will somehow induce the private sector to invest and help reduce unemployment. He's wrong. A deal on the debt ceiling, of the kind that is being proposed by both parties, actually makes it much harder for the private sector to achieve this goal.

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To recap, a government deficit generates a net injection of disposable income into the private sector, generating an increase in its saving and wealth which can be held either in the form of government liabilities (cash or treasuries) or non-interest earning bank liabilities (bank deposits). If the nonbank public prefers bank deposits, then banks will hold an equivalent quantity of reserves, cash, and treasuries with the distribution among these government IOUs depending on bank preferences. By contrast, a government budget surplus has exactly the opposite effect on private sector incomes and wealth: As the government takes more from the public in taxes than it gives in its spending, this results in a net debit of bank reserves and reduction in outstanding cash balances held by the private sector. In other words, it drains wealth from the private sector.

Firms will only employ if there are sufficient spending to purchase the output that the workers produce. 9.2% unemployment and 16.2% underemployment is clear evidence that the demand deficiency which emerged after the Great Financial Crisis of 2008 is far from over. This problem existed well before anybody even spoke about the debt ceiling, let alone started negotiating another increase. Far from solving this scourge, the Administration's own proposals will exacerbate unemployment and almost certainly cause the government deficits to rise even further.

The President has his causation completely reversed: A growing economy, characterized by rising employment, rising incomes and rising capacity utilization causes the deficit to shrink, not the other way around. Rising prosperity means rising tax revenues and reduced social welfare payments. Cutting budget deficits when there is slack private spending growth and external deficits -- as the President and his Congressional negotiators are now proposing -- will erode growth and destroy net jobs.

There is zero evidence to support the idea that a nation which cuts public spending in situations where there is high unemployment and huge underutilized resources will grow and create jobs. The ongoing economic disaster in Europe illustrates precisely the opposite phenomenon.

But, hey, what's the worry? I'm sure the Administration's spin-meisters will simply argue that it's just a few headwinds (the "bump in the road" is SO yesterday). In the meantime, just to be on the safe side, the President appears open to cuts in Social Security (which today contributes zero to the budget deficit). Why? Because it will show "the markets" that we are "being responsible" about our deficit "problems", which in turn will do wonders to restore confidence and get us out of the ditch in which most Americans now find themselves (to use one of the President's favorite metaphors).

Almost since the days of his inauguration, Barack Obama has talked a lot about digging the American economy out of the ditch which he inherited from the previous Administration. But he should bear in mind the old expression: when you're in a hole, stop digging. The Democrats are now posing as the party of fiscal austerity, offering up cuts in entitlements if only those "irresponsible" Republicans would agree to tax increases (which will further deflate the economy into the ground). And we have much of the mainstream press praising the President for his "grown-up, statesmanlike" behaviour, as he tries to out-Hoover everybody. The grim examples accelerating across Europe appear to mean nothing. And to what end? The deficits will only get larger if cuts and tax rises of the magnitude contemplated by the President become law.

If the President and his team persist with his current ruinous deficit reduction fixation, they will turn that ditch into which the US economy has fallen into a coffin. At that point, the only people who will be celebrating any "achievement" over a debt ceiling deal will be the GOP hopefuls in the 2012 election.

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

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