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Economic Recovery: Fiscal Policy and Consumer Income are the Issues
Earnings season is in full swing. Corporate earnings are responding positively with an average 35% year-over-year gain. With such good results, why is there still cautious optimism when CEOs are queried about future guidance? Balance sheets are awash with cash, some $2 trillion worth, but businesses are hesitant to invest in productive capacity and increase domestic hiring. Many economists and journalists are hearkening back to the Great Depression to find similar conditions that would explain the current economic sluggishness.
One economist, who has studied recessions and depressions first hand, is Richard Koo, the chief economist of the Nomura Research Institute in Tokyo. He has the reputation of being the most reliable economist in Asia, has served with our Fed, and has published many studies supporting his notion of a “Balance Sheet Recession”. The leading economists of the world have reviewed his works with favor, and his theories may explain our current economic situation.
According to his theory, a Balance Sheet Recession only occurs every third or fourth generation. Mr. Koo’s process begins with the bursting of a debt-financed asset bubble, leaving private sector balance sheets in shambles. Corporations move immediately to repair their credit ratings, favoring debt minimization to profit maximization. In this phase, no one is borrowing. Monetary policy is futile because banks cannot lend when there are no borrowers, especially creditworthy ones by their standards. Aggregate economic demand drops by the amount of consumer savings and business debt repayments. Fiscal policy must fill the vacuum to maintain stability. The economy becomes sluggish until balance sheets are repaired and borrowing recommences, leading once again to a self-sustaining economy.
Our present economy seems stuck in a similar “gear” at the moment. Consumer confidence is not high enough to encourage business to produce. Uncertainty over new government regulations and incentives is another common excuse given. Mr. Koo’s current solution is to continue federal stimulus or risk stalling the recovery, but the political climate is such that additional government spending is not a viable option. The response from our business leaders this quarter is that they will all be looking to Asia for future growth and demand for their products. Gradual hiring will ensue, but the majority will be overseas.
Our economy is often referred to as a consumer-driven, service-oriented economy. Stable growth rests on the backs of consumers and their ability to buy and support corporate output. Economists and talk show pundits alike seem to be ignoring the obvious “elephant in the room”, the issue of disposable personal income (DPI). There has been little growth in this figure for the past decade, to the full detriment of the housing and car industry in this country.
During the Great Depression, we were on the Gold Standard. The price of Gold was fixed, and general prices deflated to reflect their intrinsic value versus Gold. We are no longer on the Gold Standard. Richard Nixon ended that in 1971. Our currency floats, as do most global currencies, with relative values detailed by the latest forex software. True deflating prices are no longer a possibility to offset the lack of growth in disposable income. In point of fact, a recent chart surfaced that converted DPI to its equivalent in grams of Gold.
If increasing DPI is the present need, we appear to have a long way to go to right our ship. Outsourcing middle class jobs is the culprit. We can hope that these jobs will return, but without subsidies in place to encourage a reversal, the downward slope of the line in the chart will only exacerbate over time.
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