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U.S. Low Interest Rates and High Deficits Aren't Helping Jobs Growth

Interest-Rates / US Interest Rates Feb 08, 2011 - 06:39 AM GMT

By: Money_Morning

Interest-Rates

Best Financial Markets Analysis ArticleMartin Hutchinson writes: When the government released its latest jobs report last week, economists were initially cheered because it showed that the nation's unemployment level had dropped much more sharply than anyone expected.

But that cheer immediately turned into concern when the report also revealed that the U.S. economy created only 36,000 new jobs in January. That's so far below the norm for this stage of an economic recovery that it would take us 10 years to put back to work all the folks who have lost their jobs since 2007.


In short, it's going to take a decade - and probably more - for normalized job growth to return to the U.S. economy.

Something has gone very wrong with the U.S. job-creation machine. Economists have been trying to solve this puzzle for more than 30 years.

And we found the answer.

Doomed If You Do, Doomed If You Don't
Most investors are familiar with at least a paraphrased version of the observation made by George Santayana, the philosopher and writer who stated that "those who cannot remember the past are condemned to repeat it."

While we definitely want to avoid the mistakes of the past, there are also some lessons we should embrace - particularly given the anemic outlook for new-job growth this country is right now facing.

Indeed, if you want to see what should be happening right now, take a look at how the nation's economy rebounded from the 1982 recession - the last downturn that was as deep as this one.

In October 2009, the U.S. unemployment rate peaked at 10.1%. In the 15 months that have followed, the jobless rate has fallen to 9.0% and 930,000 jobs have been created.

On the other hand, during the 15 months that came after the U.S. jobless rate crested at 10.8% in November 1982, it fell by 3.0 percentage points to reach 7.8% and 4.712 million jobs were created.

In other words, the policies that were established as a result of the 1982 recession were five times as effective in creating new jobs as those that are currently being followed.

If you conduct a side-by-side comparison of the two sets of policies (1982 vs. today), there is one moderate similarity and two glaring differences.

The similarity is that, in both cases, the U.S. federal government was running a budget deficit that was described at the time as dangerous.

This time, however, the deficit has been much deeper, having twice peaked at about 10% of gross domestic product (GDP) - first in the 12 months through to September 2009 and again (projected) in the current year that ends in September 2011, with a slight dip in the year in between.

During the 1982-84 recession - in the fiscal year that ended in September 1983 - the budget deficit peaked at 6.3% of GDP. In any case, the resemblance between the two policies is close enough that excess fiscal "stimulus" is unlikely to have been responsible for the lack of job creation this time around.

Another possible explanation for the current lack of job creation is that this recession was preceded by a financial crisis. In their 2009 book "This Time is Different: Eight Centuries of Financial Folly," authors Kenneth Rogoff and Carmen M. Reinhart demonstrated that financial crashes cause recessions that are deeper and longer-lasting than the downturns that result from the normal ebb and flow of the economy.

Things Are Different This Time - Unfortunately
The financial crash that preceded it may explain the exceptional depth of this recession, but it certainly doesn't account for the pathetic job creation that we've seen since. Indeed, the aforementioned 5-1 job-creation ratio seems excessive for a financial crash that is already two years in the past.

And the earlier period was not without some major financial difficulties of its own. For instance, the 1980s saw the collapse of the First Pennsylvania Bank and the near-collapse of most of the savings-and-loan (S&L) industry, while 1984 saw the collapse of the giant Continental Illinois National Bank.

There are, however, two glaring differences between the policies being pursued now and those of the 1980s.

First and foremost, the budget deficits of the 1980s primarily reflected tax cuts reducing the marginal rate of tax on upper incomes. Today, however, they mostly represent "stimulus" spending and other public-sector commitments.

Then there's monetary policy. In the 1980s, monetary policy was exceptionally tight, with high real interest rates. Today, however, it is exceptionally loose, with short-term interest rates persistently below the inflation rate.

When examined closely, the gap between the fiscal policies of the 1980s and those of today may not have made much difference to the disparate employment outcomes.

Under current U.S. President Barack Obama, the additional federal spending certainly diverted resources into unproductive sectors.

In the early 1980s, starving the small-business sector helped finance the major defense buildup (which, as a former global merchant banker, I would argue was equally unproductive economically). And the 1981 tax cut was partially reversed in the following year. It seems unlikely that the moderate differences between the two eras' fiscal policies can have resulted in such a huge change in employment outcome.

With monetary policy, however, we are on firmer ground.

The Answer to an "Unsolved Mystery" - of 30 Years
In the early 1980s, interest rates were exceptionally high; today (at least since 2008), they have been exceptionally low.

On the other hand, productivity growth - which is actually labor productivity growth (as in the growth in output per man-hour) - is unexpectedly high today and was unexpectedly low in the early 1980s.

These two factors are connected.

Very high interest rates make capital expensive, and therefore divert resources into hiring more labor. As a result, those high rates produced faster job creation after the 1982 recession.

Conversely, the extremely low interest rates we see at present make capital very cheap, and therefore prompt businesses to invest in extra equipment. That helps companies save on labor costs, and helps boost corporate profits, but produces very sluggish job growth in the overall economy. (We saw fairly sluggish job growth in the post-2001 recovery, also.)

In short, what we've done here is to solve a mystery that has puzzled economists for 30 years.

The decline in productivity growth in the 1970s and 1980s was not due to any defect in economic policies, but simply to the high cost of money, which diverted resources from capital into labor.

Similarly, the cheap-money environment that's existed since 1995 - and particularly since 2008 - has produced an apparent spurt in productivity growth, as extra capital is used to save labor.

The result: The fast job growth that we saw after 1982 has been transformed into slow job growth today.

Back in 1984, Ronald W. Reagan ran for re-election on a platform of "Morning in America" - credible because of the huge job growth the country experienced in the preceding two years.

Today, unfortunately, the American worker must struggle through the economic equivalent of a "polar night" - a protracted stretch of darkness that seems like it's never going to end. But unlike the polar nights of Alaska, which last six months, workers are looking at an economic variant that will last for years.

That dismal outlook is the fault of the low-interest-rate policies of U.S. Federal Reserve Chairman Ben S. Bernanke. And until those policies change, there won't be a new dawn - and definitely very little sunshine - on the U.S. jobs front.

[Editor's Note: With such a dour outlook on the employment front, the "R" word - retirement - moves to the forefront as the single-biggest worry for most U.S. workers.

The problem is a simple one to understand - how long can you keep working, at your current (or even a higher) salary, so that you can save enough money to safely retire? With the U.S. deficit, the uncertain economic outlook, and companies looking to cut all the time, that's not an easy question to answer.

But there is another solution - just cut the amount of time that you require to amass your retirement nest egg.

In fact, cut it in half.

By doing so, you reduce your risk. And if you end up working longer than you'd planned, this new scenario will actually help you boost the size of your next egg.

That's all fine and dandy, you're no doubt asking by now: Just how do I cut in half the time that I need to save for retirement?

Find out by clicking here to read a report that details this strategy.]

Source : http://moneymorning.com/2011/02/08/z...

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