Thursday, June 4, 2009

Green Shoots, Red Ink, Black Holes by Eliot Spitzer

 have an unfortunate sense that the "green shoots" in the economy that everyone is talking about are nothing but dandelions. Sure, forcing $1 trillion of taxpayer money—in direct capital, guarantees, and diminished cost of borrowing—into the banking sector has permitted the major banks to claim solvency for the moment. Yet we should not forget that this solvency has come not through a much needed deleveraging of the banking sector but rather from a massive transfer of the obligations of private banks to the public, with the debt accruing to future generations. And overall loan quality at U.S. banks is still the worst in 25 years and deteriorating at the fastest pace ever.

It's a terrible mistake to confuse the momentary solvency of the financial sector and the long-term health of our economy.

While we have addressed the credit collapse, we have not begun to tackle the far more daunting, and more significant, structural problems in the economy. Instead of focusing on the green shoots, let's examine the macro data that will determine our national prosperity in the next generation. These data are terrifying.

Start with the job front. Long term, nothing is more fundamental than good jobs to creating the middle-class wealth that must drive the economy. The creation of true middle-class jobs was the great success of our economy from 1950s through the mid-1990s. Consider the job data, in aggregate and by sector, from the past decade. (All data are from the U.S. Department of Labor, Bureau of Labor Statistics.)

Unemployment Rate by Industry
YearUnemployment rateManufacturing Jobs 
(in millions)
Serv. JobsGov't. JobsTotal JobsPopulation

One-third of our manufacturing jobs have disappeared in a decade! And while population grew 12.1 percent over the decade, jobs grew by only 6.4 percent. The unemployment number, moreover, doesn't count those who are "marginally attached to the labor force," because even though they want to work and are available to do so, they have not sought a job in the past four weeks. In raw numbers, the total number of individuals counted as currently unemployed and those who are marginally attached is a staggering 15.8 million. That is an enormous mountain of job creation to climb.

This transition away from actual goods production is not merely a consequence of the current economic cataclysm. The trend line has been clear for years and is reflected in the overall escalation in the trade deficits we have incurred:

Aggregate Deficit/Goods/Services
YearAggregate Deficit 
(in millions of dollars )

The actual deficit in goods has multiplied fivefold in 15 years. The notion that service exports will somehow balance our increasing goods deficit has not been borne out and is increasingly less likely to be in the future, given that certain service sectors, such as financial services, are in sharp decline domestically. Moreover, the services we had expected to export are increasingly becoming sources of growth overseas. It is hard to believe that China will want or need to import U.S. investment banking services a decade (or a month) from now.

Even more dramatic than the growth of the trade deficit, of course, is the escalation of the federal budget deficit.

Annual Deficit/Aggregate Federal Debt
YearAnnual Deficit 
(in millions of dollars)
As Percent of GDPAggregate Federal Debt 
(in trillions of dollars)
As Percent of GDP

2009 [est]


The argument until now has been that the virtually unlimited appetite for American T-bills would permit us to issue this increasing debt without interest rates accelerating and the dollar suffering. Recent events have cast serious doubt on this assumption. The spread between two-year Treasury notes and 10-year notes is wider than it's ever been. And the Chinese government seems less and less enthusiastic about purchasing an unlimited supply of T-bills. (Has anyone wondered why we have said not a word about Chinese human rights abuses during this economic crisis and why Treasury Secretary Geithner has withdrawn the well-founded assertion that the Chinese have been manipulating the value of their currency?)

Now all of this might have been acceptable had we seen a remarkable increase in per capita income. We have not. Indeed, we have seen just the opposite: stagnation.

Median Household Income in Constant Dollars
YearMedian Household Income in Constant Dollars
2007 [most recent avail.]50,233

So, despite trillions in public spending, we are short millions of jobs, are rapidly sliding further into debt, are losing our capacity to borrow at a manageable cost, and are producing fewer of the goods that will generate real wealth.

The remarkable payments to the financial services sector and the auto industry—a quarter-trillion-dollar investment in AIG and GM alone—have produced no structural change at all. We are rebuilding the same edifice—fragile as before.

Where does this leave us? We have had a fundamentally misguided industrial policy over the past decade. Yes, industrial policy is a dirty phrase to many, some of whom would argue that we haven't had one, and indeed shouldn't. But the truth is we did have one: to leverage up and guarantee the bets of a financial services sector that has now collapsed and left nothing of value in its wake.

What would be a better approach? A policy to support those sectors that actually create goods and value. Investment in transformational technology and infrastructure are core national needs. So why not start with a government order for 500,000 electric cars, subject to an RFP two years from now, by which time a true electric car prototype will have been developed? It should be open to any manufacturer, as long as 75 percent of the value of the car is domestically produced. I don't care if the name on the plate is GM or Toyota, as long as the value added is here. (I prefer a "Toyota" produced in Tennessee to a "GM" produced in China. Why struggle to save the shell of a company—GM—that intends to ship jobs overseas anyway?) Guaranteeing an order of 500,000 will give manufacturers the needed scale to generate profits and reassure private customers that service and support will be around for the long haul. And the federal government could also issue an RFP for recharging stations, to be built by private companies, along the interstate highway system, wherever there is a traditional filling station, so that recharging will be possible.

Second, why not take an amount equal to the AIG bailout (more than $180 billion) and invest in a product that would be truly worthwhile: high-speed rail along our major economic corridors? If we transform the L.A.-San Francisco corridor with high-speed rail, and D.C.-Boston similarly, the savings and technological advances would be enormous. The $8 billion dedicated to high-speed rail in the stimulus package will accomplish little.

Wouldn't these be dollars better spent than those dedicated to propping up GM and AIG? The longer we fight the creative destruction of the marketplace by resuscitating dying companies, the slower our ability to shift capital to truly creative sectors in the economy will be.

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