The rebound from the recent recession
is the slowest economic comeback in living memory – so slow that some
doubt whether it is happening at all. The recession bottomed (the economy
stopped shrinking) in June 2009, so the recovery is now two years old. Here’s
how things looked 24 months into recovery from the last four recessions.
Recession Begins
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Recession Bottoms
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Unemployment Rate
24 Months After Bottom
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July 1981
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November 1982
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7.2%
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July 1990
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March 1991
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7.0%
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March 2001
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November 2001
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5.8%
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December 2007
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June 2009
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9.1% as of
May 2011
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The
sleepwalking during the last 24 months is all the more remarkable, given that
the economy has been treated with the biggest dose of monetary and fiscal
stimulants ever administered in U.S. history. Why the continued weak pulse?
Each
recession has its own story – how long it lasts, how deep it gets,
industries worst hit, particular bubbles burst. But in every recession, the
heart of the problem is the same, namely, an imbalance in the market for
cash. Every recession begins when the aggregate amount of cash that people
want to hold (given their wealth and the other things they want to own) is
more than the amount of cash actually in existence. That imbalance –
the demand for cash exceeding the supply – depresses the entire economy
because the flip side of the market for cash is the market for everything
else. All markets and all industries are hit, and most of them contract
because most people are trying to sell more than they buy... which is the
only way for anyone to increase his cash holdings and which is impossible for
everyone to do at the same time.
In
the period from the end of the Civil War to the end of World War II, most
recessions began when the government, by plan or by blunder, contracted the
supply of cash, so that it fell below the public’s demand for cash.
Since World War II, every recession has begun when the government, again by
plan or by blunder, allowed the growth in the supply of cash to lag behind
the growth in the demand.
The
early stages of a typical pre-WWII recession would push some commercial banks
into insolvency, which would shrink the supply of cash even further, since
insolvency meant that some part of the deposits held by bank customers were
lost. As the recession proceeded, an increase in the
demand for cash by worried investors, worried business people and worried
workers would make the cash shortage even more severe.
Every
recession between the Civil War and World War II ended on its own. In no case
was a recession brought to an end by the actions of an alert government agency
or with the advice of learned economists. Recessions were cured,
automatically, by falling prices. Falling prices were the cure because they
increased the real value (purchasing power) of whatever amount of cash the
public was holding. Prices kept falling until the real value of the existing
supply of cash grew to a level that exceeded what the public wanted to hold.
Then, as individuals and businesses began to spend the excess, the economy
would begin to recover.
Until
the Great Depression of the 1930s, the average length of a recession was 21
months. The misery that began in October 1929 lasted five times that long
– 105 months. It was the severest recession ever, with unemployment
reaching one-third of the workforce, because the shortage of cash that brought
it on was the severest ever: the M1 money supply (hand-to-hand currency plus
checking deposits) shrank by one-third. But a different factor made it the
most prolonged of recessions. Aiming at a symptom of recession rather than at
the cause, the government pursued an array of policies to prevent prices from
falling, which had the perverse effect of preventing the economy from
recovering. The government’s would-be medicine was, in fact, poison.
Even
though the government’s first active attempt to end a recession
produced a disaster, it did establish a presumption that the government
shouldn’t just stand by when the economy turns down. It should do
something, and the duty to do something has been assigned to the Federal
Reserve.
Since
the end of World War II, the Federal Reserve has acted in fire department
fashion to cure each recession as soon as it was identified. Relying on a
fall in prices to restore prosperity wasn’t an option the Fed wanted to
consider. The Fed has attached a variety of labels to its recession-fighting
steps, such as “lowering interests,” “easing credit
conditions” or, more recently, “quantitative easing.” But
they’ve all amounted to the same thing – increasing the
public’s supply of cash to a point where it exceeds the public’s
demand for cash.
As
of the end of June, we are 42 months from the December 2007 start of the last
recession. The table below shows the total growth in the M1 money supply
during that period and also during the 42 months following each of the
preceding three recessions. The most recent downturn has clearly been met
with the most aggressive additions to the supply of cash. The July 1990
recession comes close in that regard, but in that case the new cash produced
the intended effect; the economy revived. Why is it that, this time around,
the new money seems to be accomplishing so little?
Recession Begins
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Unemployment Rate with
24 Months of Recovery
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M1 Growth 42 Months
After Recession Begins
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July 1981
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7.2%
|
21%
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July 1990
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7.0%
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39%
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March 2001
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5.8%
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22%
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December 2007
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9.1% ( May
2011)
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40%
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The
answer has at least four parts.
1.
Nearly all recessions are exacerbated to some degree by an increase in the
public’s demand to hold cash. Recessions produce worry and uncertainty,
and cash is the most versatile provision for the unknown and hence is the
best anti-anxiety drug. The collapse, in 2008 and 2009, of financial
institutions that the public had taken for granted as part of an unshakeable
firmament is still a fresh memory. The public wants to hold more cash now
than it did going into the last recession because it is still worried. So
some part of the 40% increase in M1 has been absorbed by that increase in the
demand to hold money.
2.
Expected real estate deflation. In the housing market, the U.S. government
has repeated the 180-degree wrong-way error of the Great Depression –
trying to keep prices from falling. Tax credits for first-time homebuyers,
payments to lenders in exchange for rewriting existing mortgages and the
inventorying of foreclosed houses by government-dependent banks have
prevented house prices from reaching a market-clearing level. The expectation
that prices have further to fall is a reason to hold off on buying, and the
flip side of delaying a purchase is holding more cash.
3.
Unsettled loan portfolios. The echo of vulnerable real estate prices is doubt
about bank loan portfolios. As real estate prices decline, losses on
mortgages can only increase. Will the banks need to be rescued again? If so, will a
deficit-ridden government show up in time? More uncertainty means more demand
to hold cash.
4.
Uncertainty about tax rates and rules. Much of today’s tax rules will
expire at the end of 2012. No one knows what the rules will be after that.
Uncertainty about tax rules is a reason for businesses to postpone investing,
and a reason to put off investing is a reason to hold cash.
We
don’t know how much each of those four factors has added to the demand
for money, and, as investors, we don’t need to know. The critical point
is that each of the factors adds a quantity to the demand for cash, something
finite. So it is a certainty that their total effect can be overcome by yet
more increases in the supply of money.
And
more increases in the supply of money are what we are going to get until
unemployment rates come down. Don’t be distracted by speculation over
whether there will be a QE3. QE is just a slogan. It’s the numbers that
matter, and the numbers on the money supply will
keep growing. The Federal Reserve’s fear that the economy might slip
back into recession will keep the numbers growing. The Fed’s need to
protect the capital markets from the effect of the Treasury’s
trillion-dollar deficits will keep the numbers growing.
[The
public’s demand for cash is one element of a burgeoning debt crisis in
the U.S. You can learn how to protect your investments: Register for the free
online event, The
American Debt Crisis, that will
take place September 14 at 2 p.m. EDT.]
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