A simple yet overlooked thought in the current debate about the health of the economy, the subprime credit virus, and the proper role of Federal Reserve monetary policy is this: you don’t have credit blowups, liquidity freezes, dysfunctional commercial paper markets, suspect bank loan quality -- nor do these ailments spill over into London and European money markets -- when central bank policies are easy and accommodative.
Financial panics and overly stressed markets are symptomatic of tight and restrictive money. In other words, the current story of financial fear, trembling and high anxiety is itself a critically important signal that money is way too tight.
Economists are always on the hunt for indicators to determine whether central banks are fostering liquidity shortages or liquidity excesses. They look at currencies, commodities, bond rates, and a host of other price indicators. One such indicator in the economist’s arsenal demanding attention is the current financial state of extreme risk aversion, cash hoarding, and utter lack of financial confidence. More than any other gauge, it is today’s financial panic that unequivocally signals to the Fed (and perhaps the Bank of England and the ECB) that something is wrong with money.
In an important sense, this is all these bankers need to know in order to understand why their policies are off course and inconsistent with financial stability and economic growth.
Friday’s disappointing jobs report pounds this point home (though in my judgment, a one-month’s jobs decline is not in and of itself a major development -- nor does it necessarily foreshadow a recession.) But the unexpected loss of 4000 corporate payroll jobs (the first on drop in four years) plus a very unsettling 316,000-drop in the household jobs survey is of course consistent with the recent shocks to our financial system.
So were the 81,000 downward revisions to the prior months’ of June and July. Incidentally, the only reason unemployment held firm at 4.6 percent is a 340,000-drop in the civilian labor force. This undoubtedly signals worker discouragement and declining labor morale.
After President Bush slashed tax rates four years ago, many of us argued that the rising household survey of jobs gains was a good leading indicator of more work and lower unemployment. We were right. Both the payroll and the household surveys produced over 8 million new jobs, while the unemployment rate dropped from 6.3 percent to 4.5 percent. That said, year-to-date the monthly change in household employment is actually falling by an average of 16,000. This is a big negative and does not bode well for future job tallies.
There are some saving graces to the economic story. While the Goldilocks, soft-landing scenario is imperiled by the deepening financial squeeze, it is not yet completely dead in the water. Recent numbers from the Institute of Supply Managers show an expanding economy in manufacturing and services. Same store chain sales came in above estimate for August. Personal incomes after tax and after inflation are still rising by 3.8 percent for the twelve months ending in July.
Silver linings aside, the commercial paper market for short term business loans continues its deep south migration with an almost unprecedented $300 billion evaporation. In the months ahead, nearly a trillion dollars of commercial paper will have to be rolled over. It’s hard to say where all this money is going to come from in today’s risk averse environment. At present, investors are more than willing to finance short term Treasury paper at roughly 4 percent, but so-called asset backed corporate paper is going unfunded despite a better than 6 percent return. Exactly the same problem is cropping up in the London interbank loan market as LIBOR rates have jumped nearly a hundred basis points in recent days.
The main point here is that if businesses are unable to access working capital to fund its daily needs, then these firms will be forced to shrink their operations. That means layoffs.
American companies are already experiencing their first profit decline in over five years. Non-financial domestic corporations have experienced negative profit margins and falling profits over the past three quarters. Treasury Department tax collections from business income have fallen off a cliff. Wall Street analyst Dan Clifton revealed that corporate tax revenues fell 29 percent in August compared to a year ago. And these corporate tax collections have now dropped in three of the past four months. A year ago, they were rising by more than twenty percent.
So while big companies are still benefiting from overseas-based profits, the domestic story is rapidly deteriorating. Moreover, it’s a safe bet that the financial sector will deliver downside surprises as today’s mortgage mess continues to unwind.
Unfortunately, not a single one of these critical economic issues came up in this week’s GOP debate in New Hampshire. But make no mistake about it, the financial credit crunch and the economic downturn is going to loom large in next year’s election.
As for the Federal Reserve, it is of course an independent agency. None of its members will be standing in front of voters come November 2008. Nonetheless, it is the Fed, more than any other policy lever that holds the all-important key to our economic future. Disappointingly, so far they have downplayed the disruption in financial markets.
If central bankers would come to their analytical senses, they would appreciate that today’s financial panic is itself sufficient reason to slash the Fed funds target rate by at least a full percentage point from today’s 5.25 percent to something around 4 percent. New cash needs to be poured into the liquidity parched banking system. Such a move would be a much-needed injection of confidence into a rattled marketplace. In addition, a lower fed target rate would not only deliver much needed addition to bank reserves, but would help to raise asset values across the board by dropping the cost of money. A pro-growth Fed policy will actually strengthen the beleaguered US dollar and reduce the price of gold.
Earlier today, former Fed chair Alan Greenspan compared the current financial turmoil to that of 1987’s stock plunge and the 1998 dislocation of giant hedge fund Long Term Capital Management. (And, just for good measure the maestro threw in the land boom collapse of 1837 as well as the bank panic of 1907.) Fortunately, financial panics don’t occur very often. But what we have before us today is a modern version of the old fashioned run on the bank. The only difference is that the bank today is the global money market.
The Fed can fix this. But they better get moving.