Since 2009, the US economic recovery has bumped along a course of recovery from the worst recession it has experienced since the 1930s. As a result, it has attempted to institute policy remedies as a cure, none of which appear to be working effectively. Deep in debt and with few other options, the U.S. is now attempting to recover from the financial crisis by adopting a loose monetary policy. However, if the US Federal Reserve Board opts to launch a third set of quantitative easing (QE) policies, it will surely send the crisis into another downward spiral.
Federal Reserve chairman Ben Bernanke recently hinted that his board still needs to wait and see before deciding whether or not to start a third round of quantitative easing, or QE3. According to Bernanke, it is possible for the US economy to remain sluggish for a much longer time than anticipated, and the risk of deflation may arise once again. To cope with the situation, it would then be necessary to provide some policy support. In other words, quantitative easing will not be phased out before the economic recovery picks up pace.
Although the US economy is slowly emerging from the crisis, its prospect for a full recovery is worrying. According to US Department of Commerce data, the adjusted growth of the US economy was 1.9 per cent in the first three months of this year. This is much slower than previous economic recoveries, and far lower than the 3.1 per cent recorded in the last quarter of 2010 (figures for the first, second and third quarter of the year stood at 3.7, 1.7 and 2.6% respectively). According to Ken Goldstein, an economist with the Conference Board, the US economy is currently suffering from a periodic slump in which policy is the economic driving force propping it up. This means that the US economy could fall beyond remedy and, once it loses its hematopoietic function, quantitative blood transfusion may be the only way out.
Without a doubt, however, a policy of QE3 would be doomed to fail. Bernanke made two fundamental mistakes in his understanding of the current US economy. First of all, what the US economy is suffering through today is not a periodic slump, but a structural headache. Secondly, expanding demand is the key issue that needs to be tackled in the US economy prior to any monetary stimulation. The financial crisis and the debt crisis have profoundly changed the United States, its financial institutions, its enterprises, and the balance sheets of individual households. This type of balance sheet recession will take a long time to fully correct.
Banks Increasing Cash Stash as Lending Falls
The first question to ask is why is the US financial system debilitated? Because of the 2008 crisis, financial institutions exercising risk-hedging liability management have had to start de-leveraging and lowering the proportion of risk assets in their portfolios, resulting in a substantial fall in leverage ratio. At the same time, the ability of the Federal Reserve Board to print money and of the banking system to create credit is currently blocked. With banks growing more reluctant to lend, the total sum of credit has fallen while the ratio of cash kept by banks has swelled from a historical average of 3.2% to around 10% of their total assets. Although the extra-quota reserve funds of US banks have risen to close to US$1 trillion, consumer credit, business loans, and mortgage loans as a whole grew at the slowest pace in history. As far as their lending capacity and willingness, the banks have fallen to a level even lower than before the recession. According to data from the New York Federal Reserve Bank, banks have cut credit lines from US$30,400 to US$26,900 since the start of the recovery, and lowered home equity credit lines from US$1.33 trillion to US$1.15 trillion.
Why, then, are US families reluctant to spend more?
It will take time for households to restore their personal balance sheets. Low inflation and slow nominal wage growth have made deleveraging quite tricky. Added to that, families must either repay another US$3.3 trillion of debt or earn a combined US$3.9 trillion more to achieve the 84% debt-income ratio achieved in the 1980s. According to estimates by Credit Suisse this would amount to the combined income growth of about nine normal years.
Additionally, structural unemployment is going to be the largest impediment to consumption growth in the United States. What is haunting the US now is not merely cyclical unemployment, but structural unemployment resulting from de-industrialization. According to statistics, job offers increased slightly during the past 6-9 months, while the unemployment rate has remained above 9% for three full months. This is a reflection of the matching efficiency of US manpower markets. In other words, the market capacity of turning job offers into actual employment is going from bad to worse.
The U.S. Needs to Restructure its Economy
The structural unemployment haunting the US began at the beginning of this century when a wave of globalization accelerated the economic depression. When the recession began in December 2007, emerging economies represented by the BRIC countries accelerated their integration into the world economic system. In order to sharpen their competitive edge, US businesses accelerated the outsourcing of services and the transfer of manufacturing jobs. Without enough growing industries to absorb the newly unemployed workers, structural unemployment began to emerge. Statistics show that since the beginning of this century, the US work force has seen a net growth of more than 13 million people, while the number of those employed has suffered a net loss of one million people. Seen from the comparative advantage of labor cost and productivity, the US has not gained any upper hand over many rising economies as far as the labor cost in its manufacturing sector is concerned. Also, before it began to export its hi-tech goods, it was Europe that enjoyed the lion’s share of the high-end market. What the US needs now is a reorientation of its development path and an adjustment of its economic structure.
According to forecasts by the Hamilton Project, the US will settle at an employment gap of about 21 million. Only by filling this gap can it hope to bring its economy back to the employment capacity enjoyed before the start of the recession and absorb the 125,000 job seekers joining its workforce every month. Calculated against its current employment growth rate, this gap will remain for at least a decade.
Just as the Great Depression was a crisis brought on by the contradiction between overproduction and demand, the current crisis is a result of the contradiction between over-capacity and demand. For this reason, attempts by Bernanke to keep long-term interest rates at historically low levels and spur expansion of monetary credit will not fundamentally solve the issue of insufficient demand. While the stimulus package masterminded by the US Federal Reserve Board has failed, its quantitative policy produced a spillover effect immediately upon implementation. The depreciation of the US dollar will further exacerbate fluctuations in financial markets and the bulk stock market, give rise to new bubbles, and increase the possibility of global inflation, thus sending the financial crisis into yet another tailspin.
Zhang Monan is economics researcher with China’s State Information Center and frequently appears on China Daily with her “big picture” takes on the global financial system