Perspectives on Geopolitics, History, and Political Economy

Wall Street Rocks!

Dean Baker
Originally Published on Truthout, January 18, 2016

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For those who closely follow financial markets the first two weeks of 2016 have been the most fun since the financial crisis triggered by the collapse of the housing bubble. The market has lost more than 10 percent of its value since its late December peak, destroying more than $2 trillion of stock wealth.

Markets elsewhere in the world have experienced comparable declines. Slowing economic growth has sent oil prices plummeting to less than $30 a barrel, pushing many oil companies to the edge of bankruptcy and devastating the economies of countries that are heavily dependent on oil exports. All this may sound very grim, but unless you were borrowing to buy large amounts of stock or oil futures, there is no reason to look for a ledge from which to jump.

As Herbert Hoover famously said, the fundamentals of the economy are strong. Okay, that’s not serious.

The fundamentals are not strong, but the economy is also not about to fall into another recession. The basic story is the one we were seeing before all the fun on Wall Street, we are looking at an economy that is growing slowly and still has not come close to recovering from the last recession. The rollercoaster ride on Wall Street has little effect on this picture.

Later this month we will get data on GDP for the 4th quarter which is likely to show the economy growing at less than a 1 percent annual rate. That will make the growth for the year less than 2.0 percent, a dismal performance by almost any measure, but it is especially bad for an economy that has not recovered the ground lost in the downturn. The economy is almost 7 percent smaller than the post-recession projections for 2016 from the Congressional Budget Office (CBO) and other forecasters. To make up this gap, the economy should be growing 3-4 percent annually for several years.

This is not just an abstraction. If the economy had followed the path projected by CBO there would be an additional 5 million people working. Furthermore, the weak labor market undermined workers’ bargaining power leading to a redistribution from wages to profits. If we had followed the path projected by CBO in 2010, total wages would be more than 10 percent higher today.

This is a big deal, but the market turmoil of the last two weeks does not change the basic story. The economy is likely to continue to grow at a weak pace in 2016, just as it did in 2015 and 2014. There is a big question as to whether the economy can continue to create jobs at the same pace as it has recently. An economy growing at less than a 1 percent annual rate does not typically generate 292,000 jobs a month.

But even if the pace slows markedly, as is probable, we are unlikely to see a decline in the number of jobs and a rise in unemployment. Consumption is likely to grow modestly as workers do have more money to spend this year than last year (lower oil prices are good in this story). Government spending is also likely to give a modest boost to the economy as the austerity craze in Washington seems to have receded for the moment. And, housing is also likely to provide a modest boost to demand.

These positives should offset the drag from a declining energy sector, a rising trade deficit, and a likely fallback in non-residential construction. They should keep the economy moving forward in 2016, especially if the Fed can keep its fingers off the interest rate trigger.

The market turmoil stems in part from the fact that China’s stock market, which was clearly in a bubble, has taken a major hit. While this should not have been a surprise, it is apparently very easy to surprise the big actors on Wall Street. The collapse of China’s bubble is associated with a slowdown in growth in China, which could be fairly sharp, although that would not be my bet.

However even a sharp downturn in China would not send the U.S. economy plummeting, our total exports to China are only about 0.7 percent of GDP. China’s weakness will have a major impact on other trading partners, especially those heavily dependent on commodity exports. But even in a worst case scenario we are looking at a major drag on the U.S. economy, not the sort of falloff in demand that puts the economy into a recession.

The irony of this story is that the weak economy is the result of insufficient demand. And, as economic theory tells us, the remedy for weak demand is more demand. The quickest way to get more demand is to have the government spend money on things like infrastructure, clean energy, education, health care and all sorts of other goodies. That would create jobs today and make the economy stronger in the future.

But the politicians in Washington have largely put more spending off the table, because that would raise the budget deficit. Ordinarily the story is that high budget deficits lead to high interest rates and/or inflation. Currently long-term interest rates are at incredibly low 2.0 percent and inflation is far below the Fed’s 2.0 percent target (which is itself irrationally low).

This means in the United States and much of the rest of the world we have a weak economy and hundreds of millions of people that are needlessly unemployed, underemployed, or getting low wages because governments don’t want to spend money. It’s pretty damn stupid, but hey, let’s celebrate the decline in the budget deficit and thank the deficit hawks who helped make it possible.

Source: CEPR, The Center for Economic and Policy Research. This work is licensed under a Creative Commons Attribution 4.0 International License.

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This work is licensed under a Creative Commons Attribution 4.0 International License

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