Mohamed El-Erian, the CEO of Pimco, sent me a note this morning which sums up the dire straits of the economy, as revealed in today’s employment report, in one sentence:
The problem is that very few people in DC are thinking of this as a structural challenge. Until they do, there is little basis for the sketch of a potential solution.
Here’s the issue: unemployment is at 10.2%, and broader underemployment is at 17.5%. For the foreseeable future, both of them are going to be extremely high — it doesn’t really make much difference, at the margin, whether they’re going up or down. Financial markets are used to looking at first derivatives, but in this case it’s the absolute level which is important.
When you’re unemployed, you don’t spend. So long as unemployment remains high consumer demand will be depressed. That’s going to be true even if the savings rate starts dropping, thanks largely to the enormous debt burden that US consumers have already placed upon themselves. That’s important for the US economy, and it’s also a major sea-change for the global economy. As El-Erian says in today’s FT:
There is one public good that needs to be replaced: the key role that the US has played as the engine of global growth. This role is now constrained by the debt of US households.
The implications of this are huge. If the US no longer drives the global economy, then the rest of the world will be much less inclined to fund its twin deficits to the tune of trillions of dollars per year. Meanwhile, the high unemployment rate means that the Fed is going to keep the Fed funds rate at or near zero, which bodes ill for the dollar. These are huge forces, acting in an extremely complex global financial system, and you don’t need to be Nassim Taleb to know that the end result of such a state of affairs is likely to be large, unpredictable, and potentially catastrophic.
Which brings me back to Washington. Here’s El-Erian again:
The best defence against these outcomes is early recognition and coordinated action. Key economic powers must shape their expectations and policy strategies to the changed contours of the global economy. They must also actively manage policy changes at the national and multilateral level in a way that broadens the provision of global public goods.
They must, yes. But will they? I fear — and clearly Mohamed fears too — that the answer is no. So far I’ve heard nothing out of Washington which says to me that the White House has a plan for addressing long-term structural problems in terms of unemployment, capital flows, and interest rates. A lot of these problems have been around for many years, and most of them have been diagnosed sharply at one point or another by Larry Summers. So it’s not like Washington is oblivious to what’s going on. But we’re at the limits of what monetary policy is able to achieve, and the nation cannot afford to repeat the monster hit to the US fisc which we’ve seen over the past couple of years.
Maybe, then, there simply isn’t a solution: the problem is just too big, too complex, and too intractable. It’s a depressing conclusion, but also a pretty compelling one.