Offering Clear Ideas During Complex Times

For months, even years, the market has been trying to figure out when the Federal Reserve will start to raise interest rates. The question of ‘When?’ has been the subject of countless articles, reports, and debates. But perhaps the world has been asking the wrong question;  when the Fed raises rates matters much less than what happens when they finally do. The market is likely to perceive the decision to raise rates as a sign that the economy is healthy and ready to lose the training wheels that the Fed has kept it on for the better part of 7 years. What the market doesn’t realize is that they’re not just taking off the training wheels; they’re taking the economy off of life support. Low rates are the only thing keeping this economy afloat, and keeping them lower even longer only exacerbates the problem that we’re dealing with. Many economists see the Fed as the savior during a time of crisis yet ignore their implicit role in causing it. While there’s countless statistics and data that contradict the Fed’s insistence that the economy is gaining its footing, I’m choosing to focus on the labor market in this post since it’s one of the clearest signs that we’re headed for disaster.

There’s a great deal of data that can be found regarding the labor market and with that data comes some statistics that are rather useful and others that are particularly misleading. Let’s take the unemployment rate, for example, which  recently fell to 5.3% in June from 5.5% in May (BLS, 2015). At first glance it seems like a sizable improvement in the labor market, but a deeper understanding of how this figure is calculated shows that the economy is losing traction. Ponder this: to be considered unemployed, you must have looked for work within the past 4 weeks, yet people who have given up looking are no longer counted as unemployed. As more people give up looking for work the unemployment rate falls, making a bad situation look like a positive one, and as it turns out, that’s exactly what’s happening. According to the Bureau of Labor Statistics, the Labor Force Participation Rate fell to 62.6% last month, the lowest it’s been since 1977 (BLS, 2015). The participation rate includes those working and looking for work, meaning that the aforementioned group of people who quit looking for work are no longer part of the labor force. If you consider the U-6 unemployment rate, which takes into account those who have given up looking for work and those working part time but would prefer full time work, you’ll see it stands at 10.3% (BLS, 2015). Misleading is an understatement when it comes to how the government reports conditions.

Many economists will claim that the Labor Force Participation Rate has fallen due to the retirement of many baby-boomers, but I’d argue that the opposite is true. Many baby-boomers have come back into the labor force and taken jobs that are typically held by younger workers, teenagers in particular. If you don’t live under a rock, you might have noticed many older people working the registers that younger people used to work at many fast food and retail stores. But in the case that you happen to be as unaware as many economists, consider the following statistics: the unemployment rate among teenagers age 16-20 is over 18% while those 65 and older have an unemployment rate of 3.7% (BLS, 2015). One might make the argument that this lower unemployment rate is flawed because the participation rate for those 65 and older is much lower than the rest of the population. In the interest of precision, we should look at the historical participation rate among those 65 and older to see what’s really going on. In 1990, the LFPR for those 65 and older was 12.1% and today it stands at 23.8% which means that during a time where many baby-boomers should be retiring, they’re actually working again (Kromer & Howard, 2013). It would appear that many award winning economists are more delusional than many people would come to believe.

Another statistic that seems rather promising, but once again proves to be misleading, is the rise in Total Non-Farm Payrolls. According to The Bureau of Labor Statistics, the economy added 223,000 jobs in June, higher than most estimates. But where did those jobs come from, and what types of jobs were they? The sectors that added the most jobs were Professional & Business Services, Retail, and Food Services & Drinking places while Manufacturing, Mining, and Construction all showed negative or no growth (BLS, 2015). The only jobs we created were service sector jobs. What we need are manufacturing jobs, and because of unnecessary regulations and taxes, we continue to lose our productive capacity. The persistent U.S. trade deficit is evidence of this.

Works Cited

“The Employment Situation – June 2015.” BLS New Release (2015): 1-38. 2 July 2015. Web. 4 July 2015.

Kromer, Braedyn, and David Howard. “Labor Force Participation and Work Status of People Years and Older.” (2013): 1-6. Census.gov.                U.S. Census Bureau, Jan. 2013. Web. 4 July 2015.

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The debt ceiling is one of the most frequently debated topics in politics and economics today, and for good reason. Last year’s government shutdown  and subsequent negotiations have shown that Congress, and the nation, have become more  divided as to whether or not our spending limit should be raised. Perhaps the question we need to be asking is not whether the debt ceiling should be raised, but what happens when we hit our “lending ceiling” as Peter Schiff would say.

The debt ceiling isn’t really an apt term for our borrowing limit since every time we get close to reaching it, we raise it, and for those in Washington, the sky seems to be the limit when it comes to spending. However, politicians have forgotten that there are two parties involved in this whole process; the debtor and the creditor. You can’t rely on the debtor to always do what’s fiscally responsible, since it’s more lucrative to consume when someone else’s money is on the hook, which is why the creditor is ultimately the one who determines how much you can borrow. What I’m getting at is this: we can completely eliminate the debt ceiling if we wanted to, but it doesn’t mean the rest of the world will lend us the money to do so.

China is our largest creditor, and because of our trade imbalance with China, people tend to make the fallacious argument that they will continue to lend us money so that we can continue buying their imports. But we need to realize that China will eventually stop throwing good money at a bad investment. Instead of selling goods to someone who can’t pay them back, the Chinese government will eventually realize that  their own people can start to consume what they produce themselves. China, a country with the largest population in the world, has more than enough demand to satisfy their production which means that Chinese citizens will be able to enjoy the fruits of their own labor and buy all the things we used to buy. Trust me when I say that China would rather lose money on $1 trillion in Treasury bonds than $2 trillion or $5 trillion.

People also tend to make the false assumption that because we have the ability to print the money we need to pay off our bills, that our problems are solved, as if there are no consequences to that. When a government defaults on its debt, it has two options: the first is to make an arrangement with its creditors where they get paid a percentage of every dollar owed (similar to bankruptcy for individuals), and the second option is to print the money. The two options are essentially the same; if you’re getting paid back 50 cents on the dollar or getting paid back the full amount with less valuable dollars, then what’s the difference? No matter how you look at it, China will lose.

The current national debt stands around $17.5 trillion. The United States is so indebted that we can’t even afford to pay back the money we owe with real dollars; instead we rollover our debt (pay off our debt with more debt), which is the equivalent of paying off your Visa with your MasterCard. The U.S. government believes they have the equivalent of a credit card without a limit, but what they’ll come to realize is that people will eventually stop accepting IOU’s and start demanding payments. When that day comes we will no longer be discussing the debt-ceiling, but rather the lending ceiling, and we will be forced to understand what it means to live within our means.

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Since the financial crisis in 2007-2008, The U.S. economy has been on life support; banks were bailed out, the Fed lowered interest rates, and the money printing began. Like a heart attack patient receiving shocks from a defibrillator, QE1, QE2, and QE3 began in rapid succession to support an ailing economy. Our government, particularly the Federal Reserve, did everything it could to prevent Great Depression 2.0, but did it really cure the disease or just pump us full of morphine? Has the economy actually improved or has cheap money simply allowed us to forget the pain? Sadly it’s the latter, and even more unfortunately, when the morphine wears off this time, there won’t be any saving this economy.

The Fed kicked the can down the road in 2008 instead of allowing the economy to properly rid itself of previous imbalances, and in doing so, they set the U.S. economy up for an even worse economic crisis. Unfortunately most people, even financial “experts”, are oblivious to the reality of the situation. The goal of this site is to educate people from all backgrounds and levels of knowledge about the true workings of an economy, why the grow, and why they fail. I see this first post as an opportunity to explain one of the most misunderstood concepts in modern economics: the business cycle.

Business cycles are a described as a expansions and recessions; periods of growth and periods of contraction; times of wealth and times of welfare, but contrary to popular belief, booms and busts are (in large part) non-existent in a capitalist economy that is absent of central government planning. Central banks actually create the boom-bust cycle and unfortunately capitalism gets a bad reputation for the problems that emanate from central bank policies. So how exactly do they create this cycle? The answer lies in interest rates.

The Federal Reserve has various objectives and roles in our economy, one of which includes setting interest rates through the process of open market purchases. As the central bank, it has the ability to influence the overnight lending rate (the federal funds rate) between banks through the purchase of U.S. Treasury bills which in turn affects other interest rates in the economy. By purchasing these assets, the Fed pumps money into the economy and simultaneously lowers interest rates (keep an eye out for future posts for a more in depth explanation of how this process actually works). Lower interest rates are meant to stimulate growth, higher rates are meant to keep inflation low, and if you haven’t noticed yet, herein lies the problem. These types of policy arrangements rest on the assumption that bureaucrats in Washington know better than the market when it comes to determining interest rates.

You see, interest rates are price of borrowing money, and just like the price of any other good or service, they are determined by supply and demand (Note: other factors help to determine interest rates as well, but basic supply and demand underpin the entire model). The savers provide the supply and the borrowers create the demand, resulting in some equilibrium interest rate. The more savings there are, the greater the supply, the lower the interest rate, and vice versa. When the Federal Reserve artificially lowers interest rates to promote economic growth, they create the illusion of excess savings available to finance the money that is being borrowed even when no such savings exist. These low interest rates promote  excessive borrowing and consumption that lead to malinvestment on the parts of market participants (housing bubble, anyone?).

To understand exactly how the Federal Reserve creates such a cycle, let’s explore the very policies that left us  with the crippled economy we have today. In the early 2000’s, the Federal Reserve lowered interest rates in an effort to get us out of a recession following the “Dot Com Bubble” and the September 11th attacks. The Fed’s low interest rates did exactly what they we’re supposed to and within less than a year the economy was back to full output, but those low interest rates did exactly the same thing they’re doing now: numb the pain. Instead of allowing a true recession to take place and forcing land, labor, and capital to be reallocated to the most efficient sectors of the economy, the Federal Reserve gave us a quick dose of morphine and refused to admit that there was a serious underlying problem.

As you can imagine, all the cheap money that the Fed was printing following that recession came back to bite them in what eventually became the housing bubble. Easy money, along with a variety of other factors, gave way to excessive borrowing on the parts of Wall Street and Main Street alike. Rational investing went out the window as soon as the morphine kicked in, but when the low-interest rate “high” ended, we began to wake up to reality and  what we were left with was a financial crisis that nearly rivaled the Great Depression. Here’s the thing that central bankers will never understand and it’s why economies malfunction: the problem with using cheap money as a means to grow an economy is that money doesn’t stay cheap forever, and if it does, it’s worthless. Savings and production are the key to growth, not consumption and excessive borrowing.

Today we have interest rates that are more than just low; they’re zero! The Federal Reserve has yet to learn from it’s mistakes. They’ve instead chose to increase the magnitude with which they implement the same policies which can only mean that this, too, will come back to haunt them. Ben Bernanke and the Federal Reserve get a lot of praise for having “saved” the economy; they prevented an even worse crisis from occurring when the housing bubble burst. But what did they really prevent? They prevented an economic restructuring from taking place; land, labor, and capital were never reallocated. That is why recessions are actually a blessing in disguise: as painful as they are, they allow the proper adjustments to take place so that we may begin to undo all the mistakes/poor investments that were made during the phony expansion. It may be painful for quite some time, but if we actually want to fix our problems we need to be willing to bite the bullet.

Eventually we’ll have to face the fact that our economy has too many structural imbalances to be viable for much longer, and when the morphine wears off, a crisis lies ahead. But only then can the healing process begin. Only then can we once again become a wealthy nation. If only we can embrace true and unbridled capitalism, will we all be better off.

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