Markets this week lost faith in recovery. Although it is far too soon to call a double-dip back into economic shrinkage, the May-June deceleration has the policy question in everyone’s mind: Just what is going to get us out of this?
Today’s total-focus job data for June was the only report to arrive as-estimated, adding a measly 100,000 private-sector jobs.
The gaps between forecast and actual in other data best describe the slowdown: the ISM manufacturing index was 59.7 in May, forecast 59, actual 56.2; May pending home sales were forecast to decline 12.7 percent on tax-credit expiration, actual was a 30 percent free-fall.
Mortgage rates, near 4.75 percent, should have pushed purchase loan applications up last week, but they fell again, down 3.3 percent. Auto sales did rise 14 percent in June compared to 2009, but dropped 11 percent from May.
The cause of this abrupt deceleration is a puzzle even to many who had been recovery skeptics. Some of the top suspects may be terribly technical — and the term "quantitative easing" (QE for short) may become a household term before fall.
In a normal recession we recover because the Fed cuts the cost of money, floods the banking system with cash, and cheap and plentiful credit causes leveraged assets to recover (houses, autos …), and then off we go to job creation. Then jobs, after assets recover — not before.
The first modern exception to this pattern was Japan, whose banks were ruined by asset deflation beginning in 1990. The Bank of Japan deployed normal measures, but the zombie-bank wreckage blocked the flow of credit to the economy, and Japan has been in deflation ever since: the consumer price index there has fallen 1.2 percent in the last year, Nikkei stocks today at 9,204 vs. 38,957 at the 1989 peak.
The antidote prescribed in theory by Federal Reserve Chairman Ben Bernanke and others: Bypass the banks and inject cash directly into the economy.
When the U.S. approached deflation in 2002, Bernanke advised not to worry about it: Enough Fed cash scattered over the countryside would solve any deflation, which won him the nickname, "Helicopter Ben."
Neither he nor anybody else suspected that by the end of 2008 he would be forced to shovel C-notes out of Hueys. From January 2009 until March 2010, the Fed bought with invented money $1.6 trillion of government paper.
At a little more than $100 billion per month, that was three brand-new C-notes for every U.S. citizen, every month.
Then the Fed stopped. Cold. March 31. Everyone — at least everyone who believed that recovery was under way — thought that mortgage and long-term interest rates would rise. The Fed’s only worry: What to do with all of the government paper?
Correlation is not cause. However, since March 31 the yield on 10-year T-notes has collapsed from 3.99 percent to 2.94 percent — in a straight line, each week lower than the one before.
Economic data didn’t begin to slide until May, but earlier weakness was masked by inventory rebuilding and housing tax credits. Once Bernanke grounded his Huey, the non-recovery was exposed.
What to do? Fiscal stimulus is done. We can’t go back there. If the data stream gets ugly enough, the Fed might resume QE, but there are limits to that. Two: We’ve never tried it before, and have no guide to magnitude and consequences; and there’s a political limit — the Ron Paul-ers who would withdraw credit and Fed altogether.
Restoring an adequate flow of credit is the only way out of this. Once caught in a self-reinforcing credit-default/asset-deflation spiral, nothing will stop deeper deflation and deeper losses except credit — just as in any recession.
Help assets to begin modestly to rise in value, housing above all else.
The political constraint is key. We are all embarrassed about what we did with too much and too easy credit, and that has been an opening for know-nothings to exploit.
This administration has thus far been too timid or confused or overconfident or agenda-distracted to confront the economic charlatans on the right. Somebody needs to shout "Herbert Hoover!" at them in this burning theater, and real quick.