A simple yet overlooked thought in the current debate about the health of the economy, the sub-prime credit virus, and the proper role of Federal Reserve monetary policy is this: Credit blowups, liquidity freezes, dysfunctional commercial paper markets, and suspect bank-loan quality do not exist — nor do they spill over into London and European money markets — when central bank policies are easy and accommodative.
Financial panics and overly stressed markets are symptomatic of tight and restrictive money. In other words, the current story of financial fear, trembling, and high anxiety is itself a critically important signal that money is way too tight.
Economists are always on the hunt for indicators that can help determine whether central banks are fostering liquidity shortages or liquidity excesses. They look at currencies, commodities, bond rates, and a host of other price indicators. They also look at the state of the financial markets, which today includes extreme risk-aversion, cash-hoarding, and an utter lack of financial confidence. More than any other gauge, it is today’s financial panic that unequivocally signals to the Fed (and perhaps the Bank of England and the ECB) that something is wrong with money.
In an important sense, this is all these bankers need to know if they are to understand why their policies are off course and inconsistent with financial stability and economic growth.
Friday’s disappointing jobs report pounds this point home. In my judgment, a one-month jobs decline is not, in and of itself, a major development — nor does it necessarily foreshadow a recession. But the unexpected loss of 4,000 corporate payroll jobs (the first such drop in four years) plus a very unsettling 316,000-drop in the household jobs survey is consistent with the recent shocks to our financial system. So are the 81,000 downward jobs revisions for June and July.
Incidentally, the only reason unemployment held firm at 4.6 percent was the civilian-labor-force decline of 340,000. This undoubtedly signals worker discouragement and declining labor morale.
After President Bush slashed tax rates four years ago, many of us argued that the rising household survey of jobs gains was a good leading indicator of more work and lower unemployment. We were right. Both the payroll and the household surveys produced over 8 million new jobs, while the unemployment rate dropped from 6.3 percent to 4.5 percent. That said, the year-to-date monthly change in household employment is actually falling by an average of 16,000. This is a big negative and does not bode well for future job tallies.
There are some saving graces to the economic story. While the Goldilocks, soft-landing scenario is imperiled by the deepening financial squeeze, it is not yet completely dead in the water. Recent numbers from the Institute of Supply Managers show an expanding economy in manufacturing and services. Same-store chain sales came in above estimate for August. Personal incomes after tax and inflation are still rising by 3.8 percent for the twelve months ending in July.
Silver linings aside, the commercial-paper market for short-term business loans continues a deep-south migration with an almost unprecedented $300 billion evaporation. In the months ahead, nearly $1 trillion in commercial paper will have to be rolled over. It’s hard to say where all this money is going to come from in today’s risk-averse environment. At present, investors are more than willing to finance short-term Treasury paper at roughly 4 percent, but so-called asset-backed corporate paper is going unfunded despite a better than 6 percent return. The exact same problem is cropping up in the London interbank loan market as LIBOR rates have jumped nearly a hundred basis points in recent days.
The main point here is that if businesses are unable to access working capital to fund their daily needs, they will be forced to shrink their operations. That means layoffs.
American companies are already experiencing their first profit declines in over five years. Non-financial domestic corporations have experienced negative profit margins and falling profits over the past three quarters. Treasury Department tax collections from business income have fallen off a cliff. Wall Street analyst Dan Clifton revealed that corporate tax revenues fell 29 percent in August compared to a year ago. And these tax collections have dropped in three of the past four months. A year ago, they were rising by more than 20 percent.
While big companies are still benefiting from overseas-based profits, the domestic story is rapidly deteriorating. Moreover, it’s a safe bet that the financial sector will deliver downside surprises as today’s mortgage mess continues to unwind.
Unfortunately, not a single one of these critical economic issues came up in this week’s GOP debate in New Hampshire. But make no mistake about it: The financial credit crunch and economic downturn are going to loom large in next year’s election.
As for the Federal Reserve, it is of course an independent agency. None of its members will be standing in front of voters come November 2008. Nonetheless, more than any other policy lever, it is the Fed that holds the all-important key to our economic future. Disappointingly, it has so far downplayed the disruption in financial markets.
If central bankers would come to their analytical senses, they would appreciate that today’s financial panic is itself sufficient reason to slash the federal funds target rate by at least a full percentage point from 5.25 percent to something around 4 percent. New cash needs to be poured into the liquidity-parched banking system. Such a move would inject confidence into a rattled marketplace. A lower fed target rate would not only deliver much-needed additions to bank reserves, it would help raise asset values across the board by dropping the cost of money. A pro-growth Fed policy will actually strengthen the beleaguered U.S. dollar and reduce the price of gold.
On Friday, former Fed chair Alan Greenspan compared the current financial turmoil to that of the 1987 stock plunge and the 1998 dislocation of giant hedge fund Long Term Capital Management. (Just for good measure, the Maestro threw in the land-boom collapse of 1837 and the bank panic of 1907.) Fortunately, financial panics don’t occur very often. But what we have before us today is a modern version of the old-fashioned run on the bank. The only difference is that the bank today is the global money market.
The Fed can fix this. But it better get moving.