This was the series of articles that was not meant to be. When the first of the “It’s the Jobs, Stupid” pieces was written on October 8, 2009, my aim was to emphasize the importance of job creation to the still new Obama administration, and to make employment generation the primary objective of economic policy. Instead, reform of health care occupied the bulk of the new administration’s time and efforts. And as fiscal expansion focused on “cash for clunkers” and tax credits for first-time home buyers, the lack of emphasis on jobs meant that unemployment stayed high and became increasing structural. Structural unemployment typically lasts longer and, as workers lose basic skills, becomes less and less susceptible to monetary and fiscal measures. That, unfortunately, is where we find ourselves today.

According to figures released by the Department of Labor Friday, the U.S. economy posted no job growth in August, the first month with no job creation since September 2010. The 17,000 jobs created by the private sector last month were exactly offset by a similar loss of jobs in the public sector. There was no silver lining – both average weekly hours and average hourly earnings fell, and 42.9% of the unemployed had been without jobs for over six months, unchanged from the previous month. And even though the much-cited unemployment rate was unchanged at 9.1%, the less-known U-6 unemployment rate (including frustrated workers and those working part-time involuntarily) rose from 16.1% to 16.2%.

The zero U.S. job growth also had an impact beyond its own borders. Even though U.S. markets were closed yesterday for the Labor Day holiday, Asian and European equity markets fell sharply on growing fears that the data release signaled the beginning of a U.S. recession. (Concerns about the solvency of the European banking system were the other reason for the market setback.) The United States and the European Union each account for about one-quarter of world GDP, and emerging markets cannot maintain global growth despite their faster pace of expansion.

Obama Speech: Big Expectations, Fewer Results

The weak employment report has raised expectations for what President Obama will propose during his address to the U.S. Congress Thursday. He is expected to suggest that the 2 percentage point cut in the payroll tax set to expire at the end of this year be extended through the end of 2012; that unemployment compensation be provided for longer periods; and propose new expenditure on infrastructural public works projects. The objective, in each case, is to put more money in the hands of workers and, thereby, encourage consumption.

However, each of the proposals faces considerable Republican opposition, and passage during coming months is doubtful. And even if the payroll tax is actually lowered and unemployment payments extended, the impact over the next year will likely be small. The continuing fall in home prices and the persistence of a high unemployment rate have sapped consumer confidence, and the likely measures are unlikely to boost spending. While an expansion in infrastructure projects was an objective even when the Obama administration assumed office in January 2009, it has proved difficult to locate good projects and to implement spending and hiring decisions promptly.

Fed to Ride to the Rescue – Again

Doubts about the efficacy of further fiscal measures may put the ball back in the Federal Reserve’s court. At an extended meeting of the Federal Open Markets Committee to be held September 20 and 21, U.S. monetary authorities are set to decide whether, and how, to put the economy back on a sustained growth path. Much-discussed measures include QE3 which would involve a repeat of past measures to buy Treasurys to further flood the market with liquidity and induce investors to go into risk-assets such as stocks; maintaining the size of the Fed’s portfolio but swapping short-dated paper for longer-dated ones, lowering long-term interest rates; and reducing the interest paid to banks on their excess reserves from the current 0.25% to zero.

Simply put – and this is a reiteration of my past forecasts – none of these monetary measures is likely to have the intended positive impact. Economic theory suggests that, at extremely low interest rates, central banks would be performing the equivalent of “pushing on a string” in further lowering interest rates and increasing the quantity of money. For example, lengthening the average duration of the Fed’s holdings, known as “Operation Twist,” would be intended to further reduce the yield on 10-year and 30-year U.S. Treasurys. The 10-year Treasury went just below 2% in yield at the end of Friday, and fell further to 1.91% in Asian trading Tuesday morning. If that does not lead to an economic recovery, does the Fed seriously believe that a 1.0-1.5% yield would help achieve that goal? Instead, the additional liquidity resulting from an easier monetary policy would merely be hoarded – by banks and by individuals – as other concerns outweigh any encouragement to spend arising from the easier monetary policy.

Prescription for Job Creation

What should the Fed and the President do? The answer is obvious in the case of the Fed. As Chairman Bernanke explained during his Jackson Hole speech on August 26, the Fed is mostly out of ammunition. It behooves the Fed, led by Mr. Bernanke, a trained academic economist, to announce September 21 that it will simply maintain existing policy – no further easing. While such a move may disappoint equity markets – and cause long-term Treasury yields to move up – the move can only enhance the reputation of the Fed for intellectual honesty. It will also likely bring greater stability to financial markets which have been buffeted, among other things, by differing perceptions on how much hand-holding they will receive from official sources.

President Obama, on the other hand, still has some unused instruments at hand. Here are three things he can do to create employment fairly quickly.

1. To bring his goal of doubling U.S. exports to fruition, he needs to put proposed Free Trade Agreements with South Korea, Panama and Colombia on a fast track. Issues such as whether Montana beef will get a preference in entering the Korean market, and whether Colombian labor unions enjoy the same rights as those in the United States, have held back the treaties. Such special interests have repeatedly delayed a freer trade regime with significant overall benefits. An increase in U.S. exports requires no monetary easing, nor does the fiscal deficit have to rise further.

2. Rather than extend unemployment payments, the President should direct that payments be focused on keeping workers employed, even if it is at a lower wage. Public spending also needs to reward worker retraining to adjust to a changing global economy.

3. U.S. corporations are estimated to hold over $2 trillion in cash, a large portion of which is held abroad to escape U.S. taxation which could be as high as 35%, higher than in many other developed countries. A tax holiday, involving a reduction in the rate to 10% through the end of, say, 2013 would encourage a return of capital, with a portion of that used to hire U.S. workers. The move would also go a long way to help offset the President’s image as being anti-business. An improvement in the business sector’s perception of the Obama policies is probably more important than anything monetary or fiscal policy can achieve.

 

 

(c) TCW Asset Management

www.tcw.com