Declaring a "Recovery Summer" victory tour at the start of June must have looked like a pretty safe wager for the Obama administration. The economy seemed to have shifted firmly into gear during the spring. Lawrence Summers, director of the National Economic Council, told the Financial Times in early April that the economy was "moving toward escape velocity. You hear a lot less talk of "W'-shaped recoveries and double-dips than you did six months ago."
A big reason for White House optimism was a stronger job market. The economy added an average of 320,000 net new jobs a month during March, April, and May, about half of them in the private sector. Granted, the unemployment rate still hovered close to 10 percent. But if the economy kept growing at a 3 percent annual clip or greater"”creating lots and lots of new jobs in the process"”unemployment would eventually fall, perhaps dramatically. As one White House insider remarked upon reviewing all the macro-indicators and then evaluating the economic team's performance, "It looks like we got things just about right."
Since then, however, the economy has fallen back to earth, and "Recovery Summer" looks more like a bad bet. Private sector job growth has fallen by two-thirds, and the unemployment rate is still at a sky-high 9.5 percent. And if the size of the U.S. workforce, as measured by the Labor Department, had stayed constant since April"”instead of shrinking by a million"”the unemployment rate would be 10.4 percent. Jobless claims are at their highest level since February. Worse yet, the expansion is decelerating. After growing by 5.7 percent in the final quarter of 2009 and 3.7 percent in the first quarter of 2010, GDP advanced by just 2.4 percent from April through June, according to the Commerce Department. And new data show the final second-quarter number may actually be closer to flat, with growth for the rest of the year just 1 to 2 percent at best.
The White House didn't count on a summer swoon. Then again, it has suffered bouts of premature and unfounded economic optimism before, a malady that has led it to make a number of losing bets and faulty assumptions"”which, in turn, have created an even worse environment for growth and jobs. Among them:
- High unemployment is a psychological anomaly. Republicans love to mock the now-infamous chart prepared by administration economists that showed the $862 billion stimulus would prevent unemployment from hitting even 8 percent. But the White House has continued to be overly hopeful about jobs. Here's why.
Obama advisers noticed that the Great Recession seemed to be violating an economic rule of thumb called Okun's Law (named after JFK adviser Arthur Okun), which describes the relationship between economic growth and unemployment. As bad as the recession was, unemployment shouldn't have risen to 10.1 percent, according to Okun. Maybe just 9 percent or so. The administration's explanation for the overshoot: Panicky businesses shed workers willy-nilly because they feared another Great Depression.
But now with the worst behind and the economy growing again, there should have been a "catch-up" phase during 2010 when job growth would far exceed GDP growth. (That, even though there's no historical precedent for such an Okun mean reversion.) Yet revised GDP numbers show that the statistical fit between unemployment and growth has actually been much tighter than Team Obama first calculated. Unemployment rose so much simply because the downturn was deeper than preliminary numbers showed. Without much stronger growth, unemployment will stay high.
- America has economic immunity. The White House is no fan of the idea that the U.S. economy has entered a stagnant economic state, what Pimco bond guru Bill Gross has labeled the "New Normal." It describes a situation where debt overhang after a financial meltdown forces consumers and businesses to retrench for years. The result is a lengthy period of slow economic growth, high unemployment, and big budget deficits.
There's plenty of academic research to back Gross up. The economists Kenneth Rogoff of Harvard and Carmen Reinhart of the University of Maryland have found that the aftermath of bank crises in places like Scandinavia and Japan is usually marked by "deep and lasting effects on asset prices, output, and employment." Similarly, the Cleveland Federal Reserve Bank concluded that such banking events cause "negative long-term effects on the economy, such as slow growth, high interest rates, and lower living standards."
Sound familiar? Now even though all this seems to pretty accurately describe what America is currently going through, Team Obama has been continually dismissive of such scenarios. They argue the U.S economy is so big and unique"”it possesses the world's reserve currency, for instance"”that international comparisons are misleading at best, useless at worst. As the saying goes, it can't happen here.
- Ben Bernanke's got our backs. During the 2000 presidential campaign, Senator John McCain joked that if former Federal Reserve chairman Alan Greenspan died, it would be wise to prop up his corpse and keep him on the job, like the title character in the movie Weekend at Bernie's. Few observers hold Fed chairmen or the central bank in such high esteem these days. But the White House apparently does. After passing a giant stimulus in 2009, the administration pivoted to "the agenda""”health care, financial reform, cap and trade. Jobs and the economy? Certainly the combination of higher government spending and oodles of monetary stimulus from Ben Bernanke & Co. would be enough to spur a return to growth.
Yet the deluge of Fed money seems to be sitting on the sidelines. As economist David Gitlitz of High View Economics points out, interbank lending, a major funding source for consumer and business loans, has shrunk from nearly $500 billion to less than $175 billion since the fourth quarter of 2008. The Fed's low interest rate policy is great for bank profits"”institutions are able to get a decent return by borrowing cheap and plowing the money into government debt"”but that has done little to boost lending to job creators or the rest of the economy.
And Obama may now start to comprehend the frustration of predecessors such as George H.W. Bush and Richard Nixon when the Fed seemed to be unaccommodating to their economic and political concerns. Even though the recovery looks to be faltering, the Fed's recent policy meeting showed the central bank is taking only the tiniest of baby steps toward another round of "quantitative easing" by buying more Treasuries or other securities. Not that "QE2" would be a magic bullet for the economy. The White House is learning, as CNBC's Lawrence Kudlow puts it, "the Fed can print more money, but it can't print jobs."
To some degree, the tendency of the Obama White House to "slide down the slope of hope" is understandable. A New Normal scenario, for instance, looks like an economic recipe for a one-term presidency. Easier to dismiss it than seriously consider and perhaps accept it. And relying on both the Fed and its own onetime, trillion-dollar dose of fiscal steroids to restore prosperity"”set it and forget it"”freed the administration to spend its remaining political capital on passing its domestic policy wish list.
But the results of that policy positivism have been gloomy and seem unlikely to brighten. A recent analysis by the San Francisco Fed of forward-looking economic indicators finds that "the macroeconomic outlook is likely to deteriorate progressively starting sometime next summer, even if the data suggest that a renewed recession is unlikely over the next several months." The job market is also full of worrisome signs. The extended period of high unemployment may be turning from cyclical to structural, where there are not enough qualified and employable applicants for new job openings. If that happens, even higher economic growth may do little to lower unemployment.
Of course, the administration could dramatically change course and join with a more Republican Congress next year to both lower the long-term debt outlook and boost the economy by slashing taxes on capital and corporations (which mostly passes through to workers). But don't bet on it.
James Pethokoukis is a columnist for Reuters.
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