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4 Either way, it could be an unkind
cut By Henry C K Liu
Strong employment had been a key benefit
of the liquidity boom in the United States even
though wages had not been rising enough to keep up
with asset prices. But news on slow growth of
employment for July was an ominous sign that the
liquidity boom was ending.
Economists know
that employment data are a lagging indictor,
showing only the effects of previous periods. Yet official
unemployment in the US for
July was only 4.6%, or 7.1 million workers, still
"uncomfortably" near the bottom of the structural
range (4-6%) of what neo-classical economists call
a non-accelerating inflation rate of unemployment
(NAIRU).
The low structural unemployment
rate presented a lingering inflation threat. It
will continue to do so until unemployment rises
past the 6% NAIRU limit to stall the economy with
deflation.
The voodoo
theory Central banks operate on the theory
that NAIRU is the cardinal rule to keep inflation
in check, using current unemployment to fight
future unemployment, keeping some people out of
work now in hope of enabling more people to work
later.
The rationale is that excessively
low unemployment is undesirable because it pushes
up wages, in turn pushing inflation, which will
require central banks to raise interest rates,
which will in turn slow the economy, which will
increase unemployment down the road. This
necessary unemployment is called structural or
natural unemployment, and up to 6% of it must be
tolerated to maintain a non-accelerating inflation
rate. In other words, there is no case for
central-bank intervention as long as unemployment
stays below 6%.
The problem with the
concept of NAIRU is that when wages have
persistently failed to rise as fast as the
astronomical rate of asset appreciation, any talk
of wage-pushed inflation is perverse and does not
need 6% unemployment to contain. This is
particularly true when outsourcing of jobs to
low-wage countries has kept inflation abnormally
low. In fact, full employment with rising wages is
an effective way to close the wide gap between
stagnant personal incomes and runaway asset prices
buoyed by debt.
Not only is NAIRU a
dubious theory, particularly in a debt bubble, it
is also decidedly a perverse moral posture of
neo-liberalism. NAIRU condones a policy of making
a helpless minority pay heavily now for maximizing
future marginal job opportunities that may benefit
the majority, instead of forgoing future
maximization to ensure that all can have jobs now
to share the benefits of full employment
equitably. The equity issue is exacerbated when
structural unemployment consistently falls on the
same segment of the labor force that is least able
to fend for itself.
Credit crisis
aggravated by stagnant wages The credit
crisis that has been ongoing since last month was
obviously caused by years of systemic credit
abuse, but it is aggravated by stagnant wages that
have been out of step with runaway debt-pushed
asset inflation for almost a decade. Throughout
the United States, workers have been forced to
live in homes priced at levels their wages cannot
support because wages have persistently fallen
behind home prices.
The resilience of US
equity markets, buoyed by robust employment and
strong corporate earnings fueled by cheap debt,
has been frequently cited by irrational yet
unyielding optimists as proof that the credit
crisis in the money markets is merely a passing
shower in otherwise fair economic weather. The
reality is that the robust employment and strong
corporate earnings have been the unsustainable
result of systemic credit abuse. This illusion,
formed by mistaking debt-pushed exuberance in the
stock market as a sign of health in the economy,
was shattered recently by news of the first US job
contraction in four years, which many market
participants regard as the first sign of a
financial perfect storm.
Having bought
into the myth of a benign decoupling of the credit
squeeze from the real economy, analysts had
expected a gain of 110,000 new US jobs for August.
The unwarranted expectation caused market shock,
sparking sharply lower stock prices, when the ugly
reality showed a loss of 4,000 jobs. Normally,
central banks, driven by an institutional bias
bordering on phobia toward inflation threats,
would consider unemployment rising toward 6%
positive news, since it removes inflationary
pressure. But the news of a reverse in employment
in August spooked the jittery market, even though
the overall US unemployment rate stayed at a
benign 4.6%. The market surmises that when the
credit market collapses even with low structural
unemployment, the economy is heading for serious
trouble.
Talk of recession immediately
proliferated in the media as it finally dawned on
even the most doggedly wishful-thinking analysts
that August was the month that economic reality
set in to dispel doctrinaire myths that assert
that economic fundamentals can remain strong in
finance capitalism even when financial markets
seize up. Waves of layoffs had been anticipated in
all sectors related to housing and financial
services in recent months, but unemployment was
still expected to stay below the 6% NAIRU
threshold, posing no serious threat to the economy
except inflation. This is the reason the US
Federal Reserve has been reluctant to lower the
Fed Funds rate target.
Then suddenly, in
August, like the subprime-mortgage crisis
spreading to the entire financial system,
contagion began spreading unemployment to all
sectors. The market fears that unemployment might
shoot above 6% within a few short months, because
layoffs have been made easy and swift for
corporate management by government policy in the
past decade. Whether the Fed will lower the Fed
Funds rate target in the Federal Open Market
Committee (FOMC) meeting on Tuesday depends on
whether the Fed sees 6% unemployment is on the
horizon.
Poor employment data tilt
sentiment Despite reports of massive bank
exposure - approaching $1 trillion - to the
systemwide credit squeeze from a 13.4% contraction
of the commercial-paper market in the past four
weeks, the mood among equity investors had still
been one of cautious optimism sustained by silly
pep talks from giddy analysts. That unwarranted
optimism evaporated with the US jobs report for
August.
Share prices fell and both
corporate bonds and Treasuries rallied to push
yields down sharply on the very day of the bad
news on jobs, as traders fled to safety on the
realization that many more homeowners will have
difficulty meeting higher adjusted interest
payments in their floating-rate mortgages this
year and next when unemployment rises further.
Recession risks are overshadowing rate-cut hopes
as market participants begin to understand that
rates cuts can be neutralized by a liquidity trap
in which banks cannot find enough creditworthy
borrowers at any rate.
The interest-rate
futures market was already pricing in a Fed Funds
rate of 4.57% by the end of October, a
68-basis-point drop from current the Fed Funds
target of 5.25%. Fear remains that a rate cut not
only may not help alleviate the present credit
squeeze in the non-bank financial system, it could
also be a psychological trigger that would destroy
the Fed's already dwindling credibility. A market
that catches on to the impotence of central-bank
intervention can go into a free fall.
In
fact, a program of sharp rate cuts will render
risk-averse investment unattractive and revive the
insatiable risk appetite for
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