Jack Rasmus

Dr. Jack Rasmus
Copyright 2020

This past Friday, May 8, the US Labor Dept. released its latest jobless figures. The official report was 20 million more unemployed and an unemployment rate of 14.7%.
Both mainstream and progressive media reported the numbers: 20 million more jobless and 14.7%. But those numbers, as horrendous as they are, represent a gross under-estimation of the jobless situation in America!

One might understand why the mainstream media consistently under-reports the jobless. But it is perplexing why so many progressives continue to simply parrot the official figures. Especially when other Labor Dept. data admits the true unemployment rate is 22.4% and the officially total unemployed is 23.1 million.

Here’s why the 20 million and 14.7% is a gross under-representation of the magnitude of jobless today:

Only Half Month Data

First, the 20 million for April is really only for data collected until mid-April. Nearly 10 million more jobless workers filed, and received, unemployment benefits after mid-April. And likely millions more jobless have been attempting to get benefits but haven’t. Even officially, more 33.5 million have filed for benefits, with several millions more in the pipeline. So the April numbers of jobless—both receiving benefits and not yet getting them—are more than 20 million!

Only Full Time Employed Layoffs

An even greater misrepresentation is that the official 20 million unemployed represents only full time workers becoming unemployed. It’s the figure from the government report that is the category called U-3, or full time workers. There are between 50-60 million more workers who are part time, temp, contract, gig and otherwise ‘contingent’ workers (i.e. not full time) who are not considered in the 20 million and 14.7%.

Check out the Labor Dept’s own data, in Table A-8, which shows for March and April no fewer than 7.5 million part time workers became unemployed. In April jobless in this group doubled over the previous month, rising by about 5 million in April, according to the Labor Dept.’s own monthly ‘Employment Situation Report’. 5 million to 7.5 million represent what’s called the U-4 government unemployment rate.

But there’s still more. It’s what’s called the U-5 and U-6 unemployed. Who are they? They are what the government calls workers without jobs who are ‘marginally attached’ to the labor force and workers who are too ‘discouraged’. They are just as ‘jobless’ as full time and part time workers. But they’re put in another category simply because they haven’t actively looked for a job in the most recent four weeks.

You see the US government defines unemployed as that subset of jobless who “are out of work and actively looking for work”. If you haven’t looked in the last four weeks, you may be jobless but aren’t considered unemployed! Go figure. Add them to the U-3 unemployed, and the totals for unemployed in America rise to 22.4%. Add in those who filed for benefits in the last half of April, or tried to, and we get closer to the publicly admitted 33.5 million without jobs and receiving unemployment benefits.

The Disappeared 8 Million Unemployed

But that’s not even the whole real picture. The way the government defines unemployment a worker must be part of the labor force. The labor force is composed of two groups: those who have jobs and those who are officially unemployed—i.e. out of work and looking for work in past four weeks. If you are not looking, you’re ‘marginally attached’ (U-5, U-6). It assumes if you have stopped looking in the past four weeks you are part of the 850,000 ‘marginally attached’. But that figure is not credible. Somehow there are less than a million jobless who simply haven’t tried to find a job in the last four weeks? Really? There are many millions.

A government stat that suggests there are likely millions more not in the labor force who are jobless nonetheless is called the ‘Labor Force Participation Rate’. It estimates the percent of the working age population who either have a job or are officially unemployed.

There’s approximately 164.5 million employed/officially unemployed in the US labor force as of May 1, 2020. In February 2020 the labor force participation rate was 63.4% of the US labor force. As of May 1, that had dropped to only 60.2%. Roughly 8 million had dropped out of the labor force over the past year ending this April 2020. And remember: if they aren’t in the labor force they can’t be counted as unemployed. So where did the additional 8 million dropping out go?

The US government doesn’t consider them unemployed so they don’t show up in the U-3 or even U-6 statistics! But if they aren’t in the labor force they are jobless by definition. Perhaps 850,000 are counted as the ‘marginally attached’. But what about the remaining 7.2 million or so? The government has no category for them except the estimation of them in the labor force participation rate. It tries to explain the large number away by saying they retired or went back to school. But did 7.2m (63.4% in Feb. drop to 60.2% in April) retire in 2 months? And they certainly can’t have gone back to school in mid-March/April 2020.

Another government statistic that corroborates this ‘missing 8 million’ in the labor force participation rate is called the Employment to Population Ratio stat. It measures how many are in the labor force as a percent of the total US population of nearly 340 million.

If the EPOP percentage goes down, then fewer are working even though they’re obviously still alive and part of the US population. That figure has declined from 61.1% of the US population employed to 51.3% of the population employed as of May 1, 2020. That’s a nearly 10% drop. 10% of 340 million is about 34 million. And 34 million is not 20 million for April, or even the Labor Dept.’s total 23.1 million.

So both the labor force participation rate and the employed to population ratio both suggest the Labor Dept.’s official U-3 (or even U-6) unemployed figures are grossly under-representations of the total Americans without jobs today.

Voluntary Jobless Are Not ‘Unemployed’

One possible reason for the discrepancies between the official unemployed of 23.1 million vs. the 33.5 million receiving benefits, or the 7-8 million not being counted per the labor force participation rate and EPOP ratio, may be due to the government in this current crisis choosing not to count as unemployed those workers forced to leave work since February to care for dependents.

Remember the government’s driving definition of unemployed is the worker must be ‘out of work and actively looking for work’. Millions of workers who have been forced by the current crisis to leave their job to care for elderly and disabled family members, or to care for young children forced to stay home due to school closures, are not ‘actively looking for work’. Few Americans can afford nannys to watch their young children so they can work. But those in this situation are not considered unemployed by the US Labor Dept. because they don’t fit the definition of ‘actively looking for work’! It’s not clear how many in this category the Labor Dept. has recently refused to acknowledge as officially unemployed.

In America you may be jobless, but that doesn’t necessarily mean per the government you are unemployed!

The above stats and data show that the under-reporting of the jobless in the US is not some kind of conspiracy by the Labor dept. and the government. The data are there, buried in the monthly labor reports beyond the executive summaries. The government stats, moreover, are not perfect. There are serious problems related to raw jobs data recovery, to the various assumptions on that raw data the government makes to come up their jobs ‘statistics’ (always operations on raw data with assumptions which data to count and how). There are conflicting conclusions often between this or that data or statistic. Furthermore, in recent years changes in statistical processing have sought repeatedly to change definitions and processes in order to ‘smooth out’ swings in the statistics—whether employment, unemployment, wages, or inflation. The government has a vested interest in ensuring the smoothing. It reduces government (and especially business) costs of programs and operations.

If there’s a conspiracy of sorts, it’s in the media that purposely seems to always ‘cherry pick’ the most conservative stat to report. Thus we get the media trumpeting every month the nearly worthless statistic of the U-3 unemployment rate—a stat that applies only to full time workers and ignores part time, temp and other contingent labor who make up now nearly a third of the US labor force; a statistic based on a narrow definition of unemployed that has become an oxymoron when estimating unemployed; a statistic based on questionable assumptions and data gathering; and a statistic that can’t be reconciled with other statistics like the labor force participate rate.

The real unemployment rate is not the U-3 figure of 14.7% but easily 25% today. And the real total jobless are not the U-3 20 million, or even 23 million, but somewhere between 35-40 million… and rising!

However, what’s really disappointing is that many progressive and left economists simply parrot the government’s and mainstream media’s misleading U-3 statistic. One can understand why the corporate mainstream media keep pushing the U-3 stat and thus trying to make the unemployment situation look better than it is (or today not as bad as it is). But progressive economists should know better.

Dr. Jack Rasmus
May 11, 2020
Copyright 2020

Dr. Rasmus is author of the just published book, ‘The Scourge of Neoliberalism: US Economic Policy from Reagan to Trump’, Clarity Press, January 2020; and the previously published ‘Central Bankers at the End of Their Ropes, Clarity Press, August 2017. He blogs at jackrasmus.com and tweets at @drjackrasmus and hosts the weekly radio show, Alternative Visions, Fridays at 2pm eastern time.

There’s a historic experiment underway among US capitalists and policy makers. That experiment may or may not succeed. It’s the Federal Reserve PRE-BAILOUT of not only the US financial system but the entire business economy as well. The Fed has introduced at least $9T in liquidity (money) injections into the system in the goal of heading off a massive wave of potential and forthcoming debt defaults, deflation, and bankruptcies via various measures: new QE, trillions of $ to Repo markets, funneling trillions more via recent bailout funds for large, medium and small businesses through the private banks, ending financial regulations on the banks, liabilities for corporations, guaranteed loans, and so on. It’s all about fattening bank and non-bank balance sheets to weather the loss of revenues required to keep paying interest and principal on the tens of trillions of excess business and household debt (latter held by investors). The continuing payments on that debt is necessary to prevent a massive historic wave of debt defaults that will eventually sink bank balance sheets, creating a credit crash and a further and deeper collapse of the real economy–i.e. a depression. The Fed succeeded in 2008-09 in preventing a second banking crash by injecting $5-$6T into the banking system. The cost of that was to set off massive financial asset market speculation and bubbles, enriching investors as never before. The cost was also chronic low interest rates for 8 yrs that resulted in corporate binging on new business debt accumulation. Now the consequences are coming home once again. The Fed’s bailout of 2008-09 created a fragile system highly susceptible to another crash. The Fed’s solution in 2008-09 has become the Fed’s nightmare of a repeat, even greater, in 2020. So the Fed is throwing even more money at the system to prevent another crash. History will tell (soon) if it will be successful in staving off another financial crash, that will all but ensure a collapse into a bona fide depression.

The US economy is today unstably between a ‘great recession 2.0’ in the real economy and a bona fide great depression a la 1929-34. Whether the future trajectory is more like 2008-2017 or whether it slips into a 1929-34 scenario depends on whether the Fed’s $9T (and rising) money injections can prevent a financial crash in 2020-21, as defaults and bankruptcies rise and expand throughout the US economy in 2020-21.

In my Alternative Visions radio show of May 1, 2020 I discussed these conditions and scenarios in detail.

TO LISTEN GO TO

:

http://alternativevisions.podbean.com

SHOW ANNOUNCEMENT:

The US central bank, the Federal Reserve (Fed), is in the process of throwing trillions of dollars at the economy, most to businesses and corporations, in an historic effort to bail out the banks and now non-bank businesses as well (for the first time). The objective is to head off and prevent the deep and rapid contraction of the US economy from spawning a wave of defaults and bankruptcies among non-bank businesses that will soon fail to ‘service’ their massive accumulated debt loads run up since 2010. Broad sectors of US business heavily laden with corporate debt—corporate junk bonds, junk loans, and related debt amounting to several trillions $ in the US alone—are on the verge of failing to make principal & interest payments on that massive debt. The Fed is feeding them free money to continue to do so. As well as pumping up bank balance sheets to provide a cushion for the defaults and bankruptcies and avoid a banking-financial system crash in the event of defaults when they come. Rasmus explains how the capitalist drive to return workers to their jobs now gaining momentum is also about business revenue restoration to avoid defaults. Industries most prone to defaults: travel, oil and energy, retail, entertainment will be the leading edge. Rasmus explains the magnitude and composition of the Fed’s $9T commitment to ‘pre-bail out’ the banks and business, and how the US working class will be required to pay the bill—a present on this May Day to workers.

One of the readers of this blog recently asked me my views on topics such as the call by some left economists for a general debt forgiveness (Debt Jubilee), on Modern Money Theory (MMT or sometimes referred to as ‘Magical Money Tree’), and the Federal Reserve bank (central bank) pre-emptive bail outs of banks and non-banks underway and whether the latter will succeed in generating an economic recovery from the current deep Coronaviral impacted US economy. What follows are some of my quick reflections and commentary on these topics.

My views on monetary policy are somewhat summarized by the argument that in the current era of finance capitalism dominance, monetary policy has been the first and foremost choice of capitalist governments and policymakers. Push the bail out (and normal times economic stimulus as well) through the central banks and into the private banking system. The latter then distribute the money injection to the non-banks and financial investors of their preference. What trickles down to the wage earners, consumers and households is a residual in terms of income. Fiscal policy in terms of taxation is focused on business-investor tax cutting and on expanding government fiscal spending on corporate subsidies. Deficits that remain are financed by global purchases of US Treasuries as the money capital is recycled back to the US from offshore where it accumulates due to US trade deficits with the rest of the world. Industrial policy is to compress real wages, weaken or destroy unions, incrementally shift the cost of benefits to workers, and deregulate and privatize what remains of public works and public goods. Monetary policy is designed to keep interest rates low and ensure a low dollar exchange rate to maximize US multinational corporations offshore repatriation of foreign profits into the maximum amount of US dollars.

In the 21st century both monetary and fiscal policy are about subsidizing capital, especially finance capital, and less and less about stabilizing or stimulating the economy. (See my recent book, The Scourge of Neoliberalism: US Economic Policy from Reagan to Trump’, Clarity Press, January 2020, for more of this argument in detail)

As a result of this view, needless to say I am not a big fan of capitalist central bank monetary policy. Nor of monetary policy in general, since it has always been about subsidizing and/or bailing out finance capital. Debt is a means by which financial assets are subsidized as well. Money and Debt are thus central to maintaining the current 21st century capitalist system which requires excessive money injections (liquidity) and corresponding Debt accumulation as means to further expand capitalist wealth. Since it is central, I argue that capitalists and their governments will not entertain either a ‘debt jubilee’, and MMT is a theory that attempts to invert capitalist monetary policy and employ it for fiscal income redistribution to workers, consumers and households; thus that too is a contradiction to the system and would not be allowed. In short, both a Debt Jubilee or MMT require a virtual political revolution first before they could ever be introduced. The advocates of both Jubilee and MMT are politically naive to advocate solutions that cannot be introduced in the era of 21st century global finance capital hegemony. They are impossible ‘reforms’ of the system without a fundamental political change that drives capitalist interests from the sources of institutional government and state power.

READER’s QUESTIONS:

My questions for you (Jack) are about the ‘Magical Money Tree’ (i.e. MMT, my italics). Does it exist? Can the Fed create money to pay for whatever it decided was necessary for the economy? If the decision was to pay off all student debt, could the Fed do so? If so, who gets stuck with the bill. Could there be a complete debt repayment for personal debts and corporate debts? If there is not a Magical Money Tree could one be created? If so, how? What if the government took back the constitutional power to create money and a new Greenback-era developed?

MY COMMENTS IN REPLY:

This is the old Modern Money Theory hypothesis, renamed ‘Magical Money Tree’. It assumes that monetary policy, as money creation, can stimulate economic growth. MMT is just QE flipped on its head. Instead of the Fed bailing out corporations and capitalists only (per its mandate) it can be used to bail out the rest of us. But there are limits to monetary solutions to a crisis, whether QE or a public interest QE that would transform the Fed into a kind of public bank. The problem with MMT is it is politically naïve. To create a Fed as Public Bank it will take a political revolution. The banks and investors behind the Fed (they’ve controlled it ever since 1913) won’t allow that without a political fight that changes the nature of the capitalist system itself.

Beyond that, the problem with monetary solutions is that it holds that the redirecting the money supply is sufficient. It ignores the role of money demand and money velocity. You can provide all the money supply you want by creating money electronically, as the Fed does, but that doesn’t mean there’ll be the demand for money or that money demanded will eventually be used for investment, employment, and real growth. In times of deep crisis like this, much of the money supply might be ‘borrowed’ but will be hoarded, redirected offshore, distributed to shareholders, or invested in financial assets that are more profitable but produce no real growth.

Can debt be ‘expunged’? Yes, but all the talk of debt jubilee is again political naivete. Why? Because it means the finance capitalists that ultimately ‘own’ the debt will not just take a haircut but will have their heads shaved at the neck. They will resort to any undemocratic violent response necessary with the help of their politicians to stop it. All private debt forms, including credit card debt, auto debt, mortgage debt, revolving debt, and private bank provided student debt are owned by big capitalist investors. Debt forgiveness means their assets would collapse to zero. What about public held debt? US government, government held student debt, fannie mae-freddie mac government held mortgage debt, state-local government debt? While that could technically be expunged since the government (taxpayers & citizens) own it, to do so would cause a collapse of private debt markets’ price values and, in turn, mean a major loss of asset values for capitalist investors. So the latter resist that as well. A progressive government might be able to introduce a staged reduction in student debt. Or as I have argued, stretch out the 10 yr. normal term of student debt to 30 yrs and reduce the rate of interest to no more than that for the 30 yr. Treasury bond, or forgive one tenth of the principal per yr. over ten years for all student debt holders. That might pass but not with the Neoliberal governments we’ve had. Again the concern of capitalists is that even student debt expunging will have a negative impact on the values of other assets held by the capitalists.

What about relief from rents and mortgages.? Same story here. Who puts up the money capital for multi-family apartments, and for both residential and commercial property mortgages? It’s the rich private investors and their financial institutions (hedge funds, private equity, etc.). They take major losses if there’s a rent or mortgage forgiveness. A moratorium for rent and mortgages is different. It just means they move the payments to the back of the term of the debt payment schedule. On paper it doesn’t change the value of their assets significantly. But forgive it, or expunge it, and it destroys their values.

The current crisis has only just begun, both in health terms and economic. The virus is a precipitating causal force, not the fundamental driver of the current crisis–which is still unfolding both in health effect terms and independent dynamics of economic contraction. There will be a second virus wave, likely worse than the first which always happens in these severe pandemics. The present reopening of the economy by Trump and business interests behind him demanding it will exacerbate the contraction in a second wave, moreover. It’s certainly not a V shape recovery; it will be more like a ‘W’ shape, with successive contractions after short shallow recoveries. And if defaults lead to general bankruptcies it will mean a financial crisis at some point that will exacerbate the contraction still deeper.

And there’ll be no re-shutdown once a second viral wave happens, later this year most likely. Trump and broad sections of the capitalist class have already decided that they’ll accept the death toll and stay open throughout the second wave. (and the third, which also historically follows about 6-12 months later).

That’s been the pattern with the 1918 and 1958 pandemics. The second wave is always the worst.

Ditto for the economy. In other words, there are forces economic released that are now independent of the health effect, although the latter will also continue to wreck havoc economically. The massive $9T Fed-Treasury liquidity injection (so far, more coming) should be understood as a pre-emptive bank and non-bank bailout. Massive defaults are coming, already spreading from oil,energy and retail sectors, eventually to other service sectors and state and local governments. The bailouts are designed to flood the banks with liquidity and the contain the defaults in the non bank sectors. But once again, massive liquidity as money supply injection may slow down or even prevent some insolvency crises (i.e. defaults and bankruptcies) but that doesn’t mean stimulate economic investment and recovery. Once again, money solutions don’t necessary result in boosting the real economy, and that means jobs, and wage incomes that will collapse. Most of the liquidity will be hoarded on balance sheets or to make minimal payments on debt. It won’t go into real investment that generates real jobs, wages, consumption, and recovery.

Can the government, using MMT, engage in direct spending to restore the economy? Technically yes. But that kind of Treasury provided funding will add to the government debt at a time when business and capitalists are demanding more funds (and debt) for them (i.e. raise the government debt to bailout them out). So there’s a competition for who gets bailed out. Who do you think in the current Neoliberal era is going to get funded then: capitalists or consumers/households/workers? Corporations will come first, as we’ve seen in the bailouts of the last couple months: Trillions in loans and grants (mostly grants in the end since loans will be converted and forgiven eventually for businesses) for them vs. just $500b for workers. And there’ll be no more for extended unemployment benefits after July or supplemental income checks of $1200 forthcoming. That’s it. Go back to work and die. And if you’re on unemployment benefits now, if you don’t return to work you lose them.

The Fed ‘money tree’ is backed by US Treasury bonds sales. And those bonds add to the federal government debt. The Fed doesn’t simply create an electronic entry in its accounts from which banks and capitalists can withdraw funds. US Treasuries are created to allow the Fed to make those entries. And that adds to the government debt. You could have the US Treasury to perform the function of the Fed, as was the case before 1913. But the function remains the same, whether carried out by the Fed or by the US Treasury-Government. The Treasury was the Fed before 1913. So the problems of excess debt to bail out capitalism will continue even if the US Treasury took back the money supply creation function. Nothing really changes. The choice will always remain: create Treasury bonds for spending (or lending to banks, non-banks) for whom? Finance capitalists (bankers)? Non-bank capitalists? (airlines, oil frackers, etc.). Or consumers and workers? It again comes down to a political issue and whether the capitalist State will bail out capitalists or us. And who pays their politicians? So guess who they’ll bail first and foremost?

The Fed was created so that the politicians would not have to bail out the bankers and capitalists directly, by raising taxes. The bailouts funnel through the Fed, funded still however by T-bonds, which add to the national debt. How high can the US debt rise? It’s now well above 100% of annual GDP. But Japan’s is over 200%.

The US government is creating the money supply, but indirectly: by using T bonds to fund the Fed who injects liquidity into the banks (and now non-banks too). To say let’s get rid of the Fed as intermediary and use the Treasury itself only changes the structure but not the actual process. The Fed now in effect transfers the private capitalist debt on to its own balance sheet each time it bails out the banks and corps now. The Treasury would do the same without the Fed. But that would pose a political problem for the politicians with the electorate, so they prefer an intermediary like the Fed, central bank, to do it so folks don’t understand what’s really going on. Simply put, the government ultimately bails out the banks and capitalists. So ending the Fed and giving money creation back to the Treasury changes nothing but the appearances!

MMT simply creates the fiction that somehow, if the Fed or Treasury could directly fund social spending, that the liquidity injection to households could stimulate the economic recovery.

To sum up my view: it doesn’t matter if it’s the Fed or Treasury. Pure monetary solutions don’t work well in a deep contraction and crisis. Liquidity injections get hoarded not invested. And they don’t stop, only maybe slow, insolvency crises (defaults, bankruptcies). And what we have today is a Fed massive liquidity injection trying to hold off a general insolvency crisis. I predict it will fail. What we’ll need is another even larger ‘New Deal’ direct government spending, including government hiring (per WPA). But you don’t need an MMT program for that. You don’t need a Fed. The Fed is there to provide cover for the politicians and capitalist State so they don’t appear directly responsible for bailing out bankers and capitalists to the electorate. (Check out my 2017 book, ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression’ for more on the limits of monetary policy in general).

Jack Rasmus
May 6, 2020

Listen to my latest 20min. radio interview with the ‘Political Misfits’ radio program in Washington D.C., May 1, on the state of the US economy and talk of V-shape recovery. Why V-shape will not occur despite desperate ‘return to work’ orders by Trump and politicians.

TO LISTEN GO TO

:

https://www.spreaker.com/user/radiosputnik/neoliberalism-is-in-trouble

The spin is in! Trump administration economic ‘message bearers’, Steve Mnuchin, US Treasury Secretary, and Kevin Hasset, senior economic adviser to Trump, this past Sunday on the Washington TV talking heads circuit launched a coordinated effort to calm the growing public concern that the current economic contraction may be as bad (or worse) than the great depression of the 1930s.

Various big bank research departments predicting a GDP contraction in the first quarter (January-March 2020) anywhere from -4% to -7.5%, and for the current second quarter, a further contraction from -30% to -40%: Morgan Stanley investment bank says 30%. The bond market investment behemoth, PIMCO, estimates a 30% fall in GDP. Even Congress’s Budget Office recently estimate the contraction in GDP could be as high as -40% in the 2nd quarter.

Mnuchin-Hassett Promise a New Old Normal

Despite the flashing red lights on the state of the US economy, the Trump administration’s key economic spokespersons are pushing the official line that the economy will soon quickly ‘snap back’. On the near horizon is a V-shape recovery coming in the 3rd quarter (July-September) or, at the latest, the following 4th quarter. The economy may be particularly bad, they admit, but be patient folks a return to normal is on the way before year end!

Speaking on Fox News Sunday Treasury Secretary, Mnuchin, declared the US economy is about to open up in May and June and “you’re going to see the economy really bounce back in July, August and September”. And Hassett echoed the same, just a barely less optimistic viewing the snap back in the 4th quarter. Getting ahead of the bad news coming this Wednesday when 1st quarter US GDP numbers are due for release, Hassett admitted a big shock is coming on Wednesday, to be followed by “A few months of negative news that’s unlike anything you’ve ever seen”. But not to worry, according to Hassett, the 4th quarter “Is going to be really strong and next year is going to be a tremendous year”.

Meanwhile, the administration’s big banker allies were also making their TV news show rounds, singing the same ‘happy days will soon be here again’ tune. Bank of America’s CEO, Moynihan, appearing on ‘Face the Nation’ show, predicted consumer spending had bottomed out and would soon rise nicely again in the 4th quarter, October-December, followed by double digit GDP growth in 2021!

The Trump administration is pressing hard to reopen the economy now! It knows if it doesn’t the contraction of the economy could settle in to a medium to long term stagnation and decline. Business interests are pushing Trump and Republicans to reopen quickly, regardless of the likely consequences for a second wave of the virus devastating national health and death rates. There is a growing segment of US business interests desperate to see a return to sales and revenue, without which they face imminent defaults and bankruptcies after a decade of binging on corporate debt. A growing wave of defaults and bankruptcies could very well provoke an eventual financial crisis which would exacerbate the collapse of the real economy even further.

The Fed’s $9 Trillion May Not Succeed

So far the Federal Reserve central bank has committed to $9 trillion in loans and financial backstopping to the banks and non-banks, in an unprecedented historic experiment by the Fed. Not just the magnitude of the Fed bailout in dollar terms, already twice that the central bank employed in 2008-09 to bail out the banks in that prior crash, but the Fed this time is not waiting for the banks to fail. It’s pre-emptively bailing them out! Also new is the Fed is bailing out non-banks as well, trying to delay the defaults and bankruptcies at their origin, before the effects began hitting the banking system. Bailing out non-banks is new for the Fed as well, no less than the pre-emptive bank rescue and the $9 trillion—and rising—total free money being thrown at the system. But it should not be assumed the Fed will succeed, despite its blank check to banks and businesses. Its historic, unprecedented experiment is not foreordained to succeed—for reasons explained below.

For the magnitude and rapidity of the shutdown of the real economy in the US is no less unprecedented. Even during the great depression of the 1930s, the contraction of the real economy occurred over a period of several years—not months. It wasn’t until 1932-33 that unemployment had reached 25%.

As of late April 2020, that 25% unemployment rate was already a fact. The official government data indicated 26.5m workers had filed for unemployment benefits. That’s about 16.5% of the 165 million US civilian labor force. Bank forecasts are 40 million jobless on benefits by the end of May. But respected research sources, like the Economic Policy Institute, recently estimated that as many as 13.9m more are actually out of work but have not yet been able to successfully file for unemployment benefits. So the 40 million jobless may already be here. And that’s roughly equivalent to a 25% unemployment rate. In other words, in just a couple months the US economy has collapsed to such an extent that the jobless ranks are at a level that took four years to attain during the great depression of the 1930s!

A contraction that fast and that deep likely has dynamics to it that are unknown. It may not respond to normal policy like enhanced unemployment benefits, emergency income checks, and even grants and loans to businesses on an unprecedented scale such as being provided by the Fed. The psychology of consumers, workers, businesses, and certainly investors may be so shocked and wounded that the money injections—by Congress and by the Fed—may not quickly result in a return to spending and production. The uncertainty of what the future may bring may be creating an equally unprecedented fear of spending the money. Economists sometimes call this a ‘liquidity trap’. But it may more accurately be called a ‘liquidity chasm’ out of which the climb back will prove very slow, very protracted, and the road strewn with economic landmines that could set the economy on a second or third collapse along the way.

The V-shape argument is predicated on the assumption that the virus’s negative effect will dissipate this summer. Those supporting the argument assume, openly or indirectly, that the economic collapse today is largely, if not totally, due to the virus. It’s not really an economic crisis; it’s a health crisis. And when the latter is resolved, the economic crisis will fade as well as a consequence.

But this assumes two things: first that the virus will in fact ‘go away’ soon and not hang like a dead weight on the economy. Second, that there were not underlying economic causes that were slowing the US (and global) economy already before the virus’s impact. The virus is seen as the sole cause, in other words, and not as a precipitating factor that accelerated an already weak and fragile economy into a deep contraction. But the virus may be best understood as an event that precipitated and then accelerated the contraction of an economy already headed for a slowdown and recession.

These latter possible ways to understand the current economic crisis are of course ignored by the advocates of a V-shape recovery. In their view, it’s just a health crisis. And the health crisis is about to end soon. And when it does, we’ll return to the old ‘normal’ and the economy will snap back. But the depth and rapidity of the decline into what is, at least, a ‘great recession 2.0’ and perhaps something more like the even deeper and longer great depression of the 1930s, strongly suggests that forces of decline have been unleashed in the US economy that have a dynamic of their own now. And that dynamic is independent of the precipitating cause of the virus which, in any event, is not going away soon either. In all cases of such virus contagion, there has always been a second and even third wave of infection and death. And Covid-19 appears the most aggressive and contagious.

It’s not just the 40 million and likely more unemployed that define the unprecedented severity of the current crisis.

Millions of small businesses have already shut down or gone out of business. More will soon follow. And many will never re-open again. The average number of days of cash on hand for small businesses before the virus impact was 27 days. Many small businesses are projected to run out of that by end of April. That’s why we are not witnessing growing protests and refusals to abide by a ‘sheltering in place’ order announced by various state governors. Small businesses and their workers, both on the brink of bankruptcy are taking to the streets—encouraged of course by radical right forces, conservative business interests, and political allies right up to the White House.

The millions of workers who haven’t been able to get through to successfully file and obtain unemployment benefits, and the millions of smallest businesses who have been squeezed out of the Small Business bailout program (called the Pay Protection Program) are fertile ground for right wing propaganda demanding the country reopen the economy immediately, even if it’s premature in terms of suspending virus mitigation efforts and almost sure to result in a second wave of infection that will debilitate the economy again later in the year.

And the flow of funding from recent small business legislation passed by Congress has been bottled up by big banks gaming the system—first using the crisis to extract concessions from the federal government on further bank deregulation, getting guarantees by the government on liability protection, ensuring they receive lucrative fees and charges from the lending, and requiring the government to reimburse them for loans that might later default and fail.
In addition to the slow distribution of the loans by the big banks, the same big banks began re-directing the small business program loan funds first to their own largest and best customers. Thus the first $350 billion in Congress funding for small business was directed to the banks’ best customers in less than two weeks. A second $320 billion supplement just added is reportedly already accounted for in less than half that time.

Despite the data on jobs, small business, and GDP much of the liberal economist establishment appear to be falling for the Trump administration official line and spin that there’ll soon be a V-shape recovery.

Liberal Economists Buy the Mnuchin-Hassett Line

The dean of liberal economists, Paul Krugman, in one of his columns recently, says it’s not an economic crisis but a disaster relief situation. Kind of like an economic hurricane, he added, that once it passes the sun will come out and shine again at the same economic intensity as before. And then there’s Larry Summers, Harvard economics professor and advisor to Barack Obama in 2009, who agreed with Krugman, saying “it’s possible to collapse and come back quite quickly.” Or Robert Reich, Cal Berkeley professor and former member of Bill Clinton’s cabinet, who declared in another TV interview recently, that the crisis wasn’t economic but a health crisis and as soon as the health problem was contained (presumably this summer) the economy would ‘snap back’.

Theirs is economic analysis by means of weather metaphors. And the error they all make is assuming that the fundamental cause of the crisis is not economic but the virus. They don’t see the virus as only a precipitating cause, exacerbating and accelerating what was a basically weak US and global economy going into the crisis, but instead the virus is the sole, fundamental cause of the deep contraction.

Krugman and other proponents of the ‘snap back’ (V-shape recovery) thesis all deny the counter argument that the current deep and rapid economic decline is precipitated by the crisis and that there is an internal economic dynamic set in motion that is taking over that driving the economy into a downward spiral regardless of the initial health crisis effect.

As one partial example of that internal dynamic: once the contraction in the real economy accelerates and deepens, it inevitably leads to defaults and bankruptcies—among businesses, households, and even local governments. The defaults and bankruptcies then provoke a financial crisis that feeds back on the real economy, causing it to deteriorate still further. Income losses by businesses, households and local government thereafter in turn cause a further decline. Once negative mutual feedback effects within the economy begin, it matters little if the health crisis is soon abated. The economic dynamic has been set in motion. Krugman and friends should understand that but either don’t, or are cautioned by their employers and political friends not to tell the whole truth lest it cause further concern, lack of business and consumer confidence, or even panic.

When mainstream economists don’t understand what’s actually happening, they hide behind their metaphors as a way to obfuscate their lack of understanding and ability to forecast the future. Or they employ the same metaphors to avoid telling the truth. But the truth is this isn’t just a health crisis. And it won’t quickly disappear even if the health issue were resolved in a matter of weeks or months.
Instead of pacifying the public with nice metaphors, they might just look at the recent past. No snap back economic recovery occurred after 2008-09, which was a contraction far weaker in relative terms than the present, with fewer job losses and a much smaller GDP decline.

2008-09 Recovery Was No V-Shape

Even after the less severe 2008-09 contraction, bank lending after 2009 did not return immediately or even normally. Only the largest, best customers of the big banks and their offshore clients received new loans from them. Bank lending to US small and medium businesses continued to decline for years after 2009. And jobs lost in 2008-09 did not recover to the levels of 2007 just before the recession began until 2015. Wages of jobs recovered from 2008 to 2015 was much lower compared to wages of 2007 jobs that were lost. The ratio between full time jobs and part time/temp/contract work deteriorated after 2009, with more of the latter hired and the former not rehired. Real wages still has not recovered to this day for tens of millions of workers at median income levels and below.
So one c
an only wonder what the Krugmans, Summers and Reichs are ‘smoking’ when they make ridiculous declarations about ‘snap back’ recovery. They should know better. All they had to do was look at the evidence of the historical record post-2009 that V-shape recoveries do not happen when there are deep and rapid contractions! And that’s true not only for 2009, but even for 1933 when the great depression finally bottomed out.

Between 1929 and 1933 the US economy continued to contract. Not all at once, but in a kind of ‘ratcheting down’ series of lower plateaus as banking crises erupted in 1930, 1931, 1932 and then again in early 1933. When Roosevelt came into office in March 1933 he introduced a program aimed at bailing out the banks first, and then assisting business to raise prices. It was called the National Recovery Act. That program stopped the collapse but generated only modest recovery, and by mid-1934 that recovery had dissipated. It was then, in the fall of 1934, that Roosevelt and the Democrats proposed what would be called the New Deal, which was launched in 1935 after the mid-term 1934 Congressional elections. The US economy began to recovery rapidly in 1935 to 1937. In late 1937 Republicans and conservative Democrats in the South allied together and cut back New Deal social spending. The US economy relapsed back into depression in 1938 until Congress, fearful of the return to Depression, reinstated New Deal spending and the economy recovered again to where it was in 1937. The permanent recovery did not begin until 1940-41, as the US economy mobilized for war and government spending rose from 15%-17% of GDP to more than 40% in one year in 1942.

But mainstream economists are not very attentive to their own country’s economic history. If they were they would understand that deep and rapid economic contractions always result in slow, protracted, and often uneven recoveries. There never is a ‘snap back’ when depression levels of contraction occur—or even when ‘great recession’ levels occur, as in 2008-09. It takes a long time for both business and consumers to restore their ‘confidence’ levels in the economy and change ultra-cautious investing and purchasing behavior to more optimistic spending-investing patterns. Unemployment levels hang high and over the economy for some time. Many small businesses never re-open and when they do with fewer employees and often at lower wages. Larger companies hoard their cash. Banks typically are very slow to lend with their own money. Other businesses are reluctant to invest and expand, and thus rehire, given the cautious consumer spending, business hoarding, and banks’ conservative lending behavior. The Fed, the central bank, can make a mass of free money and cheap loans available, but businesses and households may be reluctant to borrow, preferring to hoard their cash—and the loans as well.

In other words, the deeper and faster the contraction, the more difficult and slower the recovery. That means the recovery is never a V-shape, but more like an extended U-shape.

Dr. Jack Rasmus
April 28, 2020

Dr. Rasmus is author of the just released book, The Scourge of Neoliberalism: US Economic Policy from Reagan to Trump’, Clarity Press, January 2020; and the preceding book, ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression’, Clarity Press, August 2017. He blogs at jackrasmus.com. His twitter handle is @drjackrasmus and his website: http://kyklosproductions.com

Listen to my recent 45 min. interview with WKPN Radio on the origins and conditions on the eve of the current Coronavirus precipitated economic crisis. How Neoliberal policies prior to February 2020 created a fragile US economy, heavy susceptible to the virus effect when it occurred. How the virus precipitated, exacerbated, and accelerated the economic crisis once the virus hit the economy. Will the central bank, the Federal Reserve, be able to prevent the deep contraction in the real economy from setting off a financial crisis in its wake? Will the Fed’s $9T (and rising) free money being injected into both banks and non-banks of all sizes prevent a wave of defaults and deflation that might in turn ‘freeze up’ the banking system? Why the current crisis in the economy won’t result in a rapid V-shape recovery soon and why any ‘recovery’ will be very slow under the best of conditions with no banking crisis in particular.

TO LISTEN TO THE INTERVIEW GO TO:

https://soundcloud.com/wpkn895/why-our-economy-fumbled-covid-19

Listen to my latest 30 min. radio interview on the US and Global Coronavirus Economy this past week, with host, Charles Dunaway, of KEPW, 97.3 Community Radio, Eugene, Oregon.

TO LISTEN GO TO:

https://widerviewradio.podbean.com/e/dr-jack-rasmus-on-the-scourge-of-neoliberalism/

DUNAWAY’s INTRODUCTION to INTERVIEW

I am very pleased to welcome Dr. Jack Rasmus to Wider View. Jack has a Ph.D in Political Economy and teaches economics at St. Mary’s College in California. He is the author of a number of books including “Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression”, “Systemic Fragility in the Global Economy”, “Obama’s Economy: Recovery for the Few” and his latest, “The Scourge of Neoliberalism: US Economic Policy from Reagan to Trump”. Jack is also host of a weekly radio show called Alternative Visions on the Progressive Radio Network. You can follow him on his blog at jackrasmus.com and on Twitter at @drjackrasmus

Listen to my Friday, April 23 Alternative Visions Radio Show, and my discussion of the 2nd Congress bailout of Small Business. Why It Won’t be Enough. What’s Already being prepared for the next May bailout. How banks and big business have been ‘gaming’ the now $1.7 trillion business loans-grants. How the bailouts are–as in 2008-09–once again being funneled through the private banking system to allow them to skim off their ‘cut’ in fees and other charges. How the required that business keep workers in jobs to get the loans is mostly a cover for the free money.

TO LISTEN GO TO:

http://alternativevisions.podbean.com

SHOW ANNOUNCEMENT

:

Dr. Rasmus begins today’s show describing the latest Congressional bailout package of $484B just passed, expanding the prior $2.3T ‘Cares Act’ bailout just a few weeks ago. How much is direct money and how much is loans funneled through the Fed and private banks. Why It won’t be enough and what’s in the next bailout package already being debated for May. Jobless numbers now at 26m, going to 40m by end of May. The ways in which big corporations are gaming the bailouts and getting free money they don’t need, while workers, homeowners, renters, and small businesses are starving for funds due to Trump administration mismanagement. Why business interests & Trump are so desperate to force everyone back to work prematurely, almost ensuring a second and potentially worse wave of infections. Rasmus explains the bailout in general is designed to go through the Fed and the private banks, as it was in 2008-09, and why this will mean a very slow recovery under the best of assumptions. Why the Fed’s multi-trillion dollar money injections may yet fail to prevent a financial crisis and an even worse economic crisis. (check out Dr. Rasmus’s blog, jackrasmus.com, for weekly up to date posts on the virus economy and join his twitter feed, @drjackrasmus, for daily commentaries)

The following is the 4th and final posting from my 2010 book, ‘Epic Recession: Prelude to Global Depression’, which provided my analysis of the 2008-09 Great Recession (which I call an ‘Epic’ recession). Understanding that event is of importance to better understanding the current emerging ‘Great Recession 2.0’ of 2020. As parts 1-3 argue, the key to understanding Great Recessions is to understand how financial cycles interact with real business cycles, and how both exacerbate the other in a downturn. In 2008-09 the mutual feedback effects were from financial cycle crash to the real economy; today’s Great Recession 2.0 has inverted that causal relationship. We have a real side of the economy crashing. Will it then precipitate a financial crisis that will in turn exacerbate the real economy contraction is the question of the day. The US central bank, the Fed, is desperately throwing trillions of dollars to bailout not only the banks and shadow banks (as in 2008-09) but the entire corporate-business non-financial sectors of the economy as well. It is a historic experiment. There is no guarantee, however, that the massive liquidity (free money) injection will prevent a financial crisis emerging. As we write, today a major warning sign the financial implosion may not be prevented is evident in the sheer collapsing of global oil prices and financial asset markets on which global oil is based. How and will this financial oil market crash spill over to other sectors of the financial system remains to be seen.

At the center of analysis of how financial instability precipitates a real more severe downturn of the economy (or how the latter precipitates a financial instability and crash) is the concept of ‘Fragility’. The debt-deflation-default nexus described in Part 3 leads to a condition of growing ‘fragility’ in the capitalist system. How that works is described in Part 4 to follow. Fragility is a condition that measures how prone, sensitive, or likely the system is approaching a financial and/or real crash once again. Debt levels and rate of change is important. But equally important in estimating fragility is the ability of businesses, households, government entities to service that debt with revenues, income, taxes in order to avoid default. Also critical are non-money decisions by govt, business or households to delay, suspend, or expunge debt servicing, in whole or part.

How fragile then is the current US and global economies? Very much so. Within the next 3 to 12 months it will become clear if another financial instability event will occur. If so, it will certainly be far worse than 2008-09.

Readers should note that the following Part 4, and the preceding Parts 1-3, represent my thinking about Great Recessions 10 years ago. My views have evolved. Five years ago I wrote a subsequent book, ‘Systemic Fragility in the Global Economy’, Clarity Press, January 2016, as an update. My writings on the current crisis, 2020, as it emerges and evolves represents my most current views on the topic of Great Recessions–and how they may transform into bona fide Great Depressions. (My forthcoming book later this year is entitled: ‘The Virus and the 2020 Great Recession’)



PART 4 of ‘The Dynamics of Epic Recession’, from the book, Epic Recession: Prelude to Global Depression, 2010.

Debt-Deflation-Default Nexus and Financial Fragility

This dynamic interactions and feedback effects between debt-deflation and, as debt-deflation intensifies, between debt-deflation and default as well, result in a further deterioration of both financial and consumption fragility.

Recall that both forms of fragility are a function of levels of debt, of the quality (terms and cost) of that debt, and of cash flow (business) or disposable income flow (consumer)—all three factors ultimately combined in the ratio of debt servicing to available cash-income flow. As debt rises or deteriorates, financial fragility rises; as the latter (cash flow) slows or declines, financial fragility rises as well.

Asset deflation drives a company toward more debt accumulation, thereby raising financial fragility. When a company’s assets are declining in value, it is not able as a rule to raise liquidity through new stock issuance. Existing stock prices in such situations are normally stagnant or declining due to public negative perceptions of the company’s future economic performance potential. Thus that door to raising cash flow to make debt payments is largely closed. In addition, the company lacks by definition necessary internal funds in such conditions. If it had sufficient internal funds it wouldn’t have to sell off assets in the first place to make debt payments.

Without internal funding or stock equity funding available, the company is necessarily driven to debt financing. Declining asset prices thus mean the company must seek more debt financing in order to make debt servicing payments. New levels of debt are added to existing debt. And if company is already overloaded with debt in the first place, new debt is normally only obtained at greater cost than old debt, which means debt quality declines and fragility rises as well. The company becomes even more financially fragile over time from debt, as asset deflation eventually forces it to acquire more debt.

But product price deflation similarly results in more financial fragility. Price deflation works on financial fragility from the cash flow side. If a company chooses to reduce product prices instead of selling assets to raise necessary cash flow, it may grow revenue and improve cash flow in the short run in order to service debt payments, but it does so by weakening its revenue base and future cash flow in the longer run. Albeit not as rapidly as asset price deflation, product price deflation therefore also eventually results in reduced cash flow to finance debt and consequently a deterioration in financial fragility.

The company can buy some time from having to resort to asset or product deflation. It may avoid reducing product prices initially by reducing planned real investment or by cutting production and operating costs, especially labor costs. Yet all three—suspending planned investment, cutting labor costs, and cutting other costs of production—also translate sooner or later into reduced revenue and cash flow. Wage cutting and wage deflation may serve as a temporary substitute for price deflation and thus delay a further deterioration of financial fragility in the short run. But wage deflation will eventually result in less productivity and thus higher costs and less cash flow. Cutting back on new investment and production also reduces productivity, with the same effects on rising costs and less cash flow. Because wage deflation’s impact on cash flow is less immediate than product price deflation, that is why businesses typically pursue wage deflation first before product price cutting. And wage cost reduction via layoffs before other forms of wage cutting, since layoffs affect productivity of remaining employees less than wage cutting for those that remain.

To summarize, there are a combination of effects from the interaction of debt-deflation-default that result in a deterioration of financial fragility. Sell off assets is the quickest way to raise liquidity with which to make debt service payments. But asset sales and asset deflation eventually lead to the need to raise more debt, locking the company in a cycle of asset sales to offset rising debt. Reducing product prices are an alternative to raising cash to cover debt payments. But it takes longer than asset sales to raise the cash and is also more uncertain. It also means the company’s real debt servicing in effect rises. Paying debt by product deflation means raising real debt. Companies if possible therefore initially turn to shutting down planned real investment and cutting operating costs, especially labor costs—first by reducing hours of work, then layoffs, then other forms of wage cuts. However, all three of these measures may result in immediate cash to service debt but ultimately result in a reduction of cash flow. All forms of deflation therefore exacerbate debt and debt servicing problems. In the real world, companies with rising debt servicing stress and facing default undertake all measures in some combination, as well seek to raise more debt (even if more costly) and delay if possible making debt payments.

Debt-Deflation-Default Nexus and Consumption Fragility

This situation is not dissimilar for consumers and consumption fragility. Consumer debt takes the form of mortgage debt, installment loan debt like auto loans and other big ticket items, credit card debt, student loan debt, and other forms of personal loans and debt. While not as massive as financial institution debt accumulation, or non-financial corporate debt growth, in the ten years leading up to the 2007 financial bust, household mortgage debt nonetheless increased by around $7 trillion in the U.S. and consumer credit from around $1.3 trillion to $2.5 trillion.

The ratio of household debt to income in the U.S. rose to 140% in 2007 and two years later still remains around 130%. This compares to the ratio’s long run historic average of around 100%, last recorded in the late 1990s. What this means is that consumers have been unable to reduce debt in any significant way since the financial crisis and recession began. They will likely remain unable to do so for some time, especially given continuing trends involving home foreclosures, rising job loss, rising credit card rates and terms, record income losses for the millions of very small unincorporated businesses, negative wealth effects due to one fourth of home values now ‘under water’, the general failure of 401k retirement plans to recover lost values—to name but the more significant factors continuing to impact consumer disposable income (i.e. consumer cash flow). The problem for consumption fragility is therefore debt, but even more fundamentally weak disposable income—especially for the bottom 80% of the households whose ratios are much worse than the 130%-140% noted above, which includes wealthy households as well as the bottom 80%. Furthermore, for the 80% at least, the problem of rising debt is a consequence, to a significant extent, of declining real disposable income.

It is important to note that this consumer debt runup was not the result of some profligate cultural attitude change. It’s not primarily that American consumers all of a sudden became reckless spendthrifts. At least not for the average American middle and/or working class family in the bottom 80% households, and in particular for the roughly 110 million who constitute the category of ‘non-supervisory production and service employees’. Their resort to credit is one of few ways that 110 million maintained their standard of living in the face of stagnating real weekly earnings and incomes over the past three decades, and since 2000 in particular. Real weekly earnings in 2007 for this group, who constitute the vast majority of consumers in the economy, were less in 2007 than in 1982, a quarter century earlier, when measured in terms of 1982 dollars. Working class living standards were propped up by credit due to a long period of wage and earnings stagnation.

The other ways in which stagnating real income were offset for a quarter century include this group’s addition of hours worked on a family basis, as spouses were sent into the labor force in record numbers and second part time jobs were taken on by primary heads of households. The group also reduced savings and even depleted retirement funds to maintain living standards. They entered the recent crisis and Epic Recession with very little income reserves and very heavy debt loads—i.e. historically severe consumption fragility. It is therefore not surprising that overall consumption in the U.S. economy nearly collapsed in late 2009 when this group was heavily impacted by massive reductions in work hours, millions of layoffs for six months running, an acceleration of wage cutting in the form of furloughs, elimination of paid leave, benefit cuts, etc., plus an escalation of home foreclosures in the millions and tens of millions of home values thrown ‘under water’. Something similar in terms of growing debt driven and income stagnating consumption fragility occurred in the 1920s through 1929-1931, according to other studies. The banking panic of September-October 2008 was an indicator of the fracturing of financial fragility. But less attention has been (and unfortunately still is) given to the fracturing of consumption fragility that quickly followed in less than a month in late 2009 as mass layoffs began.

On the income side of deteriorating consumption fragility, causes of the real earnings stagnation since the 1980s have been various: de-unionization of the general work force, atrophy of the real value of minimum wage, free trade and the relocation of much of the high paying manufacturing sector offshore and replacement of higher paying export jobs with lower paying import employment, shift from manufacturing to low paying service jobs, accelerating displacement of labor with technology, major shifts in labor market conditions from full time permanent work to part time-temporary ‘contingent’ work, shifting of costs of health care and retirement from businesses to workers, and other lesser but numerous real developments—all having some negative effect on wage and earnings levels for the 110 million in particular. These real causes better explain the shift of consumers to record levels of debt than do arguments based on consumer attitude changes.

The rising debt impact on consumption fragility is obvious. Less so is the effect of deflation. Asset deflation has little influence on consumption fragility for the ‘bottom 80%’ households, since they hold virtually no assets apart from some minor amounts in pension plans, which have declined in total value and thus had some effect. Product price deflation does not impact consumption fragility directly, but does so indirectly. Companies that engage in product price cuts to cover debt almost always introduce cuts in operations costs and labor costs. Product price deflation almost immediately results in wage deflation—i.e. layoffs and wage cutting that directly impact disposable income. Thus, rising jobless, reduced hours of work, and wage and benefit cuts translate directly into rising consumption fragility from the disposable income side.

Default for households and consumers take the form of foreclosures, auto repossessions, credit card suspensions and card rate charges and fee increases, garnishment of pay for student loan default, credit score reductions and elimination of credit availability, and ultimately in personal bankruptcy filings. Default in any of the preceding forms has a major effect on the individual and household’s consumption fragility.

As consumer fragility deteriorates from rising debt, deflation, and default it feeds back upon all three elements of the critical debt-deflation-default nexus. Increased fragility means inability to cover debt payments in a timely manner and need to borrow further to supplement insufficient household income flow. It means less consumption demand, which results in further downward pressure on product prices. And in severest situations, it translates into default—for either debt payments due on mortgages, autos, student loans, or credit card payments.

As in the case of financial fragility and its interaction with the debt-deflation-default nexus, consumption fragility similarly feeds back on the elements of the nexus, which, in turn, result in a further deterioration of consumption fragility. A dangerous potential downward spiral may subsequently set in.

Financial and Consumption Fragility Feedbacks

Financial fragility and consumption fragility also mutually determine each other, while each simultaneously reacts upon debt-deflation-default as well.

The main financial fragility to consumption fragility transmission mechanism is layoffs, hours of work reduction, and wage cutting for the remaining employed. To recall, non-financial companies facing increasing difficulty in making debt service payments may either sell assets, reduce product prices, or cut labor and other production costs; in short, resort to deflation in one or all the three forms in order to raise cash flow to service debt. Reducing operations and, in particular, labor costs are the quickest way to supplement liquid assets on hand. Selling inventories of product at lower prices and resorting to asset firesales may serve the same purpose. But those alternatives make it more costly and difficult to raise further business debt if that proves necessary. It is generally easier and less costly to replace labor than it is to replace assets and inventory. So businesses typically resort to wage deflation first (although a company in a severe economic situation may undertake all three measures simultaneously).

Wage deflation in all three forms—i.e. layoffs, hours reduction, and direct wage and benefit cuts—serves to reduce real disposable income for the company’s work force and the labor force at large. Consumption fragility subsequently grows. When wage deflation occurs broadly in scope and magnitude, when tens of millions are laid off and converted to part time, when benefits cuts and furloughs, bonus cuts, paid leave reductions, and other forms of wage cutting occur, the increase in consumption fragility becomes widespread and a major economic factor.

Financial fragility feeds consumption fragility from the debt side as well, from the direction of a contraction in bank credit and lending to consumers, which means a higher cost of borrowing for consumers. For example, credit card rates and fees rise for consumers, both for existing and future credit. Borrowing rates for consumers attempting to refinance mortgages that are delinquent, or for home values that are ‘under water’ rise as well. The unemployed consumer must pay higher rates for auto loans. Penalties for late payments on loans and credit cards are increased more aggressively and frequently. In general, the costs of credit for consumers who have no alternative but to raise more debt to cover costs becomes more expensive, while at the same time their real disposable income may be declining. Both ‘sides’ of consumption fragility therefore deteriorate as a consequence of financial fragility.

A reverse effect can also occur—consumption fragility may exacerbate financial fragility. The most obvious example is consumers who, as homeowners, default on mortgages resulting in foreclosures. Banks and financial institutions must thereafter write down or write off the loss from the defaults. Their financial fragility rises. More than a $ trillion in subprime and other mortgage write offs have occurred in the U.S. thus far in the cycle.

Credit card debt is another consumption to financial fragility mechanism. Consumers defaulting on credit card debt results in credit card companies ‘charging off’ the debt, thereby themselves becoming more financially fragile. The corporate rating agency, Moody’s Inc., estimates, for example, a 12% credit card charge off rate by 2010 in the U.S. That’s nearly $150 billion in credit card loss write offs. Card companies in response have begun raising rates on consumers still with cards to make up for the losses, even charging interest to card holders who pay off their balances monthly—all of which results in reducing consumer disposable income and increasing consumption fragility. With credit cards as a source of credit sharply reduced, and cost of usage rising rapidly, consumers are driven to default on other debt. According to some estimates, the ‘big five’ credit card companies, in order to reduce their own financial fragility, plan to cut $2.7 trillion in credit card lines of credit, that is, by more than half the estimated $5 trillion total available card credit outstanding. These draconian measures by big credit card companies represent efforts to, in effect, transfer their own financial fragility to consumers in the form of raising consumption fragility.

Just as the Federal Reserve and U.S. Treasury’s bailout of the big 19 banks represents a transfer of bank financial fragility to the U.S. government’s balance sheet, the response by banks and financial institutions, like credit card companies, to make consumers pay more for remaining credit represents a transfer of banks’ and card companies’ financial fragility to the consumer and consumption fragility.

What is described in the preceding paragraphs is not only how consumption fragility can exacerbate financial fragility, or how financial fragility in turn exacerbates consumption fragility, but how the two may continually impact each other in a negative fashion. A continuing, mutually sustaining process may potentially occur. In Epic Recessions this ‘mutuality’ of process takes place to some degree. When it especially intensifies, the momentum toward depression grows. The linkage, or economic glue, between the two forces of fragility are the mechanisms of debt-deflation-default, moreover.

Fragility and the Real Economy

Financial and consumption fragility not only partially determine each other and provide feedback on debt-deflation-default processes, but both forms of fragility drive the decline in the real economy as well. Both forms of fragility, in different yet similar ways, negatively impact real economic indicators like consumption, real investment, industrial production, exports, and employment.

Financial and consumption fragility are also the key aggregate variables that connect the processes represented by the interactions between debt-deflation-default, on the one hand, and real economic indicators like investment, consumption, production, exports, employment on the other. It is financial and consumption fragility that determine the depth, degree and duration of those indicators that define the characteristics of Epic Recession described in chapter one.

The origins of Epic Recession ultimately lie in the relationships between liquidity, the global money parade, and the growing relative shift to speculative investing. But the dynamics and the evolution of Epic Recession lie in the relationships between speculative investing, the processes of debt-deflation-default, and the conditions that define financial and consumption fragility. The processes and conditions of fragility appear, i.e. are reflected, in real economic indicators such as consumption, investment, production, export, and employment. But the essential forces and variables are those addressed in this chapter, those that produce the changes in scope and magnitude of those economic indicators that measure and differentiate Epic Recession from normal recessions.

Perhaps the most obvious impact of fragility on the real economy is the direct, negative effect of consumption fragility on the level of consumption demand in the economy. Consumption represents more than 70% of the U.S. economy today. Growing consumption fragility slows consumption over the long run, since by definition it signifies both rising debt servicing requirements and lower real disposable income. As was shown in chapter two, consumption fragility for the vast majority of consumers in the U.S. today, the ‘bottom 80%’ households, has been rising significantly due both to stagnating or declining real disposable income as well as rising debt levels and debt servicing requirements. After two years since the start of the current economic crisis, consumer debt to disposable income as a percentage has barely fallen, from around 140% to only 130%. And that’s for all households, including the top 20%. Consumers are clearly experiencing great difficulty in retiring debt and/or raising disposable real income.

Adding consumer debt in the short run to make debt payments—which has been the rule for two decades now for many consumers—only temporarily addresses the problem of consumption fragility in the short run, while actually exacerbating that fragility longer term. Increasing debt as a way to offset weakening real disposable income not only represents a temporary solution to weakening disposable income, it is at the same time a solution that exacerbates the problem of disposable income in the longer run. Assuming more debt may raise consumer income flow to enable servicing debt in the near term, but more debt raises the level of cash-income needed to pay for what will necessarily become a still larger debt servicing requirement in the longer term. Over the longer term then, rising debt actually reduces disposable income and, as a consequence, steadily slows consumption demand over time. That is why taking on more debt as a solution to lagging disposable income and consumption—the practice in recent decades—usually results in the need to take on even more debt over time. Growing consumption fragility is a reflection of this dilemma that exists in the contradictory relationship between debt and real disposable income over time.

Consumption fragility not only has a long term negative impact on consumption demand, but in times of economic crisis consumption fragility may deteriorate rapidly. When it does, it precipitate an abrupt shift in consumption demand to a lower level than had existed previously, at which it may then more or less stabilize for an extended period. This condition may be described as a ‘fracturing’ of consumption fragility, following which its feedback effects on other processes and variables intensifies.

There is an additional effect. A fracturing of consumption fragility, and consequent decline in consumption, also reduces business planned real investment, production, and in turn employment. Business expectations may shift, anticipating a lower level of future sales and rate of return (profitability) from consumers as consumption becomes more difficult to sustain. In this scenario, consumption fragility feeds back on economic indicators through the business-investment channel, as well directly via consumption as described previously. Weakening consumption can also drive companies toward allocating a greater proportion of available liquid assets to speculative forms of investing, since speculative investing depends less on (now weakening) domestic consumer demand and more on (now growing) worldwide global investor demand. That too diverts liquidity from real investment that might otherwise result in increased production and employment. So consumption fragility affects consumption directly, as well as real investment indirectly as that real investment slows or is diverted in expectation of lower levels of consumption.

Like consumption fragility, financial fragility also has both direct and indirect effects on the real economic indicators. It too may ‘fracture’ from time to time. Financial fragility fracturing is representing by banking panics, such as occurred in September-October 2008 in the U.S. Just as in the case of fracturing of consumption fragility and the abrupt decline in consumption spending that follows, financial fracturing is represented by an abrupt decline in bank spending—i.e. bank lending—that follows the banking panic. That bank lending, like consumer spending, may settle in at a lower level for an extended period—until policies sufficiently generate a return to higher levels or until another ‘fracturing’ event takes place. Whether consumption or financial fragility, fracturing does not take place in normal recessions. Depressions are characterized, in contrast, by a series or sequence of repeated fracturing events.

Considering once again the possible specific impacts of financial fragility on the real economy, an abrupt decline in a company’s cash flow amidst rising debt and debt servicing costs will first translate, in most cases, into a suspension of real investment projects in progress and a cancellation of future planned investment. Both actual and planned investment are thus negatively impacted from the outset should cash flow drop precipitously, especially when a recession is underway or imminent. A similar suspension and cancellation of investment may result from a company raising significant amounts of additional debt. Either/both a sharp rise in debt or abrupt fall in cash flow can have the same investment suspension effect. Financial fragility thus tends to have a first, and often immediate, effect on real investment. Investment is suspended or cancelled to divert needed liquidity to cash flow and debt servicing.

Concerning current production and output, it is typically the next casualty of financial fragility. Cutting operating costs, in particular labor costs, take a little longer to implement but are also preferred means by which to generate cash flow. Renegotiating contracts with suppliers, delaying payments for materials, reducing hours of work, converting full time employees to part time status, layoffs, and eventually other forms of direct wage reduction are alternative approaches to raising cash flow. But these measures have consequences in turn for consumption and consumption fragility. It increases the latter and reduces the former, for both those laid off and those who remain working with less income flow. So financial fragility works directly on investment, as well as indirectly on consumption by causing a further deterioration of consumption fragility by lowering disposal real income.

After reducing investment and production, after cutting operating and labor costs, a company that still faces severe problems of financial fragility—whether due to a collapse of sales revenue, a major credit contraction, a refusal by banks to extend credit, or lending at sharply higher interest rates—that company may also have to sell assets at reduced prices or sell inventory of products at below market prices in order to quickly raise necessary cash-flow. The need to raise additional cash might also result from a particular large collapse of asset values on the company’s balance sheet as a result of prior bad investments that failed. Resorting to deflation solutions involving asset firesales or product inventory price cutting has a long run negative impact on investment. Selling assets usually means selling the company’s better, more productive and performing assets. Those who buy the assets of a stressed company generally are not interested in buying the worst performing, but rather the best performing, assets. The loss of preferred assets usually means a weakening in productivity and thus rising costs in the longer run—with greater negative pressure on cash flow. Selling product inventory at below market prices may also initially raise additional cash, but with longer run negative consequences. Cash flow is obtained in the short run, at the expense of profitability and therefore cash flow levels in the longer run.

If sufficiently widespread among sectors and industries of the economy, the wage deflation solution to financial fragility can also have long run, offsetting, negative consequences. Should mass layoffs occur across industries, hours of work reduced in general, and wage cutting spread as a rule, then consumer demand decline will have a feedback effect on investment, production, and employment levels once again as well.

The general scenario described is one in which financial fragility impacts investment negatively in a direct way in the shorter run, and investment is impacted negatively through consumption fragility and consumer demand in the longer run; conversely, consumption fragility directly affects consumption negatively in the short run, and consumption is impacted negatively through financial fragility and investment in the longer run. The two forms of fragility are in ways mutually reinforcing. They both together affect real indictors like investment, consumption, production, exports and employment levels.

These real indicators in turn feed back upon the general process, as well as through both forms of fragility. The cycle is reinforced by both financial and consumption fragility feeding back upon the threefold processes of debt-deflation-default. The latter, in turn, exacerbate financial and consumption fragility, and so forth.

What this all produces is a tendency for the real economy to proceed in a downward trend or cycle. That trend may not be perfectly smooth. That is, it may accelerate at times of fracturing, and may thereafter settle into an extended period of more or less stagnation. That stagnation may itself also not be perfectly linear. It may represent in a series of short, shallow economic growth periods, with which may occur similar short and shallow periods of economic decline. A ‘bumping along the bottom’ with periodic bounces up and weak bounces down.

From a policy perspective this scenario suggests that checking or containing Epic Recessions, and avoiding the extended stagnation or a further descent into depression, requires policies that directly confront the key variables of financial and consumption fragility, debt-deflation-default, and the shift to speculative investing. For banks, financial institutions, and business in general, it means debt must be ‘expunged’ and not simply offset with liquidity injections by central banks. It means cash flow needs to be stabilized, not allowed to swing widely due to speculative bubbles and busts. It means consumer disposable income must be restructured fundamentally. That cannot be accomplished without some fundamental redistribution of income on a permanent footing. Consumer credit must also stabilize and not be allowed to negate consumer income. Deflation in either of the three price systems is a requirement of sustained recovery. And defaults, consumer and business alike, must be prevented. Not least, the ultimate solution requires that the shift to speculative investment is reverse and the global money parade is eventually tamed.

The following three chapters address empirical evidence in the historical record of depressions and near depressions in the 19th and 20th century in the U.S. To what extent do the three great depressions of the 19th century conform to the analysis presented in chapters one through three? And what of the two closest examples of ‘Epic Recession’ in the U.S. in the 20th century—the financial crisis of 1907-1914 and its aftermath? And the initial phase of the depression of the 1930s, the 1929-1931 stage. Both constitute forms or ‘types’ of Epic Recessions that have occurred. How the current crisis and economic contraction, 2007-2009, qualifies as an Epic Recession is discussed, as is how it is similar and different from 1907 and 1929-1931.

The final two chapters confront the question of policy, solutions and programs. To what extent has the U.S. Federal Reserve, U.S. Treasury, Congress and the President provided solutions that confront fragility, the debt-deflation-default processes, and speculation and global money parade? Are they addressing today’s Epic Recession as if it were simply a moderately more severe normal recession? Our conclusion is they have not, are not, and will likely not correctly address the problem. If not, the dynamic of Epic Recession will continue. What is necessary to successfully address the unique character of the current crisis is suggested in the final chapter.

In this part 3 in the series explaining the unique characteristics of Great (aka Epic) Recessions the focus turns to how excess Debt, when combined with Deflation, leads to Defaults (by banks, corporations, or both), which exacerbate and intensify the negative feedback effects of overlapping financial cycles and real business cycles. The contraction of both accelerate and deepen. Deflation spreads from financial asset securities to real goods and services to labor and other input prices (wages). Falling prices lead eventually to defaults–i.e. failure to pay principal and interest on prior debt loads. Deflation in fact raises the real cost of the prior debt. So debt continues to rise in real terms as the ability to ‘service’ that debt (pay principal and/or interest) declines as prices deflate and revenues and cash fall. The interaction of debt with deflating prices and defaults creates a mutual feedback effect among the three factors–debt, deflation, default–and hence creates what I call the ‘debt-deflation-default’ nexus.

Here’s Part 3 describing the processes, which create within the capitalist system a condition of ‘fragility’. That is, the increasing likelihood of a major financial instability event–i.e. stock or bond market crash, commodities futures crisis, derivative securities super-contagion and contraction, property values collapse (residential and/or commercial), and so on. (In the final Part 4 to follow, it will be explained how this process and multiple feedbacks, and ‘nexus’, occurs not just in the financial side of the economy, but may occur as well in the household consumption sector and the government sector. When all three sectors–financial, households, government–become ‘fragile’ as their separate ‘nexuses’ intensify, then the entire economic system may become ‘systemically fragile’.

Debt As Driver of Deflation

The prior debt levels created by excessive leveraging and the shift to speculative investing over the business cycle mean that, once prices of speculative assets begin to fall, the greater volume of debt previously accumulated over the cycle will result in a longer fall in the price of the assets. And the poorer the quality of that debt, the more rapid the fall. Thus the level and quality of the accumulated debt will determine the asset price deflation. Speculative investing works through the medium of accumulated debt in depressing asset price deflation, by creating excess debt as a result of creating ‘tiers’ of speculative instruments, ‘layered’ leveraging, and creating a false sense of reduced risk. Details of the debt-deflation process work something like this:

During the boom cycle, debt servicing payments are not considered a major factor to the investor. He intends to sell the asset after a price rise before the debt payments are due in any great volume. But this works only so long as the price of the asset continues to rise. When it doesn’t, if it declines, and sometimes even if it just slows in its rate of rise, then debt servicing payments come due and may become a burden. That debt servicing cost burden may prove significant if a large volume of debt was taken on in the original process of asset purchase and/or if the additional debt over time was of a poorer quality (i.e. shorter term and higher interest). Rising debt servicing costs may represent only one part of the growing cost pressure on the investor. Terms of borrowing for investors are often such that, should the value of the asset purchased fall below its original purchase price, the borrower is required to ‘make up the difference’. That is, put in more money assets or put up other assets as collateral. When that point is reached the investor typically tries to ‘dump’ the asset and sell it. But that may pose a problem as well, when most investors are trying to dump the asset and sell it at the same time. The more savvy investors quickly exited the market early in order to avoid the inevitable rising debt servicing cost and losses and write-downs that can quickly follow once prices start falling. Their exiting, however, accelerates further declining asset prices and rising debt servicing costs. Unable to sell the assets for which prices are deflating, the investor may turn to selling off ‘good assets’ (i.e. other classes of assets not losing value due to price declines) in order to make the rising debt servicing costs. In this manner asset price deflation may spread between classes of assets as well. A company as investor, for example, may have to sell its better assets in order to raise cash with which to service its rising debt costs. It can all become a self-fulfilling downward spiral; general asset price deflation can quickly set in.

Deflation Feedback Effects

It has been explained how, in the runup of a financial boom rising debt and excessive debt leveraging may result in excess demand for financial assets that drives asset price inflation to extraordinary levels. But speculative investing may also drive product price inflation in several ways. Speculation in food commodities and oil drives up futures options prices for these commodities which are passed on to what is called ‘core inflation’, energy and food prices, at the food and energy wholesale and consumer levels. Rising commodity prices for metals also causes a rise in product prices of crude, intermediate and finished producers goods, as metals and other raw materials prices are passed through producer goods prices. In turn, rising producers goods prices are eventually passed on in part to consumer products made from those producer goods. The consequence is a speculative investing-debt driven asset, as well as product, price inflation. Rising debt thus drives inflation. But the opposite may occur as well. That is, asset as well as product price deflation may actually result in a still further rise in debt levels and thus debt servicing stress.

The reverse scenario in which falling prices result in rising debt works something like the following: Once a financial bust and crisis has occurred, businesses don’t only sell assets that have started to collapse in price. First, the assets rapidly collapsing in price may prove difficult. The prices of the falling assets may have declined so far that their sale provides little revenue gains with which to make debt service payments. So the company may simply hold onto the asset that might be now virtually worthless instead of selling it. That is what, in effect, happened to many banks and shadow banks after 2007 that were caught holding collapsed securitized assets. The dollar value had fallen to as low as 10 cents on the dollar. In that situation, banks just held onto the collapsed and now nearly worthless assets. But they still had to make debt servicing payments, and perhaps as well make up for the lost value on those collapsed assets on their balance sheets. They therefore first sold other ‘good’ assets that had not yet fallen in price. That applies to non-finance companies that found themselves in a similar situation. For example, GMAC, the financing arm of General Motors, had speculated in securitized assets and lost billions. It played a major role in GM’s ultimate financial decline. GMAC had to sell off ‘good’ assets to compensate for the collapse in value of the ‘bad’ assets it couldn’t sell. Similarly, GM itself had to sell at ‘firesale’ prices real assets of several of its product divisions to cover the losses in assets at GMAC.

This, by the way, is also an example of a transmission mechanism illustrating how asset price declines can spread from asset class to asset class, eventually infecting good assets and setting off a general asset price decline. Cash flow must be raised in some manner in order to service debt payments coming due from debt accumulated during the boom phase. Selling ‘good’, as well as ‘bad’, assets is one response. But selling company assets, good or bad, is not the only way to raise cash with which to cover debt payments coming due. Reducing product prices to raise revenue and cash flow is another.

If the company is a non-financial institution, another alternative available is to sell more of the company’s inventory of real products in order to raise cash to make debt payments. But with a weakening real economy, selling more products requires lowering the prices of those products in order to increase sales revenue and raise the needed cash flow for debt servicing. This is an illustration of another transmission mechanism describing how asset price deflation can spread to product price deflation.

But lowering product prices in order to raise cash to service debt payments means the company’s real debt levels rise. Specifically, falling product prices results in rising real debt and thus a rise in the servicing costs of that real debt. The company’s original debt obligation and payments have not risen, but the company’s income and cash flow available with which to make the debt payments has fallen—i.e. the real debt load for the company has risen. Sometimes referred to as the ‘Fisher Effect’, this is an important process by which paying off debt by raising cash by lowering prices actually results in rising debt. It represents the process by which deflation can feed back and cause a rise in (real) debt, just as debt can result in deflation. If left unchecked, deflation results in a spiraling down of debt and deflation as they both feed upon and further exacerbate each other.

This debt to deflation and deflation to debt spiral is typical of Epic Recessions. If not checked early in the process, it may lead to a deepening and extending of Epic Recession. And if allowed to become particularly severe and protracted, it can play a central role in transforming an Epic Recession into depression.

Asset and product price deflation may also ‘spill over’ into wage deflation as well, further exacerbating the process. As product price deflation occurs and company revenues and cash flow eventually decline further, the natural management response is to cut operating costs as well. That is typically employment and wages for those left still employed after layoffs. In fact, it is not necessarily sequential. That is, asset firesales leading to product price deflation, then to wage deflation. A company facing particularly severe debt servicing stress may engage in all three forms of deflation at the same time more or less, selling assets, reducing product prices to raise more revenue, and cutting operating costs. However, cutting product prices will eventually lead to wage deflation. First as reductions in hours of work for a company’s labor force and in the form of layoffs. Both constitute forms of wage deflation for the general labor force at large. Total wage payments decline for workers as a group. For those still employed, wage deflation can assume more traditional forms of hourly wage rate reduction, suspension of bonuses, reductions in company contributions to benefit plans, etc. In Epic Recession, resort to non-traditional forms of wage cutting frequently occurs as well, such as ‘forced monthly furloughs’ (days off without pay), cuts in paid sick leave, vacation, and holiday pay, and other forms of supplemental compensation. The key point, however, is that product price deflation eventually spills over to wage deflation in a general way in Epic Recessions.

Wage deflation also has the effect of feeding back upon and exacerbating debt. In this case it is consumer debt levels that are affected. When workers’ experience reduced income from job loss and wage cutting, in effect their ‘cash flow’ also is reduced. Their real debt thus rises as well, as does their debt servicing stress. There is also a further feedback effect. Rising real debt for consumers means less consumption and therefore less demand for products. Product prices are in turn reduced further, causing additional rising real debt for business. In other words, rising real consumer debt results in a further rise in business real debt. Debt drives debt.

Finally, as business real debt rises and reducing product prices reaches its lower bound limits, businesses’ only option is to turn to selling more assets. Thus, deflation in wages and product prices drives a second round of asset price deflation. We now have a generalized process of the three types of prices—asset, product, and wage—each driving the other in a downward spiral through the medium of rising real debt for each. The more generalized and the more multiple feedbacks that occur, the more severe the condition of Epic Recession.

Debt-Deflation As Driver of Default

These processes of deflation and debt ultimately lead to a condition of default. When a business can no longer reduce wages (beyond a point it results in an insufficient workforce to produce its product), can no longer reduce product prices (further reductions would mean producing products for a price consistently below the cost of producing those products), and has few or no remaining real assets to sell to raise cash flow to finance debt payments—then the only alternative for the business is to default. That default may be on its debt servicing payments. Or it may take the form of a more serious company level default, meaning a bankruptcy.

Default may be postponed, however, by various means. Lenders may allow the business to ‘roll over’ its debt due—in effect reducing its debt payment levels in exchange for a longer term debt obligation. The business may simply borrow additional debt in order to make the payments on the original debt. Or it may convince lenders to accept stock in exchange for debt. If it is fortunate enough, it may invoke prior ‘covenants’ that allow it to suspend or slow its debt payments. Or perhaps the company’s original lender (financial institution) is itself near insolvent so it chooses not to take the company into bankruptcy court in response to the debt default, since doing that would require the lender to register even greater losses on its own balance sheet which it may be loathe to do. There are a host of measures that are designed to ‘buy time’ for a company facing default as bankruptcy. Most measures take the form, however, of the company taking on additional levels of long term debt amortized over a longer period in order to pay for increasingly unaffordable short term debt. A favorite option in 2009, for example, was for companies having difficulty making debt payments to sell more junk bonds to cover immediate debt. But this represents a temporary solution only. It means raising long term debt levels in order to finance short term debt payments.

A similar process to that described above occurs for consumers and consumer default. Falling consumer income from job losses, wage cuts, and growing inaccessibility to credit (wage deflation) means a greater difficulty paying for debt incurred during the boom phase (real debt rise). However, unlike businesses there are fewer temporary solutions available to consumers facing default on their debt as debt servicing burdens rise dramatically. Their options are default via foreclosure, default via credit card nonpayment, default via auto repossession, or default on student loans resulting in wage garnishing by the lender.

Unlike non-financial businesses and consumers, the so-called ‘big 19’ U.S. banks and shadow banks avoided default by the U.S. Federal Reserve or Treasury giving them interest free loans to cover their debt payments (and then some). In fact, frequently the Federal Reserve ‘paid’ banks to take its loans, in effect offering negative subsidized interest loans to banks. This amounted to the U.S. government making the debt payments for the banks. This largesse did not extend, however, to the 8200 smaller regional and community banks, several hundred of which by the end of 2009 were allowed to default and were subsequently reorganized by the FDIC.

Notwithstanding possible short term or government subsidized solutions, the more protracted the period of deflation, and the greater the prior debt levels and poorer the debt quality, the more likely is default—either in its severe form of company asset liquidation or in the partial form of company restructuring involving selling off some assets and downsizing. Once again, the medium by which the rising debt is transmitted into default is deflation in either or all of its three price systems.

Default Feedback Effects

Defaults in turn provoke further price deflation. For example, bankruptcy means severe asset firesales. Bankruptcy in the form of a total liquidation of a company means all the remaining assets of the company are sold at auction at firesale prices. A good example is the late 2009 liquidation of the once hundred billion dollar valued communications equipment company, Nortel Inc. It sold its assets for less than $900 million in late 2009. Bankruptcy in the form of partial reorganization of a company, instead of total liquidation, also results in asset sales determined by the bankruptcy courts. The asset price deflation is not as severe but still quite significant. The very best assets are typically sold off at well below market prices.

Reorganizations also almost always result in a major downsizing of the company’s workforce and thus major layoffs of employees. The remaining workers are thereafter generally paid at reduced wages and extremely reduced benefits. Wage deflation thus occurs as job, hours of work, and earnings are reduced. As the restructured company re-enters the market, it typically must offer lower product prices in an effort to re-establish a new foothold once again in the market. Defaults therefore translates into more intensified deflationary pressures across all three price systems—asset, product, and wage.

While a restructured and reorganized company no longer has the burden of excessive debt and debt servicing payments, employees of that company—those laid off and those remaining—in contrast end up with less income. Their income is less but their prior incurred debt levels have not changed. In other words, their real debt has risen and their debt servicing difficulty has grown. All things equal, employees of the company must reduce their level of consumption. Lower consumption feeds back into lower product demand and further pressure to lower product prices and cut wages.

Non-bank defaults can provoke bank defaults, as well as vice-versa. When a non-financial business defaults, it means that the debt previously borrowed from its lender, a bank or other financial institution, becomes virtually worthless. The bank-lender must then write off the now ‘bad’ debt on which the non-bank defaulted. With a loss now on its own books, the bank needs to make up the loss by either adding more capital, selling more of its stock, borrowing from the government (i.e. Federal Reserve), or getting bailed out by the U.S. Treasury. Sufficiently widespread and numerous defaults by companies it lent to may result in the bank-financial institution itself defaulting. Until its losses can be offset by other measures, like asset sales, the bank or financial institution in question is generally reluctant to loan or issue credit to its business customers. Unable to obtain credit, the non-financial customers necessarily turn to asset, product and wage deflation solutions, thereby continuing the cycle. In short, debt drives deflation, which in turn drives defaults that subsequently feedback upon deflation.


A rising level of consumer defaults—housing, auto, credit card, other loans—may lead to losses and write downs and subsequent defaults of financial institutions as well. But consumer defaults more often negatively impact secondary levels of the banking system—i.e. thrift institutions, credit card companies, smaller community and regional banks, auto finance companies (GMAC, Ford Credit), credit unions, small business and consumer installment credit, etc. The effects are thus not necessarily direct on the tier one banking and financial institutions. They also impact what are called secondary credit markets as well. In the U.S. these include the securitized markets for credit card, auto, student and other loans which after 2007 virtually shut down and, at the present, have still to revive.

Epic Recessions occur when the debt-deflation process results in an increase in defaults that are sufficient in scope and magnitude to feed back upon and exacerbate debt and deflation—and in turn cause a further deterioration in both financial and consumption fragility. An Epic Recession evolves and grows in momentum, bringing it closer to depression, when the scope and magnitude of defaults significantly exceed historic averages, and when business and consumer defaults feed back upon financially fragile banks and institutions and precipitate a second round of major financial instability. In contrast to Epic Recessions, depressions are characterized by a series of banking-financial crises that take place in the context of a further deteriorating financial and consumption fragility.

Debt-Deflation-Default Nexus and Financial Fragility

This dynamic interactions and feedback effects between debt-deflation and, as debt-deflation intensifies, between debt-deflation and default as well, result in a further deterioration of both financial and consumption fragility.

Recall that both forms of fragility are a function of levels of debt, of the quality (terms and cost) of that debt, and of cash flow (business) or disposable income flow (consumer)—all three factors ultimately combined in the ratio of debt servicing to available cash-income flow. As debt rises or deteriorates, financial fragility rises; as the latter (cash flow) slows or declines, financial fragility rises as well.

Asset deflation drives a company toward more debt accumulation, thereby raising financial fragility. When a company’s assets are declining in value, it is not able as a rule to raise liquidity through new stock issuance. Existing stock prices in such situations are normally stagnant or declining due to public negative perceptions of the company’s future economic performance potential. Thus that door to raising cash flow to make debt payments is largely closed. In addition, the company lacks by definition necessary internal funds in such conditions. If it had sufficient internal funds it wouldn’t have to sell off assets in the first place to make debt payments.

Without internal funding or stock equity funding available, the company is necessarily driven to debt financing. Declining asset prices thus mean the company must seek more debt financing in order to make debt servicing payments. New levels of debt are added to existing debt. And if company is already overloaded with debt in the first place, new debt is normally only obtained at greater cost than old debt, which means debt quality declines and fragility rises as well. The company becomes even more financially fragile over time from debt, as asset deflation eventually forces it to acquire more debt.

But product price deflation similarly results in more financial fragility. Price deflation works on financial fragility from the cash flow side. If a company chooses to reduce product prices instead of selling assets to raise necessary cash flow, it may grow revenue and improve cash flow in the short run in order to service debt payments, but it does so by weakening its revenue base and future cash flow in the longer run. Albeit not as rapidly as asset price deflation, product price deflation therefore also eventually results in reduced cash flow to finance debt and consequently a deterioration in financial fragility.

The company can buy some time from having to resort to asset or product deflation. It may avoid reducing product prices initially by reducing planned real investment or by cutting production and operating costs, especially labor costs. Yet all three—suspending planned investment, cutting labor costs, and cutting other costs of production—also translate sooner or later into reduced revenue and cash flow. Wage cutting and wage deflation may serve as a temporary substitute for price deflation and thus delay a further deterioration of financial fragility in the short run. But wage deflation will eventually result in less productivity and thus higher costs and less cash flow. Cutting back on new investment and production also reduces productivity, with the same effects on rising costs and less cash flow. Because wage deflation’s impact on cash flow is less immediate than product price deflation, that is why businesses typically pursue wage deflation first before product price cutting. And wage cost reduction via layoffs before other forms of wage cutting, since layoffs affect productivity of remaining employees less than wage cutting for those that remain.

To summarize, there are a combination of effects from the interaction of debt-deflation-default that result in a deterioration of financial fragility. Sell off assets is the quickest way to raise liquidity with which to make debt service payments. But asset sales and asset deflation eventually lead to the need to raise more debt, locking the company in a cycle of asset sales to offset rising debt. Reducing product prices are an alternative to raising cash to cover debt payments. But it takes longer than asset sales to raise the cash and is also more uncertain. It also means the company’s real debt servicing in effect rises. Paying debt by product deflation means raising real debt. Companies if possible therefore initially turn to shutting down planned real investment and cutting operating costs, especially labor costs—first by reducing hours of work, then layoffs, then other forms of wage cuts. However, all three of these measures may result in immediate cash to service debt but ultimately result in a reduction of cash flow. All forms of deflation therefore exacerbate debt and debt servicing problems. In the real world, companies with rising debt servicing stress and facing default undertake all measures in some combination, as well seek to raise more debt (even if more costly) and delay if possible making debt payments.