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David Stockman: The 2008 Hoovervilles Were in China

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In an excerpt from his new book, Stockman proposes that in 2008, Wall Street's presence in the Treasury Building "could not have been more timely or strategic."

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The reason for this more benign balance sheet condition was straightforward. On the eve of the Great Depression the primary production industries-agriculture, mining, and manufacturing-accounted for more than 70 percent of GDP. These sectors have a long pipeline of crude, intermediate, and finished inventory and therefore exhibit high inventory-to-sales ratios.

By the time of the 2008 financial crisis, however, the primary production sector had become a mere shadow of its former self, amounting to only 17 percent of GDP. When recession hit the American economy, therefore, the downward spiral of inventory liquidation was muted. Aerobics class instructors, for example, experienced modestly reduced paid hours, but unlike factories and mines, fitness centers didn't go dark in order to burn off excessive inventories; they stuck to burning off calories.

In fact, by 2008 China, Australia, and Brazil had become the world's new mining and manufacturing economy; that is, the United States of 1930. When upward of 50 million Chinese migrant workers were sent home from idle factories in late 2008, the villages of China's vast interior became the "Hoovervilles" of the present era. So owing to the fact that inventory and production adjustment took place mainly in the outsourced economies abroad and that the automatic stabilizers were already in place at home, there was no downward lurch in US incomes and spending.

The vast difference between 1930 and 2008 is crystallized in the data on personal consumption expenditure and personal income. When the bottom dropped out of the primary production sector during the Great Depression and took employment and incomes down hard, real PCE subsequently plunged by nearly 20 percent. By contrast, even without any significant Keynesian stimulus during the initial nine months after the September 2008 financial crisis, real PCE declined by only 2 percent.

This order of magnitude difference-that is, only one-tenth the Great Depression era impact-is dispositive. Furthermore, the relative resilience of PCE, which accounts for 70 percent of GDP, should have been easily predicted in September 2008, even under the assumption of no extraordinary policy stimulus. Bernanke's depression call, in fact, was reckless and uninformed.

The reason that PCE remained resilient is that in present times roughly 90 percent of personal income comes from private service industries, government jobs, and transfer payments. As Professor Bernanke made his rounds warning about the Great Depression 2.0, there was absolutely no reason to believe income from these sources would plunge.

In fact, during the next nine months government transfer payments rose by 16 percent, or at an annualized rate of $300 billion, and thereby offset the $275 billion drop in total wage and salary income. Moreover, even this 4.1 percent drop in wage and salary income, the raw material for consumption spending, was highly skewed. On the eve of the crisis, government employee compensation was $1.15 trillion, and not surprisingly it increased at a 2 percent rate during the nine months after the Lehman events; likewise, compensation in the private service sector was $4.2 trillion, and it declined only modestly, at a 3.8 percent annualized rate.

On the other hand, the goods-producing industries-manufacturing, construction, and mining-had been shrinking for decades and therefore posted a total payroll of only $1.2 trillion by the time of the financial crisis. So even though wage income in this sector fell at a steep 12 percent rate during the nine-month period, this drop was a rounding error in the larger scheme of things, amounting to just 1.1 percent of overall personal income.

Ironically, therefore, the long-term structural challenges facing the American economy-the offshoring of goods production and the massive growth of transfer payments and government payrolls not financed by current taxes-functioned as ballast to the Main Street economy in the immediate aftermath of the Wall Street meltdown. Yet none of these structural dynamics were a mystery. As a plain matter of professional competence, the chairman of the Fed should have known that the vast bulk of wage and salary income no longer came from the inventory-intensive sectors and that consumption spending would be powerfully boosted by automatic transfer payments. There was simply no structural basis for the kind of self-feeding economic free-fall implied in the Great Depression 2.0 horror show that Bernanke pedaled to petrified congressmen.

As it happened, the initial wave of inventory liquidation and labor-shedding triggered by the Wall Street meltdown burned itself out quickly during the first nine months after the Lehman crisis. Thus, business inventories totaled $1.540 trillion in August 2008. While that figure dropped by about $215 billion during the course of the recession, fully $185 billion of the liquidation had occurred by June 2009. Thereafter, business inventories bounced along a bottom of $1.325 trillion from August through December, indicating that the downward momentum of the economy had already dissipated.

The story was similar with nonfarm payrolls. While the recession had technically started months earlier, the jobs count was still 136.8 million as of August 2008. During the subsequent course of the recession, 7.5 million of these jobs were eventually eliminated before the bottom was reached in February 2010. Once again, however, about 6.6 million of this payroll reduction, nearly 90 percent, was completed by June 2009.

During the six months from November through April, job losses averaged 750,000 per month. This heavy labor-shedding cycle occurred because the Wall Street meltdown was the equivalent of an economic punctuation mark; it demarcated that the credit-fueled housing and consumption binge was over. Accordingly, American businesses downsized their payrolls on a one-time basis by about 5 percent, in accordance with the now far less sanguine prospects for the economy-but this did not mark some irrational binge of job destruction that could spiral into depression.

In fact, the labor force adjustment subsided quickly and convincingly. During the May-June period the rate of job loss slowed to 400,000 per month, followed by 250,000 per month in the July-September quarter, and about 135,000 per month in the final quarter of 2009-before the job market stabilized and then began to rebound in early 2010. The adjustment in business spending on equipment and software was even more short-lived: it dropped by 16 percent between the third quarter of 2008 and the first quarter of 2009, and then stabilized during the June quarter before beginning to recover thereafter.

In short, by the end of the second quarter of 2009 the sharp recession triggered by the Wall Street meltdown was all over except for the shouting. There is nothing in the pattern of inventory liquidation or production, consumption, employment, income, or business capital spending that even remotely hints of a self-feeding doomsday scenario. In truth, the Hoovervilles were in Sichuan, Hunan, and Jiangxi Provinces. The chairman of the nation's central bank made a depression call based on errors that the Fed did not make in 1930–1933 and that were, in any event, predicated on a world that no longer even existed in September 2008.

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