[ADDENDUM: My book is almost finished and I should be back to blogging shortly!]

Moving into last night’s contest, the only things we could be sure of was that climatic change would leave us exposed to more frequent storms in the future (although half the country seems intent on disagreeing with that statement), and that our federal government would remain deeply divided and dysfunctional.

Seems pretty clear, right?  But allow me to advance an alternative narrative. 

President Obama’s victory last night provides the country with an opportunity that was, unfortunately, squandered during the president’s first term. The White House, chastened by a narrow victory and benefitting from the freedom to operate that historically characterizes second term Democratic administrations, is likely to move into next week and next year with a far more combative message than the milquetoast and entirely elusive “bi-partisanship” of the president’s first term.

Moreover, the Republicans in the House of Representatives, and to a lesser extent in the Senate, will today come face to face with the reality that their message could not defeat a Democratic president suffering from a nearly 8% unemployment rate, and a massive 14.5% underemployment rate, to say nothing of a generally anemic economy and a lackluster set of policy responses to same.

They blamed the president for four years for an economic and financial crisis that misguided Republican supply-side and deregulatory policy wrought upon this nation on-and-off for nearly three decades. The Republicans pounded the president – attempted to obstruct and generally succeeded in blocking even the most moderate of Obama’s initiatives. 

But they couldn’t pull it off, they failed.  The tens of millions upon tens of millions, from the .01%, injected into the Republican juggernaut—ineffective.   And now they face a president empowered to pin them with outright blame for continuing to thwart progress.

So here is what I believe will result from the new status quo.  A newly re-elected president will finally be outraged enough to call out those on the Hill who have essentially shut down the federal government.  He will, this go-round, take his case directly to the American people and leave the obstructionists with a clear and unambiguous choice: put partisanship aside and get with the program, or be prepared to see the full dismantling of the post-Reagan Republican misadventure in the 2014 congressional mid-term election.

That the country didn’t buy the Republican argument is now established fact. That they are exposed to the power accruing to a president who no longer needs to be concerned with his re-election is equally obvious.  And that Republicans in congress must now choose between holding their seats and going down in a blaze of ideological glory will be pretty much the only two options available…if a re-elected Barack Obama has any sense of the political advantage that he was graced with yesterday.

I’m betting that the somnambulant Obama of the first debate is wide awake today. And I’ll wager that a large number of Republicans will choose their hides over their failed message.

Simply put, outstanding consumer credit has now surpassed its bubble-era high. So clearly people are borrowing – albeit mostly for education and autos. Revolving credit balances (aka. plastic), which were declining,  have started to rise as payrolls stall amidst continued increases in healthcare, education and, intermittently, food and energy costs.

When the underwater portion of first mortgage loans and now-mostly-uncollateralized, fully-drawn HELOCs and second mortgages are added to the mix, real “consumer-credit” has blown past all prior metrics (adding between $750 billion and $1 trillion to “unsecured” consumer debt).

I believe the events of the past decade have proven beyond doubt that consumers are pretty near always inclined to borrow and consume if credit is showered upon them. We have already, in fact, set ourselves up for a credit crisis in student loans and potentially in the re-emergence of subprime auto, that has already begun in the former in my opinion.

Yes, some folks are being more careful – as well they should. But even they can be tempted by low-interest-rate opportunities for immediate consumptive gratification. The problem is less that they are resisting and more that consumers’ creditworthiness (balance sheets) and incomes don’t warrant more borrowing.

Banks may actually be right on this one – they do desperately want to lend to shore up current earnings, but the long term costs of free credit for all who can fog a mirror are too fresh in the minds of both management and examiners.

The policy debate on this issue in Washington comes down to discussion between the financial institutions soundness and stability folks in the regulatory establishment, and the macro policy guys, mostly at the Fed and at Treasury (the latter of whom have run out of tools to reduce the household debt overhang and are now considering the “dark side” possibilities of yet more credit creation).

Let’s continue to root for the soundness and stability guys. After all, they missed the real issues for nearly a decade and know as well that the portfolio side of bank balance sheets are still bedeviled by legacy loans (those HELOCs and underwater first mortgages) that really are unsecured consumer loans and in great jeopardy, especially if the economy continues to soften.

Bottom line: It’s not that consumers don’t want to borrow, any more than alcoholics aren’t desperate to drink. It’s that they shouldn’t.

• There is a global insufficiency of demand relative to an immense oversupply of labor and productive capacity.
• The imbalances between high-wage/current-account-deficit/balance-sheet-indebted nations and lower-wage, surplus nations have produced a glut of savings in the latter, relative to the opportunities offered for profitable investment of those savings in additional capacity either at home or abroad, given the absence of demand for such additional capacity.
• The excess savings have inexorably reduced the cost of money in the developed world to the historically low levels we again achieved this week. The sole exception to this phenomenon being in the peripheral regions of the Eurozone, owing to the perverse and economically unnatural condition of their being caught in a currency union absent a fiscal union and internal credit support (a subject of many earlier posts on this blog).
• The private sector debt overhang in the advanced deficit economies (including, for this purpose, the portion of the sovereign debts of those countries that was taken on to subsidize internal welfare systems in lieu of, or in addition to, households taking on debt directly) is preventing the recovery of internal demand. Moreover, as the great Irving Fisher wrote during the Great Depression, the very act of attempting to reduce debt has once again ignited the paradox of reduced economic activity, employment and income causing consumers to become even more debt-dependent. Quoting Fisher: “The more debtors pay, the more they owe.” We saw this materialize vividly during the second quarter as aggregate consumer debt zoomed past its bubble era highs.
• We are enduring the unfortunate coincidence of the two foregoing phenomenon coincident with a generational (as in, once-in-a-generation) new technological plateau that appears to find an ever expanding number of labor-saving, productivity-increasing, job-obsoleting applications; and
• The developed world has achieved population demographics that force us to confront painful intergenerational economic issues—amidst the historic levels of economic insecurity that impact younger generations as a result of the foregoing issues.

I will hereafter refer to the above as the “Four Factors”—summarized as follows: (i) exogenous oversupply relative to global demand, (ii) classic Fisher-described debt deflation, (iii) excess technological productivity relative to the availability of global labor, and (iv) inter-generational demographic challenges.

Any one of the above Four Factors has a fairly obvious (at least to those of us observers who enjoy salt water and air in the summers) set of solutions that would no doubt be both appropriate and successful if applied in the absence of the remaining three.  The challenge that is confounding all schools of economist—well, not all of them, the “austerian-liquidationists” (who summer by lakes it is said) seem not to be confounded, merely lacking in logical coherence—and the political elements who depend on economists to read the entrails of commerce and provide answers, is the need to address all Four Factors simultaneously (or, if not to address the, at least to consider the impact of each upon the others).

That challenge is not only unmet, it is sadly under-discussed in the context of the Four Factors’ impact upon one another.  It also poses a confluence of circumstances that are nearly impossible (or at least extraordinarily difficult) to model quantitatively and approach uniquely within any one of the several macro-theoretical constraints.

Putting aside what I view as theories and models discredited as the result of recent events (in part because they assume away the possibility of all, or some, of the Four Factors—to say nothing of generally assuming-away that which is inconvenient), there would seem to be a resistance even among those disciples of John Maynard Keynes, Fisher and one of my favorite practical thinkers, Hyman Minsky, to put aside their own models and start thinking out-of-the-box, as those latter three gentlemen most certainly would were they to have lived to contemplate our present situation.

In defense of many, this is hard stuff. The world has never experienced anything like this. And all of us considering what is to be done are constrained by political realities that seem stacked against any reasonable progress in considering a unified solution.  But then again, much of our political dysfunction results from a failure to inform and explain, to those in power and to the broader polity, what we are up against—a failure that extends from the economic intelligentsia’s inability to agree on what that is.

For example, New Keynesian macroeconomists, as well as some of their post-Keynesian and Hicksian cousins (yes, I am including Paul Krugman in this category, much as he is to be admired for his outspokenness) have posited that gargantuan additional amounts of monetary expansion will succeed in overcoming the debt deflation. If debt deflation were all we were dealing with—it very well might.  It would even take a good shot—albeit a painful one—at addressing the intergenerational imbalances in the advanced economies by making sure that aging savers (who would otherwise prefer to “clip bond coupons”) become desperate to make expansionary investments amidst Japanese-style bond yields and panicked fears of inflation.

Yet we now have enough of a post-crisis track record to see that efforts to induce inflation, and efforts to target and forcibly obtain high rates of nominal GDP growth (the hope of all who seek to induce debt-devaluing, and investment-inducing inflation/financial repression—see Christina and David Romer, Kenneth Rogoff, and his collaborator, Carmen Reinhart) are not working.

We are at the zero lower bound of short term interest rates.  Long term rates are certainly being manipulated by central banks—but the mass of excess capital floating about with no sensible investment alternatives given the excesses of supply relative to demand, would keep them low anyway.  The reason the Japanese experience is applicable to the rest of the developed world is not because of their inescapable recession/deflation—it is because it was the first advanced economy to experience a massive private sector debt overhang contemporaneously with a substantial excess of savings relative to opportunities for domestic investment when the “Asian Tiger” economies began to challenge Japan’s manufacturing and export hegemony. Then, as now, savings sought the security of hard currency government debt and reasonable equivalents (excluding, in the present iteration, debt of troubled Eurozone countries without control over their own currency) when there was no reason to finance additional capacity.   

In addition to historically low interest rates and a banking/credit system choking on un-lent, and foolish-to-lend, liquidity, we have the subsidizing effect of low interest rates on banks and corporations (and, to a far more limited extent because of the decrepitude of household balance sheets, consumers). We even have, as a result of the household debt crisis and the underwater mortgage crisis, 6.5 million households that are delinquent or in default on their mortgage and essentially living “rent free”—a most insidious form of subsidy.

There is so much cash floating around in the capital markets that money supply long ago ceased to be the metric targeted by the Federal Open Markets Committee of the U.S. Federal Reserve Bank—it is now all about interest rates and I would dare say that with 10 year and 30 year U.S. treasury bonds, at below 1.5% and 2.5% respectively, if nominal GDP can’t be made to grow, and inflation to ignite under present circumstances there must be something else going on! Something bigger, even, than the classic liquidity trap in which we are very much caught.

I believe that the so-called “doves” at the Fed realize this as well.  Markets may trade on the expectation of further monetary intervention, but the intervene-ors are beginning to conclude that further easing is likely not to be productive—and, worse yet, possibly counterproductive. And with no small irony, this is not because of the typical fears of their inflation-hawk colleagues.  Rather it is because we haven’t been able to produce much inflation at all, apart from bouts of commodity inflation that correspond with periods of massive easing and each time only succeed in quashing economic activity at the margin, as consumers cannot keep up.

Wages, unfortunately, refuse to track the rise in those prices that are influenced by more liquidity, lower interest rates, and short-lived fears of inflation-that-is-not-to-be.  And, yes, that is because there is too little aggregate demand for labor relative to a global surplus thereof.

Critics of this view are many.  Some, like Krugman, readily acknowledge that wages are stuck at rigid nominal levels—refusing to grow, but also refusing to fall in the absence of demand. And the truth is that employees aren’t given to offering to work for less and employers seldom cut wages—preferring instead to cut workers—so wage rates are, in fact, quite sticky.  As I sat down to write this essay, I noted a blog post by Professor Krugman precisely on this point, written within hours of my putting my own thoughts down. In it, Krugman asserts that falling wages would precipitate “destructive deflation” and maintains that while wage cuts could theoretically be thought of as expansionary (because such cuts would notionally increase the demand for workers, thus creating jobs and increasing demand) they would exacerbate the debt problem, as households earning less would have a more difficult time deleveraging and between that, and the downward price adjustments that would need to follow wages, we’d be off on the road to Tokyo before long.

But that view ignores other realities.  Yes, nominal wages are downwardly rigid and, yes, reduced nominal wages would result in reduced nominal prices before too long.  And reduced rents, both real and economic, ultimately reduce asset values that are reflective of the nominal wages and prices. It is hard to argue in the alternative. 

Yet it is, as I see it, similarly hard to argue that further monetary expansion will succeed when wages cannot be forced to rise. It is even harder to argue that wages will rise when we are at the zero lower bound of short term interest rates and long term interest rates imply a near-negative rate of future inflation. And it is—in my judgment at least—impossible to argue that wages will rise now that we have been through multiple rounds of unprecedented monetary intervention, with the only result being that we have stabilized the developed economies a few yards short of descending into full-fledged depression.

And it is particularly difficult to ignore that, measured in terms of headline CPI for Q2 2012, for what it’s worth statistically (not much unless it continues)—we actually experienced price deflation (March CPI = 229.018, June CPI = 228.618, subject to revision).  .

Without going too far into a discussion of the emerging economies, the disinflationary patterns we are seeing in China as growth slows, is particularly alarming.  We badly need an overheated Chinese economy to inflate in order to partially offset the supply/wage imbalances and induce cross border currency revaluation to the detriment of the U.S. dollar. Today, the dollar is flying way too high, having risen in recent days to a two year high. Too high to be helpful (indeed, it will soon be the opposite) in addressing trade and current account balances.

If all we were experiencing was a debt deflation, the easing by the Fed, ECB, BOE and BOJ would have actually accomplished something. If that were the case, than central banks would have the ability to force growth in nominal GDP. But, as demonstrated via consideration of the Four Factors, such is not the case. Not even close.

Note that I am not saying that the presence of a global supply glut knocks into the gutter all economic theory that says such a thing can never occur. Markets and economies do of course tend towards Walrasian equilibrium. But I am saying that the magnitude of present imbalances, especially if not properly addressed, would take quite some time to rebalance.

As an analogy, consider that we have, since the Renaissance, generally understood that the earth always turns daily on its axis from west to east. A giant meteor slamming into its surface might alter that rotation with the result that its restoration would take considerable time, during which costs to the residents of the planet would undoubtedly be severe.  In the case of global macroeconomics, it was no meteor that hit us. We were hit by a ton of BRICs.

Irving Fisher taught that to prevent a deepening slump amidst a debt deflation we must stabilize economies and then go all-out to reflate them. The monetary authorities in the developed world have engaged in massive coordinated action to stabilize their financial systems and economies to prevent depression (at least so far). But they have not succeeded in being able to reflate the advanced economies—and will not be able to do so through a singular reliance on the blunt instrument of further monetary easing. Fisher would certainly have seen this.

We must move from stabilize and reflate, to stabilize and recalibrate:

• It is time for creditors throughout the developed world to finally take the write downs that have long been coming their way in connection with the trillions of dollars of truly un-payable household and sovereign debts that resulted from the credit bubble of the 2000s.  Yes, this will pressure lenders and, yes, they will need to be recapitalized to the detriment of their existing stakeholders.  But there is presently no shortage of capital seeking reasonable risk-adjusted returns, and I have every confidence that it will flow eagerly into the financial sector—if only the balance sheets of our institutions were honestly reckoned by having the currently unrecoverable carrying value of assets written down to that which can be recovered today from borrowers and/or underlying collateral.
• As I have been saying and writing about for years, we must accept the reality of what the credit markets are telling the planet’s most creditworthy governments, particularly that of the U.S.  The message is “please, here, take our money…take it cheaply and keep it safe…we have no fear of lost purchasing power, the trend is not inflationary…now take it (and use it to fix your  economy).” And that is what we must do. We must take as much 30-year money at these depression level interest rates as we need to re-employ our underemployed workers directly, on public infrastructure projects that return benefits to the economy more than sufficient to repay the sums borrowed when the time comes.  The private sector will not hire until it sees a recovery in demand—so the only agent for re-employment of workers and regeneration of demand may, for an extended time until the imbalances at least decline somewhat, be our governments.  It is long past time to pack away austerity agendas.
• And yes, we must address and manage the process of nominal price, wage and asset value declines. The advanced economies are experiencing the effects of a supply glut, a debt overhang, massive technology-induced productivity (soon to transfer to the emerging economies, worsening the glut), and aging populations. These are all disinflationary factors. And the aggregate effect of their contemporaneous existence is deflationary—full stop. Yet in relying on monetary intervention alone we are fighting the battle to control the pace of deflation (forget about reflation) with one hand tied behind our back.n  Instead of targeting growth in nominal GDP, which I am proclaiming here to be a futile endeavor, we must target renewed global competitiveness and, at the very least, growth in real GDP. That means both allowing our price and wage structures to align themselves with global supply and demand and, more importantly, feeding and nurturing investment in those areas of the private sector that can employ large numbers of people at market clearing wage rates. Especially in those sectors that are more readily protected by geography from global competition.

I am convinced that if our economic policy had more closely acknowledged and addressed the challenges posed by the Four Factors, we would have made far more progress over the past five years. Let’s not waste the next five years ignoring the reality thereof.

In the second quarters of three successive calendar years—2010, 2011 and 2012—improvements in the U.S. economy that generated hopes for economic rebirth were dashed by what seemed to have been economic forces of gravity that mysteriously pull glimmering positive trend lines downward just as the crocuses of spring are pushing up through the earth’s soil.

In each of those years, for example, the rate of growth in aggregate U.S. payrolls spiked and then declined, leaving hand wringing for much of the balance of the year.  Hourly wage growth attempted to turn positive on a “real” (inflation adjusted) basis, only to be dragged back into the same pattern of stagnation or decline that has been characteristic of each of the last dozen years, save for the years of the Great Recession itself, when the U.S. experienced deflation and real wages rose as a result. 

And sometime in the autumn of each of 2010 and 2011, people (myself included) from every school of economic thinking penned white papers, articles, op-eds in a cacophonous chorus prescribing—in the aggregate—a bipolar set of solutions for aiding the economies of the U.S., and the rest of the developed world, to achieve escape velocity from what can be characterized as a perennial pattern of printempal slump.

There are always other factors at play, the “if only’s,” that pose distraction: If only Europe wasn’t going to hell in a hand basket, if only the U.S. had a government that could achieve consensus on matters of extreme importance, if only the consumers would click their collective heels together and believe enough in economic recovery to go out and “do what they’re supposed to do.”

But the fact remains that consumers gave it their all over the past seven months or so.  As my post on consumer credit, of March 22, 2012, demonstrated the consumer bought into this last round of false-recovery hook, line and sinker—going back towards record-setting levels of unsecured debt in order to continue to show up at the malls and the auto dealers (to say nothing of colleges). The “confidence fairy” successfully covered consumers with pixie dust and—despite Europe and a dysfunctional U.S. government—the 70% of our economy that is dependent on consumption of goods and services was given every benefit of the doubt.

And yet here is where we have, once again, ended up—confidence misplaced and the engines of recovery once again threatening to stall in unison and send us crashing into the turf.

I have been closely watching two Bureau of Labor Statistics’ data points over the past several years: average hourly earnings and the index of aggregate weekly payrolls (in both cases for all private, non-farm workers).  The index of aggregate weekly payrolls, by the way, is a measure of all the total payrolls of all establishments in the country—all the money paid out to workers.  My hypothesis is that each time that average hourly earnings show any acceleration in the rate of growth, whatever growth in aggregate payrolls that we associated with a burgeoning recovery became short-lived and, in fact, fell sharply thereafter.

The May 2012 Employment Situation report released on Friday has given me enough data to confirm at least some of what I have been thinking in this regard.  That is that the ability to absorb the massive amount of underutilized labor in the U.S. (both within and outside of the official labor force tally) appears to be conditioned on the price of labor falling sufficiently to offset at least some of the unprecedented global wage imbalances within the competitive universe of manufacturing and, to a lesser extent, service industries.

But as the Federal Reserve Bank of San Francisco pointed out in an excellent paper in April of this year on wage growth and the impact of nominal wage rigidities (the tendency of employers not to actually reduce—and employees to resist the reduction of—nominal wages, especially during hard times), rather than falling in nominal terms to reflect the excess availability of labor, they have actually risen.  This is not to say that wages haven’t fallen in real (inflation adjusted) terms—they were doing so before the Great Recession and resumed doing so again after the brief bout of price deflation we saw during the recession.  But it is nominal wages (combined with the value of the dollar to an extent) that makes the U.S. economy more or less competitive globally. And the aforementioned wage rigidities are not helpful—and, I would argue, are about to be tested again.

The below graph shows a history of the 3-month moving average growth rates of both hourly wages and aggregate weekly payrolls.  It is annotated in a self-explanatory manner, so suffice it to say that in each of this year and the past two the acceleration of payroll growth may have been undermined by slight upticks in hourly wage growth.  And, in fact, a flat or down-trending wage environment may have fostered hiring. The spread between the two rates of growth is shown as a purple dotted line on the graph.  Put simply, the employment picture is better off when the dotted line is between the two other lines (the closer to the red line the better) and worse off when it falls below.  Note that the dotted line, together with the growth rate for aggregate payrolls has once again fallen off sharply.

Source: Bureau of Labor Statistics (please click to enlarge graph)

The concerns I have here are principally twofold:

• Structural issues are not bringing the people willing to work the cheapest (those who have been out of work the longest) back onto payrolls at lower wage rates because of employers’ resistance to hire them.
• The very nature of the present crisis is inherently deflationary, and developed countries’ central bank policies are vigorously attempted to counteract those deflationary pressures.  But as extraordinary monetary easing is not flowing into real economies beset by an already existing glut of capacity, but is rather inflating commodities—we find ourselves with price inflation in food and energy that is ultimately not able to be offset by increasing wages (the latter being under global pressure from emerging markets) and we then suffer the stalling out of growth.

We have allowed hopes for revival of developed world economies to transcend the reality of their condition—facing enormous competitive and deflationary pressures and deep in unyielding indebtedness, at both household and governmental levels, that we can’t reduce through austerity in times of sub-par economic activity and, because of anemic business conditions, can’t grow ourselves out of either. 

While we sit about obsessing over paltry levels of job creation and an unemployment rate that fell during late 2011 and early 2012 as much because of departures from the labor force than from job growth, we ignore the real nature of employment in the U.S. and Europe (and to a lesser extent in Japan, which offers a cautionary demographic conundrum as well): Near historically high levels of underemployment (those working few hours combined with those working none), labor force participation levels and the ratios of those employed to total population that are abysmal, and whatever new jobs that are created being overwhelmingly in the lowest paying ranks of the service sectors (a phenomena shared with Japan—despite its vastly lower headline unemployment rate). 

While headline unemployment in the European Union, at 10.25%, is at a post-recession high, and in the peripheral nations of the Eurozone averaging over 17%, the fact remains that—even with a lower official rate of unemployment—the U.S. has only 114.8 million full time workers and 27.5 million part time workers supporting a population of some 315 million people (243 million of whom the government estimates are eligible for work, based on age and other matters).  This waste of human resources is draining society of its vibrancy.  And we cannot hang our hopes on marginal changes in the number of low paid service workers amidst such conditions.

This is not just a “blame Europe” story, as the media would sometimes have us believe.  It is certainly not a U.S. government debt, interest rate fear, or tax uncertainty story, as the Republican’s in congress would have us believe (after all, one cannot be but stunned by the rates in U.S., U.K. and German long term bonds at rates never seen since The Great Depression).  This is a global imbalance/emerging nations integration story and until we start addressing that story directly, the threat of a far more devastating collapse will remain.  Come this winter, there may be no Christmas-to-Easter respite.

Professor Krugman has posited for months now that Bernanke has come up short in failing to follow his own prescription for post-bubble, debt-deflationary economies (namely, that of Japan, which the Chairman wrote about as an academic a dozen years ago). In essence, Professor Bernanke’s view was to push both monetary and fiscal stimulus to the point at which it would generate above-natural rates of inflation for a period of time sufficient for such economies to reflate and discount the indebtedness accumulated during credit bubbles.

In the course of Krugman’s commentary he has pushed the notion that Bernanke is either politically intimidated by the right, fearful of uncontrolled inflation, or possessed of a shy personality that is vulnerable to peer pressure within the FOMC (Paul…seriously?).

While some of what is in Ben Bernanke’s mind may be made more clear with tomorrow’s FOMC meeting announcement, in the meantime allow me to rise to Chairman Bernanke’s defense and suggest to Professor Krugman, as I have in the past, a different – yet still quite Keynesian – explanation for our Fed chairman’s current point of view (and in doing so give Paul a piece of my own mind, as I doubt Ben will rise to the bait himself).

Ben Bernanke is neither overly “shy” nor out of touch with the world, as Professor Krugman would have us believe.  To the contrary, I believe the Chairman has correctly assessed the limitations of extraordinary monetary intervention at the zero-bound (short term interest rates at or near zero) and comprehends a present inability of the U.S. economy to generate the sustainable inflation that the professor correctly notes would help us out of our debt-deflationary slump.

I am sure that Professor Krugman agrees that the Great Recession and its sluggish aftermath saw a mammoth decline in aggregate demand.  But if present levels of aggregate demand are insufficient to revive our economy, such demand must be insufficient relative to something else. And in this case – seen from a global perspective – that something else is the global aggregate supply of labor, productive capacity and, yes, even capital.  Much of this excess supply can be traced to the historically sudden emergence of the post-socialist nations into the global market economy – which nations are characterized by extremely low wages relative to those of the developed world.

As a result of the foregoing, wages in the U.S. and other areas of the developed world are unable to “track” (that is, to follow along with, even on a lagging basis) the type of inflation resulting from the ocean of liquidity that quantitative and credit easing policy of the Fed, the ECB and the Bank of Japan has produced – generally speaking, inflation in highly tradable commodities and financial assets.  No wage growth (because of the dampening effect of excess emerging market labor, always standing by to work cheaply where it can compete with endogenous U.S., European or Japanese labor)…no sustainable inflation.  As a result, high levels of inflation tend to collapse economic activity, as limited per capita wages are shunted to oil and food, rather than to more expansionary forms of consumption.

Extraordinary monetary measures will remain a critical weapon in fighting the deflationary pressures that result from our continuing debt overhang and global wage imbalances. But I am afraid – as I believe Chairman Bernanke may well be – that attempts at “reflating-to-recover” are, in the end, somewhat counterproductive under present circumstances.

March 22 (Bloomberg) — Cliff Noreen, president of Babson Capital Management LLC, Dan Alpert, managing partner at Westwood Capital LLC, and Mark Luschini, chief investment strategist at Janney Montgomery Scott LLC, talk about the U.S. economy and corporate profits, the credit market and student debt, and the political debate over the federal budget deficit. They speak with Pimm Fox on Bloomberg Television’s “Taking Stock.”

As many of you who frequent this space already know, I have been tracking the rates of change in the 3 month moving averages of U.S. consumer credit outstanding and retail sales since a piece we did on the subject in November of 2010.  We look at aggregate consumer credit (and not merely the revolving portion more commonly associated with retail activity) because we believe that term loan borrowing—where available (chiefly student loans and autos)—frees up cash for other consumption.  Another way of viewing this is that transportation and education are not truly elective purchases and not leveraging those purchases would otherwise reduce overall consumption.

What the numbers tell us today (as illustrated in the below graph) is that, as of January 2012, the growth rate in all forms of consumer credit on a 3 month average basis grew at a rate greater than at any time during the credit bubble.  Moreover, at $2.495 trillion, outstanding consumer credit stands a 97% of its peak of $2.576 trillion in August of 2008.  Deleveraging, my friends, this is not.

Yesterday the Consumer Financial Protection Board reported that student loans alone likely moved past the $1 trillion milepost at year end.  This not only acts as a present danger, but will reduce consumption years into the future as the present cohort of students enter their prime consuming years “pre-burdened” by indebtedness.  Normally, we would rely on post-recession rapid growth to reverse the situation, but in an oversupplied, demand-impaired global economy GDP growth proves elusive.

While aggregate payrolls are up 4.6% YoY since February 2011, as 2 million net jobs were created over the past year, this has come at the expense of declining real wages and pretty flat (up 1.8% YoY) nominal wages.  So the income/expense hole for many workers has become wider, and even the newly employed and re-employed are coming on in such low wage categories that when you subtract foregone transfer payments (unemployment and other benefits) their net additional income (and the contribution thereof to consumption/GDP) hasn’t risen all that much.

As we all sit here in our liquidity-bloated, but still over-leveraged, developed world economies, wondering if this year’s rendezvous with recovery will be the real thing – I offer the following three thoughts with regard to the below graphic:

• Are we once again entering a zone similar to the period immediately prior to the Great Recession in which consumer borrowing also grew rapidly, and more and more of the new borrowing was applied to debt service instead of new consumption? Watching retail sales trends over coming months should be instructive in this regard.
• The crash in the housing market has left us with $873 billion in Home Equity Line of Credit balances (at Q4 2011) owed by consumers, most of which is no longer collateralized by home value. While borrowers may be making payments (many at vastly reduced rates of interest given the floating rate nature of those loans), I would put forward the argument that as a practical matter unsecured consumer debt in the U.S. is actually well over $3 trillion.
• We are programmed by past cyclical phenomena to look at consumer credit expansion after a recession as being a positive – heralding the arrival of the “confidence fairy” who the more supply-focused in the macroeconomic establishment view as the critical element to a recovery.  There is no doubt that there is an element of this in the expansion illustrated below but, like so many things about the present secular crisis, that is surely not the driving force when a substantial portion of the increased indebtedness is applied to making ends meet, rather than triggered by optimism about the future.