A Recovery In The Making?

"The lesson of history is that you do not get a sustained economic recovery as long as the financial system is in crisis." - Ben Bernanke

The news regarding the United States economic recovery was relatively good this week.  Barring the business interruption of Sandy which will have an impact on fourth quarter GDP it appears that housing is rapidly finding a base and that banks are finally getting to grips with the problem and are becoming more proactive in writing down debt so that they can clear out the bad wood and start to lend.  The question is can the recovery take proper hold and for this to happen jobs need to be created and interest rates need to remain low for a long period of time.

Let's look at job creation first.  In recent weeks there has been a slew of companies laying off thousands of workers.  Bank of America is laying off 30,000, HP 29,000, Staples, FedEx and others bring the total to over 100,000 jobs.  This is not good news and comes in the face of very poor results from some of Wall Street's bell weather stocks.  Apple shares have been crushed from a peak of just over $700 to $590 today.  Google shares are down over $100.  Banking shares continue to languish and the S&P 500 is down 5% over the last two months.  This economy needs jobs to maintain its recovery.  Wall Street knows it and this is why the markets are turning over.  So how do we get that going?

Well ask either of the presidential candidates and they are going to create millions of jobs overnight.  We all know that is not going to happen, but I did stumble across one very interesting idea that may have a very good result.  What if, instead of paying people unemployment benefits for 99 months we poured that money into removal of the minimum wage?  A radical idea to say the least but let me clarify.  If there was no minimum wage I know a number of businesses that would hire workers right away.  Sure they would only pay them $5 an hour but that is far better than sitting at home wasting away.  Once you are back at work the juices start to flow and suddenly you are able to find better opportunities.

Now here is the best part.  The government would subsidize the difference between minimum wages and what the company pays the employee.  So for example if the worker is paid $5 an hour but the minimum wage is $8 then the government would top up the workers pay at the end of each month.  This three dollar difference would be far less costly and far more efficient in getting people back to work than our current program.  Once a target of full employment is reached, there would be a slow re-introduction of the minimum wage, there would be a slow transfer of the burden back to the companies reducing the government's involvement.  The idea is that at that time the economy would be at full employment so the demand for workers would bring the hourly rate up anyway and this would have the result of slowly reducing the government's burden as things improve.  Furthermore a lot of the burden would be offset by the receipt of more tax revenues. 

To me this idea has a lot of merit and is far superior to the money printing philosophy that we have in place right now.  This philosophy has resulted in an economy that is still stagnant.  Furthermore as I have repeatedly mentioned in this blog that the old ideas of pumping money blindly into a black hole are not targeted and are not producing the results that are needed but are creating a fiscal problem of the magnitude never before known.

The second piece of the puzzle is keeping interest rates low.  This is key to the continued recovery in housing.  A spike in interest rates would cripple the housing recovery which in turn would derail any form of moderate economic recovery.  For now it seems that the continued transfer of toxic debt from banks to the Federal Reserve is containing interest rates but rates need to remain low for an extended time without printing money. 

The first thing to do is to ensure as best as possible that banks are not involved in risky investments.  In an article in Bloomberg it was mentioned that Dodd-Frank has done nothing to curtail banks enthusiasm for taking on risk.  Furthermore as we have seen in crisis after crisis not only do bankers not fully understand risk but their greed gets the better of them and they need to be reigned in to abide by strict parameters.  Let the hedge funds and alternative investment fund managers handle the risky stuff, banks need to be the backbone of the economy and the only way to do this is to limit the risk by increasing their reserve requirements.  This is very simple to do but at present very risky as banks are already struggling to maintain current requirements while they unload their toxic debt.  Increasing this now would cripple banks and put a big stake into the heart of their ability to lend.  That said it should be ratcheted up over time to ensure that banks are not as vulnerable to systemic shocks as they were.

By strengthening the banking system with increased reserves and by increasing the base of employed workers I would argue that the economy would strengthen attracting foreign investors.  This would keep interest rates low for an extended period.  The only reason that interest rates would rise in this scenario is if magically Europe fixed its problems and there was reduced demand for perceived risk free investments.  At this point interest rates would have to rise to attract investment.  Outside of that unless inflation spikes interest rates should remain low, maybe not at the low levels they are right now but certainly not at massively elevated levels that people fear.  A strong US economy would produce the desired result particularly while Europe struggles.

All of these ideas are relatively simple to implement but like any idea it would take time to produce the expected results however I believe those results would be achieved far quicker and far more cheaply than our current strategy.  In the meantime we will have to deal with the approaching fiscal cliff and a globe that continues to be mired in uncertainty.  Worse still we have an economy that does not have a repaired financial system and an economy that appears to be on the verge of a recession.  Weak earnings, recession in Europe and problems in the United States are no reason to stay invested in an over inflated stock market.