Falling Wage Syndrome

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Paul Krugman
May 3, 2009 - The New York Times

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Some of the wage cuts, like the givebacks by Chrysler workers, are the price of federal aid. Others, like the tentative agreement on a salary cut here at The Times, are the result of discussions between employers and their union employees. Still others reflect the brute fact of a weak labor market: workers don't dare protest when their wages are cut, because they don't think they can find other jobs.

Whatever the specifics, however, falling wages are a symptom of a sick economy. And they're a symptom that can make the economy even sicker.

First things first: anecdotes about falling wages are proliferating, but how broad is the phenomenon? The answer is, very.

It's true that many workers are still getting pay increases. But there are enough pay cuts out there that, according to the Bureau of Labor Statistics, the average cost of employing workers in the private sector rose only two-tenths of a percent in the first quarter of this year — the lowest increase on record. Since the job market is still getting worse, it wouldn't be at all surprising if overall wages started falling later this year.

But why is that a bad thing? After all, many workers are accepting pay cuts in order to save jobs. What's wrong with that?

The answer lies in one of those paradoxes that plague our economy right now. We're suffering from the paradox of thrift: saving is a virtue, but when everyone tries to sharply increase saving at the same time, the effect is a depressed economy. We're suffering from the paradox of deleveraging: reducing debt and cleaning up balance sheets is good, but when everyone tries to sell off assets and pay down debt at the same time, the result is a financial crisis.

And soon we may be facing the paradox of wages: workers at any one company can help save their jobs by accepting lower wages, but when employers across the economy cut wages at the same time, the result is higher unemployment.

Here's how the paradox works. Suppose that workers at the XYZ Corporation accept a pay cut. That lets XYZ management cut prices, making its products more competitive. Sales rise, and more workers can keep their jobs. So you might think that wage cuts raise employment — which they do at the level of the individual employer.

But if everyone takes a pay cut, nobody gains a competitive advantage. So there's no benefit to the economy from lower wages. Meanwhile, the fall in wages can worsen the economy's problems on other fronts.

In particular, falling wages, and hence falling incomes, worsen the problem of excessive debt: your monthly mortgage payments don't go down with your paycheck. America came into this crisis with household debt as a percentage of income at its highest level since the 1930s. Families are trying to work that debt down by saving more than they have in a decade — but as wages fall, they're chasing a moving target. And the rising burden of debt will put downward pressure on consumer spending, keeping the economy depressed.

Things get even worse if businesses and consumers expect wages to fall further in the future. John Maynard Keynes put it clearly, more than 70 years ago: "The effect of an expectation that wages are going to sag by, say, 2 percent in the coming year will be roughly equivalent to the effect of a rise of 2 percent in the amount of interest payable for the same period." And a rise in the effective interest rate is the last thing this economy needs.

Concern about falling wages isn't just theory. Japan — where private-sector wages fell an average of more than 1 percent a year from 1997 to 2003 — is an object lesson in how wage deflation can contribute to economic stagnation.

So what should we conclude from the growing evidence of sagging wages in America? Mainly that stabilizing the economy isn't enough: we need a real recovery.

There has been a lot of talk lately about green shoots and all that, and there are indeed indications that the economic plunge that began last fall may be leveling off. The National Bureau of Economic Research might even declare the recession over later this year.

But the unemployment rate is almost certainly still rising. And all signs point to a terrible job market for many months if not years to come — which is a recipe for continuing wage cuts, which will in turn keep the economy weak.

To break that vicious circle, we basically need more: more stimulus, more decisive action on the banks, more job creation.

Credit where credit is due: President Obama and his economic advisers seem to have steered the economy away from the abyss. But the risk that America will turn into Japan — that we'll face years of deflation and stagnation — seems, if anything, to be rising.

Taliban prepare for U.S. surge

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Militants in Afghanistan say plans for Obama's new troops include more IED, suicide bombers and assassinations


Jessica Leeder
May 4, 2009 - Globe and Mail(Canada)

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KANDAHAR, AFGHANISTAN — Taliban fighters say they are planning a bloody summer campaign of buried bombs and staged ambushes in rural areas and a rash of multiple co-ordinated suicide bombings and assassinations in urban Kandahar.

Designed to spread terror across the most densely populated areas of this province, the militants' ramped-up battle plan is a response to the impending surge of U.S. troops and retrenching of other forces here.

After two weeks of interviews with Taliban, close observers and Afghan government officials from some of the province's most troubled districts, a picture emerges of what to expect from what may be the most intense fighting season in years – and places nervous civilians squarely in the crosshairs.

"We have new plans, new tactics," a Taliban logistics director based in the volatile Panjwai district says. He recently returned from high-level meetings with militant commanders in Quetta, Pakistan, and spoke about plans on condition his name remains unpublished.

"The new strategy of fighting is very important for us," he said. "It will be very dangerous for the government and for foreign troops."

Central to the summer strategy is a two-pronged terror campaign currently being mapped out by Taliban planners in a mountain refuge in northern Maywand district. The area links Afghanistan's Helmand and Kandahar provinces and is poised to become a focal point of the war when U.S. troops deploy there.

Their plan will be carried out by young fighters who, in recent weeks, have been trickling into the notorious rural areas west of Kandahar city, armed with new machine guns and sustained by villagers' donations of dry bread and watery yogurt.

When their commanders give the green light, these young militants, mainly between 18 and 30 years old, will instigate clashes on two fronts: the first will be across rural areas west of the city – the traditional summer battlefields for militants clashing with coalition troops. The second will be in urban Kandahar city, home to key provincial government offices and a hub for Canadian troops.

Out-powered in rural areas by military weaponry, fighters there will carry machine guns and attempt to sharpen the results of their ambushes, but they will rely more on land mines and improvised explosive devices, sources say.

Inside the city, insurgents plan to stage more frequent multi-bomber suicide attacks and targeted assassinations. Government officials and civilians who appear to be in favour of the current government regime will be hunted with new intensity.

"If a man or woman is working with the government, or they are supporters of the government or of the foreigners, we want to kill them," said one Taliban organizer speaking through a Pashto translator. "We want to put the pressure on Kandahar city. And we want to dissolve the government."

The militants' renewed focus on disrupting peace in Kandahar city comes at a time when Canadian troops are also setting their sights on the city. Under the command of Brigadier-General Jonathan Vance, Canada has for weeks been preparing to draw back from some of the remote outposts soldiers have been spread across – making room for the U.S. troop surge – and focus instead on securing urban Kandahar and the area immediately outside of it where the majority of the province's population resides.

This regrouping, which will take shape as U.S. troops make their way into the theatre over the course of the coming months, represents a transformation in Canada's approach aimed to allow troops to make headway on the nation building projects that ongoing security problems have stymied over the course of Canada's involvement in southern Afghanistan.

How locals respond to troops remains to be seen. In the city, confidence in both government and coalition forces has waned, and military officials acknowledge research confirms the forces' sunken popularity.

Their approval ratings have not been helped by a spike in large-scale violence over the course of the past month. Militants successfully carried out deadly bombings at the governor's mansion and the provincial council offices. Assassinations have become a daily occurrence, so much so that victims of the gruesome killings only make the news now if they are well-known figures.

In rural pockets, confidence in government and foreign military has also dropped. In some districts with a sparse military presence, landowners who were anti-Taliban last year say they've grown weary of ineffective government, corruption and poor security.

In Zhari and Panjwai districts, where military forces engage Taliban fighters regularly, villagers are fed up with the dangerous bombings that occur when ground troops call in air support. Residents worry the incidents, which occasionally claim civilian lives, will only increase as the U.S. troop presence builds.

All of that has made many long-time landowners wonder whether, if the Taliban cannot be beat, it's safer to simply join their cause.

"Last year, people were trying to convince the Taliban not to fight. Now people feel it is their obligation … to start fighting," said one middle-aged farmer from Maywand district, where militants say they maintain two fortified, armed positions. "People see the government as weak. They're not defending the common people. The government can't bring security," he said.

Mullah Masood, Maywand's district leader, said allegiances to militants will not change until foreign stakeholders invest properly in Afghanistan.

"My suggestion is for the foreigner to find work for the common people, the people who are poor," he said. "Find food for the children. Otherwise, this joining of the people with the Taliban will continue

The Greatest Cost

The greatest cost

Doug Noland
May 05, 2009 - Asia Times

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An astute analyst posed the following question last week: "The current debate is centered on whether the [US Federal Reserve] can take back the liquidity in time in order to prevent inflation. Suppose it can. Suppose they execute this perfectly. But if the Fed is able to flood the system with the liquidity (thus reducing the severity of the downturn) and take it back before it causes inflation, it seems there is a free lunch. We get something for nothing. So, assuming a perfectly executed game plan by the

Fed, is there a cost? Do they keep rates low for a time, only to raise them a lot a year down the road - is that the cost? Or is there another cost?"

I'm short on time today, so I'll attempt a brief response.

First of all, while it often appears otherwise, finance provides no free lunch. The mispricing of credit and misperceptions of risk in the marketplace have deleterious effects, although their true impact may remain unexposed for years. Indeed, the more immediate (and always seductive) consequences of loosened financial conditions tend to be reduced risk premiums, higher asset prices, and a boost to economic "output". Conventional analysis of monetary policymaking still focuses on "inflation" and "deflation" risks. I would strongly argue that our contemporary world has already validated the analysis that acute financial and economic fragility are major costs associated with market pricing distortions.

When the Federal Reserve collapsed interest rates following the bursting of the technology bubble, the results seemed constructive. Stock and real estate prices inflated; a robust economic recovery ensued. There was at the time some recognition of the potential for real estate excesses. But this was seen as such a small price to pay in the fight against the scourge of deflation. It was not until 2007 that the nature of the true costs of a massive "reflation" began to come to light.

Many would today argue that it was simply a case of the Fed's failure to take the punchbowl away in time. Such analysis misses a key facet of bubble dynamics. Once the mortgage finance bubble gained a foothold, there was absolutely no way policymakers were going to be willing to risk bursting such a consequential bubble.

I see ample support for my view that bubble dynamics have taken root throughout government finance. This unprecedented inflation includes Federal Reserve Credit, Treasury borrowings, agency debt, mortgage-backed securities issued by government-sponsored enterprises (GSEs) such as home-loan guarantors Fannie Mae and Freddie Mac, Federal Housing Administration and Federal Deposit Insurance Corporation insurance, massive pension and healthcare obligations, the myriad new market support programs, and so forth. This government finance bubble is domestic as well as global. Amazingly, the scope of the unfolding bubble dwarfs even the mortgage finance bubble. And, importantly, it is reasonable to presume that the Federal Reserve will find itself in the familiar position of being trapped by the risk of bursting a historic bubble.

So I see the probabilities as very low that the Fed will reverse course and impose tightened liquidity conditions upon the marketplace. Actually, reflationary pressures may force the Fed to increase its Treasury holdings in an effort to maintain artificially low interest rates. At the same time, I don't see higher inflation as the greatest cost associated with this predicament. Much greater risk lies with the acute systemic fragility that I believe is inherent to major bubbles.

Similar to mortgage finance 2002-2007, the marketplace is significantly mispricing the cost - and failing to recognize the risks - of a massive inflation of government finance. And while every bubble has its own dynamics and nuances, the unfolding government finance bubble has even more precarious Ponzi finance dynamics than the mortgage bubble.

The markets are on tract to accommodate US$2 trillion or so of Treasury issuance this year. This incredible amount of debt creation is in the range I would expect necessary to temporarily stabilize the US ("services") bubble economy. Importantly, this amount of new finance both plugs financial holes and works to stabilize inflated income levels. From last week's income data, one can see that personal income was up 0.3% year on year to $12.04 trillion. And while 0.3% is very meager growth, without massive government fiscal and monetary expansion (inflation) the economy would have suffered a destabilizing income contraction. Keep in mind that personal income has inflated 65% since 1998 and 33% from 2003.

I'll try to explain my belief that dangerous Ponzi finance dynamics are in play with the current course of policymaking. First, I view panicked policymakers as seeing no alternative than to try to sustain the current (deeply maladjusted) economic structure. A more natural course of economic adjustment - from finance and consumption-driven bubble economy to a more balanced system - was going to be much too painful to endure. So a massive government inflation was commenced in desperation - with the grandiose objective of revitalizing securities markets, housing prices, and the overall US economy. I just don't see how this reflation goes much beyond stoking a susceptible artificial recovery.

First and foremost, with government finance now completely dominating the credit system, I can't even begin to contemplate how this process might nurture an effective allocation of financial and real resources. Indeed, I see today's manifestations of credit bubble dynamics as an extension of similar mispricing, misperceptions, and over-issuance that led to last autumn's near financial collapse.

Admittedly, the massive extension of government credit and obligations works wonders in stabilizing a devastatingly impaired system. Inflationism is always seductive; trillions of dollars worth is absurdly seductive. Yet this extra layer of debt does little to effect change to the underlying economic structure. Actually, a strong case can be made that it only delays and sidetracks the necessary adjustment process. And, importantly, this enormous additional layer of system debt exacerbates system vulnerability.

At the end of the day, a system is made or lost on the soundness of its underlying economic structure. I posit that a sound economic structure is reliant upon only moderate credit growth and risk intermediation. Our system requires massive credit expansion and intensive risk intermediation. I would also posit that there are no benefits - only escalating costs - to throwing massive credit inflation upon an unhealthy economic structure. And, returning to Ponzi dynamics, one of the major costs to such inflationism is a massive expansion of non-productive credit - obligations that are created without a corresponding increase in real economic wealth producing capacity. The debt can only be serviced by the creation of more debt obligations.

The danger is that markets too easily and for too long accommodate massive credit expansion during the boom. Federal Reserve policies are fundamental to this dynamic. But at some point and out of the Fed's control, as Wall Street learned, greed inevitably turns to fear and a reversal of speculative flows marks the onset of the bust. And it's the massive inflation of non-productive credit that ensures the unavoidable crisis of
confidence. Can the underlying economic structure service the mounting debt load or, instead, is it the massively inflating debt load that is sustaining a vulnerable economy? And it is in this vein that I fear the government finance bubble is on track to destroy the creditworthiness of the entire economy. And this Ponzi dynamic is the greatest cost to what I fear is a continuation of unsound policymaking.

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Doug Noland is a market strategist for the Prudent Bear Funds.