The Slowing Economy – What is the Cause?

In the last few months, there have been a spate of ever worsening economic reports. The big number, the overall growth rate of the Gross Domestic Product, has been reported as anemic and then been revised downward; it is now well below 2%. The creation of new jobs which seemed to be moving up at the start of the year has also stalled. The “consensus” is for the report for June on Friday to show about 90,000 jobs created, but that same consensus has been way high for each of the last few months. There would be little surprise if the number came in at 30,000 instead. The unemployment rate is expected to hold steady at 8.2%, a figure that remains intolerably high. In the last week, we learned that manufacturing contracted for the first time since the end of the formal recession. Much worse, the figures for orders for future delivery fell drastically to a very low level. The orders are the leading indicator as to what the next few months will bring. In short, the economy is getting worse and worse; we may soon see the second part of the double dip recession. I say double dip even though the last recession formally ended three years ago; there has been no real recovery since then since there are still millions fewer people with jobs in America than there were at the start of the last recession.

The grim economic news brings forward two logical questions: 1)what is the cause of this current downturn; and 2)how do we get the country out of this mess? These are simple questions, but the answers are anything but simple. For the moment, let’s examine the cause of the downturn and leave the remedy to future posts.

President Obama has a simple response when asked about the cause of the current economic troubles. Obama’s response is like a mantra; he always repeats it, although in slightly different form each time. Here is the essential Obama answer: “It is not my fault!” In Obama’s oft expressed view, the economic downturn is the fault of a) George Bush; b) the earthquake and tsunami in Japan; c) the Arab spring; d) Congress; e) international unrest; f) the problems in the European Union; g) wealthy Americans who do not pay enough in taxes; h) big oil; i) excessive consumption of sugared drinks; j) a visit by the Recession Fairy, etc. Never once in the last four years has Obama ever said in essence that he and his administration had made a mistake on any action and that he was going to modify it to meet the ongoing economic problem. It is always someone else’s fault. The economic problems, however, have not gone away; only the identity of the culprit of the moment has changed in the Obama speeches.

There is no question that some of the villains identified by Obama have had a negative impact on the economy. The last recession began during the Bush presidency. The Japanese earthquake, the Arab spring, and the problems in Europe have all had minor negative impacts for a time on the American economy. Of course, the recovery in Japan after the earthquake has meant more orders of American goods which had the opposite effect, a fact that Obama carefully omits from his speeches. The main point, however, is a different one. The items that Obama identifies in his blame-shifting speeches are not the major causes of America’s economic difficulties. It is like having a patient with both a sunburn and pneumonia admitted to a hospital and blaming his life threatening condition on the sunburn. Sure, the sunburn makes things a bit worse, but the pneumonia still needs to be treated or the patient will die.

So what are the main causes of the current downturn? One of the biggest (which is often overlooked) is energy prices. High energy prices have usually meant that the economy stalls or contracts. Many folks do not recall, but in 2008, as the last recession really got going, the price of oil rose to all-time highs. The price at the pump for gasoline rose higher and higher, and with each uptick of that cost, the level of consumer spending on other products fell. As oil prices rose, more and more dollars were sucked out of the American economy to be sent to countries like Iran, Venezuela and Saudi Arabia. By the time that Lehman Brothers failed in September of 2008, the high energy prices had already driven a stake into the heart of the consumer economy. In the past, other big spikes in the price of energy have had the same effect. In 1973, when the first Arab oil embargo hit, the price of energy quadrupled and the economy tanked. Each time since then when there has been a major rise in energy prices, the economy has swooned. Just last year, the economy seemed to be gaining strength at the start of the year. Then oil prices rose dramatically and the recovery stalled. The “summer of recovery” became a “summer of despair”.

Earlier this year, we all watched as the price of oil went higher and higher. Some pundits said that what was actually happening was that the dollar was going lower rather than the price of oil going higher. This may be an interesting discussion, but it does not change the effect. Oil prices peaked in April of this year. That is the same time that the economic reports got materially worse. Job creation stalled. Consumer spending was also hurt. Don’t get me wrong. The economy was in a mess before the latest rise of energy prices; our current problem is not all the fault of high energy prices. The actual facts, however, show that the recent high energy prices are a likely cause of driving the American economy over the cliff or, at least, to the edge of the cliff.

If the economy has been weak, how could energy prices have gotten so high? Obama blamed speculators from Wall Street in part. It is yet another excuse for a failure of Obama’s own policies. If Obama thought that speculators were to blame, he could easily have remedied that problem. In one day, Obama could have gotten the margin requirements for buying oil on American and world markets raised. If the speculators had to put up all the cost of buying crude rather than just a small percentage of the cost, they would have bought less and sold much of what they already had. The price would have fallen. Of course, to take that action, Obama would then have been left with reality. If anti-speculation measures did not work, then it would be revealed that speculators were not at fault for the high prices.

So what did cause the high prices? Some blame unrest in the Middle East, particularly centering on Iran. Really? We are right now near the breaking point in negotiations with Iran about its nuclear program. America has just sent additional naval vessels to the region to safeguard the flow of oil. Iran is launching multiple missiles in “test” that are aimed at mock American bases in an effort to intimidate the United States. Europe is carrying out harsh sanctions against the Iranians. In short, tensions with Iran are at an all-time high. Strangely, however, the price of oil is much lower than it was. It seems that unrest with Iran was not the cause for the high prices.

Now let’s look at reality. The perception in the first two months of 2012 was that the economy was starting to gain traction towards an actually recovery. Jobs were being created. The unemployment rate was coming down. Remember all those articles about how the economic recovery was going to deprive the GOP candidate of using the issue against president Obama? It was an indicator of the conventional wisdom that the economy was finally recovering. But what did that mean for energy prices? If the American economy actually started growing robustly again, there would be a marked increase in the American consumption of oil. Prices started to rise at that point because those in the market knew that demand was going up, but the supply was being constrained. Since taking office Obama has done all that he could to stop drilling for oil in the USA. Drilling on federal land, the one area under total control of Obama, is way down over the last four years. With the price of oil at record highs, there should have been a marked upturn in such drilling, but that upturn never materialized. The Department of Energy blocked much of the drilling and slowed approvals for the little that was allowed. Meanwhile the same DOE modified the approval of permits for off shore drilling so that it now takes about 9 months to get approval instead of the 6 days that it used to take under previous administrations. In the areas that Obama could affect, oil production is down around 20% since the beginning of his presidency. The only area of growth has been drilling on private lands, particularly in shale layers where the use of fracking is required. Even there, Obama has been on the attack to reduce drilling. The EPA has regulations written and ready to be issued in December, once the election has passed. These regulations will effectively reduce the level of fracking used in the USA in dramatic fashion. Once this happens, American oil production will plummet. Is it any wonder that oil prices went up?

Another major cause for the economic slowdown has been the almost incomprehensible regulatory and legal miasma that Washington has inflicted on the businesses of America. How many regulations govern a new business? Fifty years ago, if someone wanted to open a new venture, he or she did so with little involvement from the government. Not anymore. Now there are all sorts of regulatory hoops that one has to jump through. Want to hire an employee? That means requirements of health insurance, unemployment taxes, workplace rules, and a host of other laws that have to be followed. Want to fire an employee? That too has become much more difficult. Indeed, given the possibility that firing will be difficult, it makes employers more hesitant to hire in the first place. Then, of course, there is the issue of tax rates. What will they be next year? Right now, no one knows for sure. Nearly everyone expects that the current tax law will be changed, but just how that will happen is uncertain. Will Obamacare and all its rules be repealed? No one knows. Will corporate tax rates be reduced as Romney wants or increased as Obama is calling for. America already has the highest corporate tax rates in the world; if Obama’s plan to tax foreign subsidiaries of American companies passes, will that send more American business overseas? The uncertainty or possibly impending economic changes is paralyzing economic activity. Obviously, not everyone is paralyzed. The problem is that enough companies are waiting to see what happens so that the economy is limping at best and collapsing at worst.

The burdens of government are another problem for the economy. For the last forty years prior to Obama’s term, the federal government spent roughly about 18-20% of GDP each year. That meant that about one in five dollars of economic production in America was devoted to government in Washington. It was a heavy burden, but one with which business was able to deal. Since Obama took office, the government has been spending nearly 25% of GDP each year. That extra 5-7% of GDP used by the government has tipped the balance. The burden on the economy has gotten too big. Assets that should have been used for new investment that would lead to growth have instead gone to government. Say what you will, assets devoted to government do not lead to economic growth. Even the most ardent supporter of big government would not be able to make a coherent argument to the contrary. It is not one program in particular; it is the total mass of government spending which is causing the problem. Think of a soldier out on a fifty mile hike with a full pack. In the pack is a weight equal to 18% of his body weight. Because of his good physical condition, the soldier is able to keep going forward at reasonable speed even while wearing the pack. Now comes the new regime and the weight in the pack is raised, this time to 25% of the soldier’s body weight. The soldier is able to move forward for a bit, but after a short while he starts to stagger from all the added weight. If nothing is done to reduce the burden, the soldier eventually falls. He can go no further. The burden is just too much.

The Obama spending spree has acted on the American economy like the added weight in the soldier’s backpack. Unfortunately for all of us, if the economy gets to the point where it falls due to the intolerable weight, we all will live through a depression.

Change is needed for the economy to recover. Change is the only thing that can save America. We need a leader who can recognize that certain policies are hurting the country and who can then change direction. Obama will not even recognize that his policies have caused any of the problem. It is always someone else’s fault. In his own mind, Obama can do no wrong. Even his cronies do not understand. How many times have we heard that Obama’s policies are great, but that they have not been properly sold to the American people? Obama is surrounded by folks who, like him, refuse to accept the possibility that Obama’s policies are causing harm to the economy. In all those 12 step programs, they always say that the first step to a cure is to recognize that you have a problem. We have a president who cannot even master that first step. We all suffer as a result.