Posts Tagged ‘Unemployment’
The hidden cost of the credit crises
Some economists are trying to estimate the cost of the current mortgage crises, unfortunately, most of them are blind to the real costs of the crises. IMF recently estimated the cost to $945b. This estimate has misled even some distinguished economist in believing that the mortgage crisis isn’t that serious. The political economist, Anthony de Jasay is one example. In his latest article “A trillion dollar “catastrophe”?” the Anglo-Hungarian economist, argues that the sub prime crises isn’t really a crises, but for the most part a zero-sum-game. In his words:
The current “crisis”, as every opinion-maker persists in calling it, is primarily […], one of loss of confidence.
and
[m]ost if not all of the trillion dollars is only a loss to one side in a zero-sum game; it is a gain to the other side. If the mortgagee lends too much on a house to the mortgagor, the latter gains what the former loses; the house itself suffers no material damage. If the mortgagee escapes the loss by having the mortgage “packaged” with many others in a “collateralised debt obligation,” that is passed on to some institutional or private buyer, it is the buyer who takes the loss if some of the mortgages in the CDO turn out to be worth less than their face value. There may be a whole chain of buyers sharing in the loss. Some in the chain may even gain.
Jasay reaches his conclusion by looking at the nature of derivatives. Since derivatives to a large extent, actually are zero-sum games, where someone’s loss is another one’s gain, he believes the effect of the crisis is limited, mostly to some redistribution effects. But as I argue, the loss from bad derivative transactions are not the only cost that needs to be considered in gauging the effect of the crises. The real costs are the opportunity costs from misallocated investments and capital.
When interest rates where held artificially low in the past, entrepreneurs got the impression that real savings in the economy had increased, fueling capital spending and investments to unsustainable levels. What we now are beginning to see is that entrepreneurs are starting to realize that they don’t have enough funds in order to finish and maintain the new productive structure, causing distress for many businesses.
According to the Austrian business cycle theory, firms far away from consumption, is hit the hardest, as their amount of malinvestments tend to be higher. Therefore, we need to watch the manufacturing sector in order to gauge the real cost from the credit crises fallout.
According to the Institute for Supply Management, the manufacturing sector has now been falling for the third consecutive month. In the April report, increasing price presure and growing inventories show clear signs of troubles down the road as profit margins for manufacturers shrink, leading to slower economic activity, and finally to higher unemployment.
In addition to ISM, the Employment situation show that, non farm employment have now been falling for the fourth consecutive month. While the headline number in the Establishment survey is -20 000, looking at the broader measure for unemployment in the House hold survey, where we include officially unemployed, the number of marginally attached workers, and the number of working part-time for economic reasons, total unemployment surged to 9.2% in April from 8.2% since last year.
A trillion dollar “loss” in derivative related assets may not be Judgement day. But the fact that the manufacturing sector is slowing and unemployment are on the rise, should result in deep concerns, also for people like Jasay.
According to economic theory, illustrated by economic data, the current credit crisis is not only a crisis, but a severe crisis. The real cost for the economy is not primarily related to derivatives, but are found in the malinvested capital. What we are now seeing in the ISM report and in the Employment situation report is a reflection of the process where capital is being liquidated. Some invested capital will be reallocated to better use. But a large part of the capital stock is fixed capital, and cannot be transformed to any other productive use. These investments will be a total waste of resources, and constitute the real unseen cost of the credit crisis.
