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January 03, 2017

How the Fed and Dodd-Frank Killed Jobs

Every economist worth her or his salt has a theory about why the great recession was followed by a nearly jobless recovery. Historically, lots of jobs are created in a surge when the economy is recovering; didn’t happen this time; many people left the work force and never came back.

I’m not an economist but I like mysteries and I think I know who done it: it was a toxic combination of unintended consequences of the Federal Reserve’s low interest rate program, which is still going on, and the Dodd-Frank bank regulation bill, which may be targeted for elimination or serious modification by the new gang coming to town.

What the Fed Did

It is normal Federal Reserve behavior to shovel out cheap money when times are tough in order to jumpstart the economy. The idea is that the availability of capital will lead to business expansion and a rising tide will lift all ships. The Fed shoveled out the money; the stock market recovered (aka the rich got richer); various interesting bubbles have developed; but the job market didn’t recover as measured either by percentage of the labor force employed or rising wages. Oh, BTW, some people seem to be rather pissed off about this; but let’s stay away from politics. Point is that the economy strengthened but didn’t create the usual surge in demand for workers. We might well have lost jobs overall if the invention of horizontal drilling and hydraulic fracturing hadn’t led to a boom and only partial bust in energy and associated industries. That’s why we’re better off than Europe, IMO.

What happened? Where are the jobs?

Well, suppose you run a factory and you see the economy getting better and the demand for your widgets growing. You want to increase production. You have a choice to make: hire an additional shift or buy a new machine. Ordinarily, in the cautious beginning of a recovery, you might go with the people; you can always lay them off if things change and you’re going to be stuck with the payments on the machine. But these aren’t ordinary times; interest rates are near zero; the payments on the machine won’t be that bad. Energy costs to run the machine are going down, not up. And there are some really nifty new smart machines out there. In fact, as you shop around, you realize that if you replace some of your existing equipment as well, maybe you can actually reduce staff and still increase production (you’re a hard-headed, hard-hearted business person). Your banker really wants to “give” you the cheap money the Fed crammed into the bank’s vault. You go with the machine; GNP and your profits go up; employment and wages aren’t helped.

Classic economists will object that, even if you buy the machine, someone has to make it and that’s jobs. But these aren’t classic times. New “machines” have a large software component. It takes programmers to write the software. But it takes the same number of programmers to create the program whether you sell one copy or a million (I used to be in that business). Moreover, for the hardware, maybe the machine maker also just orders a new machine rather than increasing staff.

What Dodd-Frank Did

But new businesses always create new jobs. That’s still true. The availability of cheap capital should have led to new businesses and new jobs. That’s where the unindicted co-conspirator Dodd-Frank comes in. The bill actually had a reasonable premise: if the public is going to bail banks out (as we unwisely did), then we have not only a right but a responsibility to regulate them so they don’t need bailouts. Trouble is that the new rules effectively said that banks could only lend the flood of cheap money they were being force-fed by the Fed to very, very well established businesses; that doesn’t include startups even if the founders have great records and the collateral is rock solid.

This was a double whammy if you’re a startup (I was one but am not bitter; we got funded but not by a bank). The old established guys that you could easily knock off by being more innovative and aggressive get free money and you don’t get any at all. Access to capital, as all us capitalists know, is essential to business growth and formation.

So, to sum it all up: the Fed, through the banks, makes almost free money available to old established businesses who use it to increase production without hiring more people. When this doesn’t create jobs, the Fed makes even more cheap money available. Profits go up (it’s nice to have free money), but wages and employment don’t. Dodd-Frank assures that even less money at even higher rates than normal is available to the small businesses and startups which have always accounted for the bulk of new jobs (and keep the profits of the old guys under control).

That’s how we got an almost jobless recovery. It’s almost enough to make you want to occupy Washington, DC. Or maybe that’s what’s about to happen.

More including how to undo Dodd-Frank and bank bailouts at Dodd-Frank and Me.

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