This morning’s update on initial jobless claims is both sobering and clear: the economy is contracting and the trend has legs.
There’s no debate on this point now, nor is there much to be done in the short term to alter the fate that now awaits the U.S. The wave is crashing and the unwinding will have its way. Yes, government can and should soften the blow, particularly for the least fortunate. But in macroeconomic terms, there’s no stopping the recessionary forces now unleashed.
Unfortunately, this process is still in its early stages and so the pain has only just begun. Indeed, for the first time in this cycle, last week’s new filings for unemployment benefits–a forward-looking indicator–rose above 500,000, as the chart below shows. The nation’s unemployment rate, as a result, is sure to rise further in the months to come.

For all the bearish news of the past year or so, much of it has been finance related. The fallout is now taking its toll on the broader economy, which is to say consumers, who collectively represent about 70% of GDP. If nothing else, everyone needs to recognize what awaits. The storm is here and will blow for some time.

The last time initial jobless claims moved above 500,000, the event was short-lived. The economy won’t be so lucky this time around. After the tech bubble burst in 2000, the blowback on consumer spending was virtually nil. Indeed, Joe Sixpack kept spending, in part because the Fed dropped its benchmark interest rate to a mere 1%. The central bank has done so again, but low interest rates won’t help this time. Even a 0% Fed funds rate, which can’t be ruled out in the near future, won’t do much to stimulate demand.
The system must be purged of the excess and it will be purged, and this time the man on the street agrees. There’s no other way to reach equilibrium for asset prices and supply and demand in the economy generally. Policy makers, in turn, must focus on how best to deploy future stimulus efforts so as to maximize the benefits. That’s not going to be easy, for several reasons.
The biggest challenge is the magnitude of the correction/recession. For the past generation-plus, economic corrections have been mild and infrequent, and so there’s been limited attention cast on dealing with deeper, longer recessions. That’s changing, of course, as current events are pushing policymakers to undertake a crash course in pain management.
That leads to the second problem, which is figuring out what to do without throwing money down the drain. Some issues are clear cut, like extending jobless benefits. We don’t need a Congressional hearing to understand the reasoning for this action. It’s a different story when it comes to the more innovative plans afoot, starting with the $700 billion bailout package enacted last month that gives the U.S. Treasury authority to, well, spend a lot of money in an effort to prop up the financial system and by extension the economy. Alas, there’s no consensus on the most efficient and effective way to spend the money, as yesterday’s volte-face announcement by Treasury Secretary Paulson suggests.
Are we making it up as we go along? Yes, at least to a certain extent. Like FDR in the 1930s, the U.S. government in the 21st century is engaged in a massive experiment in macroeconomic policy intervention. Some of the efforts will work, some won’t. Ultimately, we’ll learn a lot when this is over, but the education will come at a price.
Brace yourself.