October 13

from A long road ahead in regaining lost jobs in the NYT:


Fed Chief Gets Set to Apply Lessons of Japan's History. John Hilsenrath, WSJ.

flashback to 1999:
Japanese Monetary Policy: A Case of Self-Induced Paralysis? Ben Bernanke.

Why is the Fed doing this? James Hamilton.

Why printing money makes sense. Dean Baker, Guardian.

The Japan syndrome. Ethan Devine, Foreign Policy.

China's teetering on the verge of its own lost decade, and a meltdown in Beijing would make Japan's economic malaise look like child's play.

other fare:

Global power: On top of the world. Why the West’s present dominance is both recent and temporary. The Economist.

What Mr Morris shows is that over a period of 10,000 years one civilisation after another hit a “hard ceiling” of social development before falling apart, unable to control the forces its success had unleashed....
There is, on the other hand, a real possibility that we fail to negotiate even the next 50 years without triggering environmental catastrophe, global pandemics or nuclear war. In which case, both West and East will simultaneously crash into the hard ceiling of our own era.

Global aging. Phillip Longman, Foreign Policy.

The Real Perils of Human Population Growth. David and Maria Pimentel.

Is it always a lagging indicator?

There are some themes or ideas that are just accepted as common wisdom, and, as such, ordained as truisms.

For a time, one of those ideas was that the U.S. consumer was resilient; for a long-time this remained true ---- until it wasn't. Another such theme was that of global decoupling; for a while, it too looked like it might turn out true --- until it didn't. A third was that subprime would be contained --- which, likewise, wasn't based on facts or evidence or even well thought-out analysis, but was just an optimistic assumption, or, better yet, presumption, that ultimately got disproved.

The problem with ideas such as these is that the reason for the platitude is hardly ever examined; its truism-ity is usually just assumed on a prospective basis, often because it has been generally true retrospectively.

I worry that the notion that labour is a lagging indicator is just such a notion.

Undoubtedly, in most recessions, labour has been a lagging indicator. But most recessions that we are familiar with have been inventory-cycle recessions, or have been recessions caused by the Fed hiking rates until something breaks, after which time they drop rates again and re-start the economic cycle, principally by way of the credit cycle.

In an inventory-led recession, such as the dot-com bust, companies project the good times too far out into the future, they build to over-capacity, find out they have too much inventory, cut back on hiring, do some firing, work down their inventories, and its only after a while of those inventories being worked off, whether or not sales have picked up, that they need to resume the labour cycle, once their inventories are lean again. Therefore, labour indicators lag in such a cycle.

In other Fed-hiking-induced recessions, the Fed fears the inflationary effects of an overheating economy, so it hikes til the economy breaks/brakes; then once it has decided that it has slowed the economy enough that inflation will remain contained, it reduces interest rates, which spurs lending, as both consumers can incur new debt more cheaply to finance their spending (mostly through housing) and businesses can likewise finance more projects because their cost of financing has fallen, which makes more projects profitable. As such, the economy gets going again, and as consumers spend and as businesses ramp up, more labour is required, and hiring picks up, but in lagged fashion.

These are the typical types of recessions we are familiar with; and these are the types of economic cycles from which we evolved the common wisdom that labour is a lagging indicator.

But is that equally true today? Needless to say, I have my (serious) doubts.

Back on April 9 I published a post called U.S. Employment Data, at the conclusion of which I noted:
"Labour data is considered a lagging indicator. While that surely remains true (i.e. the economy will show other signs of rebounding before labour does), labour trends impart their own impact on the economy, particularly in a recession that is being consumer-led, unlike some past inventory-cycle recessions. In this case, the consumer retrenchment can't help but be re-inforced by the employment trends, as overly-indebted consumers are now also increasingly income-constrained consumers."

Normally, when the Fed tries to rescue the economy by cutting interest rates, that works its magic by restarting the credit cycle --- borrowing escalates, which finances economic activity, which spurs labour creation. Today, the Fed has dropped rates to as low as they can go, but its magic has lost its magic. Banks are not expanding the credit on offer. And even if they were inclined to, consumers are in no shape (or mood) to incrementally add to their monstrous debt burdens.

Furthermore, the primary channel through which Fed-engineered interest rate changes has historically had its impact is through housing: low Fed rates tend to lead to lower mortgage rates tends to lead to more housing activity, including all the various multiplier effects therefrom. But in this cycle, because of the still large overhang of excess homes, that's simply not happening. Sure, homeowners will refi as much as they can to take advantage of lower interest payments on outstanding mortgage burdens, and this will help ease their pain and suffering, and, at the margin, will mean they have more money in their pockets to spend on gas and groceries, and it will also allow their debt repayments to work more on reducing the principal rather than just paying mostly interest, but it does NOT mean they will take on more debt.

Households are deleveraging. They have taken a huge hit to their wealth, there is no more MEW available, they are closer to retirement than they were a decade ago, during which time they've had very little savings (relying instead on asset price appreciation that has quickly since dissolved), and, even for those who had pension plans, those too have taken a serious hit, so they now realize they need to save. They need to repay their outstanding debts, and also to re-build their nest eggs (can't just retire off the proceeds of a future house sale), which means that consumption must be constrained to something less than their incomes. Which, in the meantime, is falling (not just from lost jobs, but from lost hours for those still working, and from neglible wage gains).

Similarly, businesses haven't much motivation to leverage off of low interest rates to increase their activity. They have huge levels of unutilized capacity, so, as low as (government-backed) interest rates are, they have little incentive to take that money to invest in new productive capacity or in the creation of new widgets. And, not all businesses have access to government-guaranteed debt, so funding costs for the broader business community, due to still-wide spreads, are not that incentivizing in any case.

Therefore, if the Fed can't re-start the credit cycle, then it can't restart the economic business cycle, and thus it can't do much to promote job growth.

Banks don't want to expand lending (they have enough NPLs and bad debts to worry about already, and why extend more credit into an already debt-heavy economy that is in recession and to debt-burdened consumers who have poor job prospects and declining collateral values). Consumers don't want to take on more lending (for all the same reasons the banks don't want to extend it --- both groups are properly motivated to see debt levels in aggregate fall). And businesses might be in a position to borrow money, but the question for them is what to do with it (Microsoft, for instance, did a very opportunistic (first ever, I believe?) debt issue to lock in some nice borrowing rates (just 100 back of Treasuries), but it was already sitting on a ton of cash, and its not as if issuing a bunch of bonds has any implication for its order book.)

So, without labour growth, where will expanding economic activity come from? For now, there is some that is coming from the government purse, and that increase in federal expenditures (above and beyond the decrease in state and local outlays) will likely be sufficient to impact growth in the near-term, but does little to address the structural problems in the economy (i.e. excessive debt) that do not bode well for the mid- to long-term.

At the end of the day, what promotes economic growth is spending growth, and what promotes spending growth is income growth, and what promotes income growth is job growth. And we ain't got none of that right now.

As long as deleveraging persists (and it will for quite some time given that total economy-wide debt loads have continued to increase relative to the size of the economy or personal disposable income, which have fallen faster than debt has been paid off, and given that the mirage that it was sustainable on the back of housing values has been discredited, and given that housing prices still remain stretched relative to historical norms), it is my belief that job growth will be a leading, not lagging, indicator of demand, and, therefore, of economic activity.

And, most unfortunately, we are stuck in a vicious circle. Businesses' profit margins have been crushed, so pressure remains on them to cut costs (i.e. cut labour). As labour conditions continue to deteriorate, aggregate demand will continue to be stifled. And so it goes and so it goes.

At some point, conditions will have reached a point that sustainable growth will become inevitable. But a decade-long debt-drinking binge will not be cured with a 10-month hangover --- not until all that bad booze has been purged from the system and the drunks are over the memory of how bad that hangover felt.

U.S. Employment Data

UPDATE:
check out the chart at the post Revisions to Payroll Employment at Economist's View of how payrolls were initially reported each month, and to what they've been revised to in successive months. Needless to say, downward revisions have been significant.




Canadian jobs data was released today, but I thought I'd take a closer look at last week's U.S. jobs data.

As bad as the official stats are, its clear that they don’t do the situation full justice. I’m not suggesting there’s an Obama administration conspiracy to make things look better than they really are (or not as bad as they really are). But, nonetheless, there have been changes made to BLS calculation methodologies over the years, going back to the Reagan and Clinton administrations, that do make some of the reported results a little rosier than they ought to be.

Take for instance one pet peeve of mine, the birth-death model, which the BLS includes in its establishment survey of payroll changes. Basically, what they do is survey a bunch of companies to find out how many jobs were gained or lost at each, and they add all that up. They then extrapolate this to the full work force. However, recognizing that such a survey is less than comprehensive, and, in particular, does not capture any information from brand new firms that have just started up, nor from dead firms that have just expired, the BLS has added a modeled-component to their payroll calculations. Basically, based on past trends, they guesstimate how many net new jobs (new jobs added less old jobs lost) were created each month from the birth and death of new and old firms.

In March, BLS assumed that 114k more new jobs were created than jobs lost from the birth and death of firms; in February, the assumption was a gain of 134k. These assumed numbers are pretty close to the numbers assumed in each of February and March of 2007 and 2008, and are in fact rather higher than the averages for those two months from 2000 through 2009. This doesn’t seem particularly realistic given the prevailing environment. Its not as if the BLS doesn’t admit that their model will be inaccurate at turning points in the economy – they do. But, nonetheless, there’s a clear bias introduced here into the results.

Despite that bias, the employment picture is rather grim. Over 7 million jobs (on a non-seasonally-adjusted basis) have been lost since the peak in November, 2007; the loss is 5 million on a seasonally-adjusted basis. The average monthly loss over the last six months is 619k and over the last year is 400k; if you back out the birth-death contributions, the average loss is 459k.

Chart 1: Monthly Payrolls Data, with 3-mth (blue) and 12-mth (red) moving averages, since 1998 (January was the worst month to date, with a loss of 741k jobs):

On a longer-term basis, job losses over the last year are as bad as they’ve been since the late 1950s.

Chart 2: Historical Non-farm Payrolls (seasonally-adjusted) Growth YoY (red line shows how current level of -3.7% compares historically; grey bars are recessions)

What you can note from the chart is that past recessions usually started as soon as YoY employment fell below 1%, but, more to the point, didn’t end until YoY employment headed upwards.

Clearly, the downward trend in payrolls doesn’t look like it will turn around anytime soon (not given the state of credit conditions, nor the increase in inventory-to-sales ratios, and the continuing climb in jobless claims). On a peak-to-trough basis, seasonally-adjusted payrolls are down 3.7% from the peak, which is also the worst result since the late 1950s.

Chart 3: Historical Non-farm Payrolls (SA) Growth, Decline from Peak

Of course, the above charts include the B/D contributions in the NFP results. And those have been systematically positive even in this terrible environment. (In the third chart below, the negative brown bars mean that annual job growth was negative while B/D contributions were positive; for the years 2003 to 2007, it seems that between one-third and all of job gains were derived from the model, i.e. from companies not surveyed.)

Chart 4: (a) Annual Monthly Change by year (blue - NSA; green - SA); (b) Birth-Death Model's Average Monthly Contribution by Year (peaked at 88k in 2006; was 60k in 2008); (c) Percentage Contribution of B/D Model to NSA NFP

Its interesting to note from the chart below that the seasonality of the B/D contribution has been pretty impervious to the deteriorating environment. So we can expect a nice contribution again in each of March, April and May before those contributions fall off for the rest of the year.

Chart 5: Monthly Birth-Death Model Contributions, since April 2000

Chart 6: Historical NFP Growth (NSA) (ex-B/D model contributions) (latest level is down 3.5%)

Another pet peeve of mine is the focus on the official (U-3) unemployment rate. At the current rate of 8.5%, it has more than doubled from the 2000 low of about 4%. As bad as that is, it still misses out on all the people who are no longer counted as part of the labour force, and also does not account for all the people who are still working but are now part-time or have otherwise had their hours cut back. The broadest measure of unemployment is the U-6 rate, and it has climbed to 15.6% (on a seasonally-adjusted basis; over 16% NSA), as shown below.

Chart 7: Unemployment Rates, Monthly (green U-3; red U-6, both seasonally adjusted)

Chart 8: Unemployment Rates, Annual, SA

For more perspective than the unemployment rate gives you, consider just how many jobs have been lost since the peak at the end of 2007. But, more than that, consider also the increase in the people not just who have been added to the rolls of the unemployed, but those who are no longer counted in the labour force (NILF: Not In the Labour Force).

Chart 9: Average Monthly Changes in Number of Employed and Number of Unemployed and NILF since December 2007 and in last six months

Chart 10: Monthly Number of Employed (lhs) and Unemployed/NILF (rhs)

Once again, though, even that portrays less than a complete picture due to under-employment; there are a number of people who have been fortunate to have retain some level of employment, but have been cut back from full-time to part-time. The number of full-time workers has fallen now by over 8 million, while the number who now work part-time has increased by about 3 million (for the net loss of jobs of about 5 million, on a seasonally-adjusted basis).

Chart 11: Full-Time Employment and Part-Time Employment

Labour data is considered a lagging indicator. While that surely remains true (i.e. the economy will show other signs of rebounding before labour does), labour trends impart their own impact on the economy, particularly in a recession that is being consumer-led, unlike some past inventory-cycle recessions. In this case, the consumer retrenchment can't help but be re-inforced by the employment trends, as overly-indebted consumers are now also increasingly income-constrained consumers.

p.s. sorry for the awful quality of the charts; I'll fix them as soon as I have a chance