Current State of Play

Having been off-line for a few days because we needed to clean out the damage left by a malicious visitor, I think it would be appropriate to take a deep breath and give the current state of play – just where does the economy stand?

The first part of this is to report very quickly on the employment news at the end of last week: while the rate of jobs being lost has clearly diminished from the horrendous pace of late 2008 and early this year, they are still being lost in very large quantities every month. We lost a further 216,000 jobs in August and the unemployment rate has now hit 9.7%. The fact that we can take heart from the news that we lost ‘only’ 216,000 jobs is a startling reminder of just how bad things have become during this cycle. And don’t forget: that unemployment figure excludes anyone who is so discouraged by the situation that they have ceased looking for work. Add those folks in and the unemployment rate shoots to above 16%.

Also hidden from view by this statistic is the large and growing number of ‘underemployed’. These are people who are either working fewer hours, or are doing a job for which they are heavily over-qualified. Both these categories have exploded in size during that past year as jobs become more scarce and extremely hard to hold onto.

From a dispassionate perspective unemployment and underemployment are indicators of how far from full capacity the economy has fallen. Evidently we have a ton of slack to get through before we can start to talk about solid growth again. That gives us plenty of room for growth, but it also means we don’t need to re-hire any time soon.

And all this has to be put in even more broad context: our population is growing. This growth adds each month to the workforce. By most estimates we need to add about 200,000 jobs a month just to keep up with population growth. So a drop in employment of 216,000 means we have fallen 416,000 deeper into the hole. In aggregate terms we have lost about 6.9 million jobs in the recession during which time we should have added about 3.6 million to keep up with growth. That means we are beginning the recovery with an unemployed labor pool of around 10.5 million. Which ignores all those underemployed workers I mentioned above.

I say all this by way of setting the table.

The economy is now growing. I think that much is certain. Manufacturing has just started to grow and as it regains momentum we would typically expect the job market to recover. I say ‘typically’ because all the signs this time are that the employment outlook will remain grim for much longer this time than before.

The news that trickles out of the job market indicates an extremely poor few months still lie ahead. The Manpower Survey, undertaken by the epynomous job search and hiring firm, has just come in with its worst reading ever. Apparently the employers in the survey have very few plans to hire in the fourth quarter. The survey has been in existence for over forty years so it includes the very nasty recession and job market of the early 1980’s – which only reinforces the bleak picture for today.

It bears repeating: the job market and the recovery are obviously inter-linked. The recovery can begin within a very poor job market – it has now – but it cannot sustain itself in such a situation. We will reach a point before long where all the early inventory replenishment, which is the driver of growth at the outset of recovery,has been taken care of. After that we need growth to be generated in response to growing consumption and export activity. Consumption growth requires income growth or a depletion of savings. To the extent that consumers have been hammered by the loss of wealth in home equity and the stock market, they will prefer to save more rather than spend from savings – the savings rate has jumped up this year after several years of decline. So without consumption from savings we will be relying even more on income growth as an engine to maintain the recovery. Income growth can be fed by productivity – in the long run this is the primary source of wealth growth – and from an increase in jobs, which is where we usually get the initial spurt of new wages available for consumption.

So all roads lead back to jobs.

I mentioned that a second source of income growth was from exports. There seems no doubt that our economy will have to be restructured to rely more on a better balance of trade. In the past few years we have consumed far more than we produced domestically which meant we ran a huge trade deficit. This implied that we had to import goods to meet our consumption habits and that we had to ‘export’ debt in order to pay for it – to the extent a country runs a trade deficit it must run a surplus on its capital account to make the books balance, that implies, in turn, that we borrow to pay for the consumption.

As we rebalance the economy, which will take some years to accomplish, we will have to constrain consumption or increase our own exports to reduce our overseas borrowing. This means that some countries that have typically relied on trade for economic growth will have to reduce their own exports or increase their imports of our goods. The obvious big three such nations are China, Japan, and Germany all of whom depend heavily on trade. All three ‘under consume’. By this I mean that, given their level of development, they have economies that are unbalanced – their standard of living is over-reliant on consumption elsewhere. If that source of consumption declines, as is the case now in both the US and the UK, then those exporting economies suffer heavily as they have a weak domestic ability to make up the lost business.

So the re-balancing of the American economy has very significant implications worldwide and requires a coordinated approach with countries such as China, Japan, and Germany. This is why the media is full of reports about trade meetings etc.

Under any circumstance the next few quarters will be choppy. Re-balancing has both long and short term aspects. Long term, which not concern us here too much, it will mean a re-working of the Federal Deficit – higher taxes are a certainty at some point; it will require a shift in trade – a weaker dollar combined with an increase domestic production from new industries [which is why the US cannot fall behind in such growth sectors as environmental engineering]; and a focus on savings rather than consumption by the American public – this will generate the capital for those new industries and replace the amount we no longer borrow from abroad.

It is the short term impact of these emerging trends that we need to harp on: they all require less immediate growth as we shift our emphasis back to longer term thinking.

That sets up the state of play: yes we are recovering. In a technical sense the recession is probably over. But so what? We are now heading into a period of less than normal growth for a few years. This will mean that the job market recovers more slowly than usual. That poor growth acts as a brake on growth too. Within this medium term trend I expect one or two quarters of strong growth – this is not a contradiction but an acknowledgement that we will see the occasional spurt of activity as that enormous slack in the economy is worked down.

And the danger is more on the downside than the upside. We have more chance of falling into a ‘double dip’ recession next year, than we do of seeing rapid growth. Neither chance is zero. The odds are like this: moderate growth, a 50% chance – say of 2% GDP growth; double dip recession, a 30% chance; and rapid growth – say of 3.5%+ GDP, a 20% chance.

That’s where we are now. With all eyes on that job market.