Stagnation Beckons

So. What is going on?

Today’s report on new claims for unemployment assistance looks good on the surface. It undoes some of the backwards motion of the last few weeks, and so arrests the decline. But it is nowhere near sufficient for us to claim that the jobs market is back on track. The 44,000 drop to a total of 434,000 is much better news, and reverses the terrible increases we saw in April, yet it adds to the confusion. Most analysts expected a bigger reversal and that the total would be even smaller. This expectation was based on a string of one off explanations for each of April’s poor numbers, which, when accumulated, would have been enough to get us back below the magic 400,000 mark. Even if we set aside my view that 400,000 is still poor and that a healthy labor market would have claims in the 325,000 or below region, the current pace of claims is still way too high to offer any strong encouragement. The labor market still sucks. Back in February we were at 375,000, and falling. That was a three year low. The perspective then was that the recovery was about to kick into a higher gear and thus we could shift our attention away from unemployment to ther issues like the deficit and inflation.

Or, rather, that was the establishment view.

I have disagreed with that idea throughout.

I do not see any lasting support in the data for the notion that the recovery is either strong enough, or deep enough, to eradicate the blight of unemployment any time soon. On the contrary, all I see is bumpy data, slow progress, and risks lurking in the shadows.

There is no question that unemployment remains our foremost task. Yet it attracts little attention. The media and our policy makers all were in a hurry to rush onward to a new agenda when the claims figures seemed to show gathering strength. They were glad to be rid of concerns about jobs, since fixing employment implies an argument over the extent of government intervention. Both sides of the political aisle had exhausted themselves over the last two years and the November election, with its overt punishment for economic failure, accelerated a desire by all concerned to be able to announce a victory over unemployment. So it was with great relief that the February improvement was greeted, prematurely in my mind, as a sure sign we could all move on.

I find this both frustrating and naive.

History tells us that recoveries from crises stemming from absurd finance and an implosion in banking are slow moving and fraught with risk of regression. With asset values thrown into doubt, balance sheets in need of repair, and credit suddenly hard to find, businesses and households withdraw to recoup. Banks, in their inestimable way, go through great cycles of over- and then under-extension of credit, and thus amplify the underlying business cycle. If the problem starts inside the banking or financial system, as this one did, then the feedback from the financial system into the real economy is even greater. As Minsky described it the problems all arise when underlying cash flows in the economy can no longer support the level of debt. When we reach such a point the values ascribed to that debt are no longer appropriate, and someone, somewhere, is sitting on an unrealized loss. When, as inevitably happens, an event triggers the need to make that loss visible, mayhem breaks out.

For a subsequent recovery to be both sustained and strong, asset values need to be re-establisehd at new and more realistic, lower, levels and cash flows need to be able to sustain the burden of debt within the economy.

We are still going through this adjustment phase. Especially in real estate. It looks as if there are similar problems in sovereign debt markets too – is all that Greek debt really worth a hundred cents on the dollar? I suspect that there are plenty of banks with unrealized losses still lurking in the weeds. So, despite the recent spate of bank profits, finance is not yet healthy.

Likewise the corporate sector is reporting huge profits, but it is not investing at the rate required to expand the economy sufficiently to draw down on unemployment. Why not? Expectations. Businesses report that their number one issue is lack of sales growth. Aggregate demand is still too soft to justify investment or expansion. So cost cutting and various book keeping tricks are the best sources of profit growth at the moment. But those things run out sooner or later. Sometime soon businesses need to see demand returning in order to make positive plans.

But, as this morning’s weak retail sales report shows, there is no sign of substantial demand growth. On the surface the numbers were fine. Not good. Just fine. Sales grew 0.5% in April, and the March figure was revised upwards to 0.9%. That upward revision to the March number may boost GDP when it is revised, but the April number is disappointing, especially when we adjust it for gasoline and auto sales. Without those sales it growth was negligible. If we also take into account the recent spike in inflation, it is easy to argue that demand growth is almost non-existent.

So businesses are likely to be very hesitant in hiring. This, of course, simply aggravates the poor outlook that households have, and so we enter another period of retrenchment or restricted demand.

Add in the cutbacks going on around the country at the state budget level, and the fact that Washington is seized by a bout of austerity fever, and it is very easy to build a case for stagnation rather than good growth.

We seem to have fallen into the same rut as Japan.

The signs are not encouraging.

I want to be wrong. I am not sure I am.