unemployment

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Production, Inflation and Wages: More of the Same?

The data so far this week has simply added to the feeling that while things are getting worse less slowly, they are still a fair way off actual improvement. The data is sparse, so I won’t spend much time on it.

Industrial production continues to decline, it fell another 0.4% in June. The decline is widespread across the economy and is the seventeenth month out of the last eighteen that we have experienced a fall. The rate of decline is slowly getting better though: the rate of decline in the second quarter was a ‘mere’ 11.6%, compared with the first quarter’s 19.1%. Obviously none of these figures can be construed as being ‘good’, except in our extraordinary times. The level of capacity utilized by industry dropped to a record low of 68%. That means business investment will not be a major driver of GDP growth for the foreseeable future.

This industrial perspective paints a very ugly picture for unemployment over the next few months. There isn’t any strength in manufacturing on the horizon to spur a surge in hiring.

As for inflation: the bumping around in energy prices meant that the Consumer Price Index rose in June by 0.9%, bringing the annual rate of inflation over the last year to -1.4%. The news here is that there was no real news. Pretty much everyone anticipated that energy costs would distort the data, which it did. There seems to be little or no inflationary pressure on the economy at the moment other than the arbitrary way in which oil prices are moving – and they have backed off considerably lately.

From a thematic point of view I think the threat is still on the side of deflation rather than inflation.

Why?

Because wages are now starting to suffer. The important factor to notice in today’s report on wages is that real wages, i.e. wages adjusted for inflation, dropped 1.2% last month. That wasn’t simply due to inflation rising because it was also affected by the loss of hours being worked. As wages are constrained by continuing unemployment and by business cost cutting efforts, more and more buying power is being sucked out of the economy. That means less consumption and a risk of deflation. Here’s where the message gets difficult to interpret: nominal wages, i.e. wages not adjusted for inflation, actually have fallen over the past twelve months – average weekly wages were $609.37 in June compared with$613.80 a year earlier – but that drop was eliminated by deflation, remember that the CPI fell over the past year. The result was that real wages actually rose 2.6%. This means that employer efforts to cut wages have been to naught – deflation ran more quickly – so effective business wage costs rose even though wages fell. That conundrum implies even more efforts to cut costs in the near term. So look for wages to continue to fall.

None of this is good news. Nor is it really bad news. The data all seems to be reinforcing a simple message: more of the same. The recovery is somewhere out there. But it’s not here yet.

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Catching Up: Grab Bag

First of all an apology to you all: I haven’t posted anything for a few days. While I’d like to say that was because I was on vacation, the real reason was a mysterious technical outage. Apparently Time Warner Cable decided to take some time off. That’s a monopoly for you. Leisurely system upgrades during peak hours. Ugh.

Meanwhile back to work:

This week will see some interesting statistics released, starting with retail sales tomorrow. I think we are headed into a ‘make or break’ period for the administration. There are several signs accumulating that the economy’s recovery is not far off, but like a very tired runner covering those last few yards is getting very difficult.

For instance, last week’s consumer confidence data was quite disappointing. The index fell sharply after having registered four straight months of increase. While there is no direct correlation between consumer confidence and consumption at the aggregate economic level, any decline in confidence at this point in the cycle must be cause for concern. The hope has been that as job layoffs start to decline, and as home prices reach the bottom, consumers will start to venture out of their foxholes and begin to spend once more. There had been tentative signs of that happening – one of those signs being the steady increase in confidence registered since earlier this year. A sustained about-face by consumers would open up a wide hole in the recovery strategy.

The obvious reason for the drop in confidence is the continued poor employment situation. Jobs are simply very hard to find at the moment and there are no signs that employers are about to shift back towards hiring. The numbers of people who have now been unemployed long term is rapidly growing and that is surely eating away at the public’s mood.

Which brings us to the stimulus debate.

As you all know I have been an advocate of much larger stimulus from the beginning. For whatever reason – and frankly I haven’t heard a good one yet – the administration low-balled the amount of effort that we put into the recovery. I have a suspicion that the powers that be thought that once the financial sector was stabilized the economy would right itself fairly quickly. Where they got that reasoning from I don’t know, but it was bogus all along. History tells us clearly that recessions and depressions caused by a collapse in finance are much more severe and need much more stimulus to correct. Add in the devastation caused by unwinding the real estate bubble and the downward spiral was bound to be dramatic.

What we got was a bureaucratic response rather than leadership.

Now we have to dig our way out of two problems: the economy is still stuttering, and the political backlash against stimulus has gathered steam making it difficult to fix the original error. We may be condemned to allow things to get worse again before the political winds changed sufficiently for further stimulus.

Note to self: in a crisis such as this, bold leadership is preferable to calm calculation. I suppose it would be better to combine both, but that would take the presence of a truly historic leader, and the current administration is resolute in not rising to that level of performance.

Too bad.

Meanwhile the opponents of massive fiscal spending haven’t had a good time of it either. A couple of weeks ago the media was full of bombast about the horrendous and impending inflationary impact that the stimulus and loose monetary policies were having. One sure sign of disaster we were told was the run up in long term US government bond yields. Since then those yields have eased off considerably. As a result the opposition has had its main counter stimulus argument neutralized.

Clearly we all need to be very concerned about the long term fiscal balance of the Federal budget. It was the prospect of perpetual deficits that was supposed to be the cause of the sudden spike in rates since earlier this year.

I acknowledge that in an economy operating close to capacity excessive monetary expansion ‘should’ show up as price inflation. But we are nowhere near capacity: the Congressional Budget Office – the politically neutral scorekeeper Congress uses to analyze policies – estimates we are as much as 8% from capacity. So all that money being pumped into the economy ‘should’ flow into propping up demand rather than merely raising the prices of existing demand.

I think a more plausible cause of the rise in rates was simply that the bond and other credit markets were adjusting back to more normal levels after months of traumatized and excessive caution. Such an adjustment would mean a flow of cash from US bonds into competing private uses. The result would be a natural bidding up of bond prices as the government was forced to pay more to keep the flow of bond sales satisfactory.

Confirming this explanation is the fact that bond sales have settled back down. When the first stories started to appear about the glut of US bonds on the market the government faced some stiff market conditions: buyers were reluctant to buy bonds and T-Bills because a glut would reduce their future value. Those difficulties have faded, and for now at least, the government doesn’t appear to be having any difficulty raising the cash it needs to keep the stimulus going.

But a word of caution: there is no doubt at all that we are entering a period of higher taxes. The whole Reagan/Bush era was predicated on tax reduction which was supposed to provide stimulus to the private sector and thus drive wealth creation. If we look back over the entire period the policy failed. The only element in the economy that prospered at an above average rate was corporate profits. Apparently tax reduction had no enduring effect elsewhere – wages are certainly a very weak spot in the Reagan/Bush record books. One thing they did leave us with are massive deficit problems that are now impeding our ability to correct the economic downturn. Even if this was the only imbalance we needed to fix, taxes would need to rise. But the recession has blown a hole in Federal revenues, and the political agenda now includes fixing our broken health care system. That will cost money.

So taxes will tend to rise over the next few years. There is no alternative: the public does not seem to have the stomach for the huge service cuts that would be implied by sticking to current Federal revenue levels and then trying to balance the budget. Neither does it seem possible to rein in defense spending. Something has to give. The Republican dream of dismantling the New Deal has been thoroughly shattered every time they mention it to the voters. Yet they have been very successful in selling the ‘trickle down’ snake oil. So the general public is now inured to the notion that taxes can stay low, yet services remain high.

Only in dreamland is such folly possible.

So, I repeat: taxes are set to rise.

In that context an obvious target would be the corporate tax deduction for health care expenses. This deduction costs us $250 billion a year in lost revenues. Its elimination would more than cover the cost of the health care plans now being debated in Congress. It survives because the unions see it as a employee benefit, and are fearful that its loss would force companies to stop offering health benefits. Ironically that is exactly what I would want to happen: business shouldn’t be the source of health care for the simple reason that a rational business sees the cost of workers as a total cost, inclusive of wages and health care. In that scenario a business is legitimate in cutting wages in order to keep offering health care benefits. All the evidence supports this notion: studies indicate that wages in the US as a whole are about 6% less than they would otherwise be were health care not offered through employers. So American workers are paying a significant, but hidden, price for the ‘benefit’ of health care.

Finally, as I catch up ahead of this week’s news, for those economics geeks out there: I read with amusement an article in the Financial Times on Friday that US oil prices were dropping in reaction to news of a rapid build up in inventories. Those of you who follow text book theory will immediately see the oddity of this news. One of the central assumptions of the text book theory is that prices already embody all the news people need in order to buy and sell goods and services. Ergo, there should be no adjustment: the effect of inventory increases should already be built into the oil price. One would think that the economics theorists who defend that notion of prices are currently scurrying about trying to square away the FT’s comment with their theory. But no. One of the most unfortunate aspects of the current crisis is that it has exposed just how oblivious and indifferent those theorists are both to the damage their ideas have wrought, and to the inherent stupidity of them.

As you all know I try to pour as much contempt on the standard economics theory as I can. So spare me this small moment of triumph!

Meanwhile: that increase in oil inventories is occurring especially in the kinds of oil that farming and industry use for fuel. So a back up in inventory could be a sign that usage is not as high as anticipated. In turn, that means the economy may be slowing its improvement.

That gets us back to the stimulus.

More please!

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Unemployment: Very Mixed

Today’s employment report from the Department of Labor has an odd feel to it. The figures are always adjusted for seasonal factors so whenever we read about the ‘new claims for unemployment assistance’, we are not looking at the raw data, but at a figure manipulated to offset any peculiar and recurring movements. The typical surge in seasonal hiring during the summer is a good example of such an adjustment. The idea being , of course, to get at the underlying trends that such a seasonal ‘bounce’ might obscure.

Ironically today’s report that initial claims fell by 52,000 last month may be an example of the adjustment process producing a perverse result. The data has been scrubbed to exclude the usual summer variations, one of which is the ‘normal’ auto industry round of layoffs prior to the summer time re-tooling for next years model introductions. This year all those layoffs occurred in the spring when Chrysler and GM went through bankruptcy. So the seasonal adjustment downwards of the raw number may not be justified this year and so the reported improvement may not be representative of a long term trend.

There’s a lot of ‘mays’ and ‘ifs’ in that analysis, which only goes to highlight the difficulty we have in getting at what’s really going on. So I repeat my mantra: watch the data accumulate and don’t focus too heavily on any one week’s or month’s numbers.

With that in mind I want to point out one worrisome fact that we ought to be paying attention to closely over the next few months: ‘repeat claims for assistance’. This figure shows us the trend in long term unemployment. While ‘initial claims’ obviously reveal recent layoffs, ‘repeat claims’ give us an idea of how easy or difficult it is to find work. If the ‘repeat claims’ keep on edging up, as they did this week, then we can assume that employers are not re-hiring. So the two figures provide insight into the two parts of the employment cycle: when the initial claims figure starts to drop, we know that the run up in unemployment is ending; and when the repeat claims start to drop we know that the unemployment rate will start to fall also.

Right now the trends seem to show a slowing but still rising trend in unemployment with no shift towards decline in sight.

To put the employment picture in perspective: the number of people claiming unemployment insurance was 3,218,000 at this time last year and is now 6,883,000. That’s the size of our problem. We need to get these folks back to work.

Addendum: Unemployment and the stimulus package …

As an afterthought: unemployment is a lagging indicator. It rises after a recession has begun and improves after a recovery has started. There is no way that the unemployment rate will improve in the near term. So all the current hyped up talk over the ‘failure’ of the stimulus package is just that: hype. There hasn’t been enough time to have an effect. The original proposals laid out very clearly that the earliest expected improvement in employment resulting from the stimulus was in the late third and early fourth quarters this year.

We should therefore ignore the critics.

In any case anyone suggesting that we don’t need a stimulus should be clear about what their alternative is. Reduce interest rates? Can’t do that: they are at zero. Cut taxes? Did that already in 2001 and 2003: nothing happened, the last eight years have been the weakest employment years of any post war expansion. What else? …

Exactly. We have one policy option. Get over it.

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More Stimulus Nonsense

As an update to my last post on the stimulus: the drumbeat of criticism that the stimulus is not working is just annoying. Anyone who took the trouble to read the actual proposals back at the time the stimulus package was legislated into being would know that no one thought it would start to have any real impact until later this year at the earliest. In all the charts that I saw the impact was concentrated in the fourth quarter this year and then in the entirety of next year.

So of course there isn’t much impact yet.

Duh.

But this simple observation eludes, presumably for partisan purposes, large swathes of the analytical and media elite. By arguing that the stimulus has failed these people are putting at risk an essential part of or escape plan: the fact that we evidently need a larger stimulus than the one we have.

This extra need is not because the current plan ‘is not working’ but because the economy is significantly worse off than thought by those responsible for its size.

There were some of us who argued for a much larger package back during the original debate. Unfortunately we have been proven right. That’s why we need more stimulus and quickly.

Parenthetically: let’s all get rid of this ‘wait and see’ attitude. By the time we find out whether the current package was the correct size we will have lost another year or so of recovery. The cost in human terms of all that lost time vastly overwhelms the risk that we may not need more stimulus. Unemployment is already above the upper limit the original plan was designed to combat, it is therefore self-evident that more work is necessary.

And to all those who decry the tardiness of the government’s efforts: may I remind you all that we have just spent the best part of three decades gutting the ability of government to act effectively. The word ‘Katrina’ surely still means something does it not? The whole purpose of the Reagan/Bush agenda was to render government ineffective. So cranking up government spending in order to stave off depression may take some extra time: we have to resuscitate government competency at the same time.

It is both fatuous and disingenuous for those who bash government and who strove to disembowel it to argue that it is failing just when we need it.

So: if you want to argue against the stimulus plan please do so on the basis of its size being too small, and not on the basis that it isn’t working.

Size mattered. And it still does.

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More Stimulus … Now!

Having reflected on this week’s ‘not so good’ jobs data I can come to only one conclusion: we need, as a matter of urgency, to push through a second stimulus package. Those of us who thought that the original package was far too small and poorly constructed are on the verge of being vindicated. And this is one time I wish we were wrong.

This does not mean that the current package is not working: it is facile and disingenuous to argue that. We can allow the Wall Street Journal to rant about the administration’s failure, the ideological divide runs too deep for the WSJ to be supportive and, in any case, any organization run by Rupert Murdoch nowadays runs fast and loose with the facts – the WSJ has been reduced to being a shill for Hooverite policies, safe in the knowledge that it has no responsibility and therefore is able to say stupid things.

No. The existing package is working. It just is miserably inadequate to the task.

What disappoints me most is that this inadequacy was always easily predictable. The failure was not one of analysis or even understanding the correct policies. It was a failure of political willpower.

Having just won a crunching electoral victory Obama decided to be weak. He adopted unnecessarily centrist positions in order to woo ‘centrist’ GOP Senators. He watered down policies in order to avoid confrontation and he reached out to the very people who caused this disaster – bankers – for advice about the cure.

With much of his agenda now so lame that it makes a mockery of his call for change, now is the time to discover his missing backbone.

And I mean now.

Not the Fall.

Let’s recap the situation we find ourselves in:

  1. The economy is still shedding jobs in large numbers. Not as rapidly as before, but still enough to scare everyone.
  2. This masks the problem: we need to be adding jobs to keep up with population growth. It is easy to forget this. Under normal circumstances the economy needs to add about 100,000 jobs each month just to keep up with our growing workforce.
  3. So a loss of 500,000 jobs in one month leaves us 500,000 + 100,000 adrift of where we need to be to keep the economy close to its potential.
  4. Do the math: we have lost a net of about 6,500,000 jobs due to the recession. And demographics have added about 2,000,000 new workers during the same period. So we are 8,500,000 jobs in the hole.
  5. Worse: the labor surveys are beginning to show tons of worker disillusionment. The number of people who report that they are part of the workforce is shrinking – despite the demographics just mentioned – so the economy is losing capacity.
  6. Lost capacity constrains future wealth generation. The OECD estimates that the recession will permanently shrink US wealth by about 1% per annum. That’s $145 billion, or plenty enough to provide for health care.
  7. The current Federal level stimulus is, at least in part, being offset by spending cuts at the State level. So we have contradictory economic policies: the Fed’s are trying to expand the economy, while the States are trying to shrink it. This needs sorting out.
  8. We are playing for big stakes.
  9. We need appropriately big responses.

Are we getting them?

No.

Instead we have a lame stimulus that was, because of excessive pandering to ‘centrists’, tilted towards ineffective tax cuts and cash rebates. We have a limp set of banking reform proposals that are thick with micro-level bureaucratic kluges and exceedingly thin with respect to the big issues like regulatory capture and ‘too big to fail’ solutions. And we have a health care plan being tossed and turned by those same centrists that screwed up the stimulus.

Meanwhile the economy burns.

I mentioned yesterday that we should not panic over one month’s data. But the warning signs are flashing distinctly and brightly on the downside. What worries me most is that wages are showing every sign of decline. And I doubt that the official figures properly catch the localized, but now frequent, give-backs by workers: shorter work weeks, furloughs, and outright wage cuts. This is the stuff of deflation.

I have argued all I can about the fears now building amongst many right wing commentators that we are running a risk of high inflation. I don’t believe that inflation is a credible risk anytime soon, and certainly not as long as the economy is stuttering so far from its potential. It is ridiculous even to think such a threat exists in the near term. Longer term? Yes. Shorter term? Not a chance.

On the contrary. The risk is still on the downside. Deflation, which is a sure associate of depression, is still a bigger risk than inflation is.

The problem comes down to analytical accuracy.

All those viewing the scene through the prism of textbook economics will see inflation as a problem. That’s because the textbook is wrong. The effects of financial relationships and in particular the effects of uncertainty are not accounted for in textbook theory. As a result the textbook fails to contain analysis of a recession where labor markets are thrown way out of balance and where debt reduction becomes critical. Combine these issues and deflation becomes the problem. And the textbook offers no cure.

The liquidity trap we find ourselves in – a situation where normal monetary policy is totally ineffective – reduces our policy options to just one: a purely Keynesian stimulus.

That is, government consumption in excess of its means. Ugly but effective.

Tax cuts and cash rebates do not work as part of such a stimulus precisely because of the de-leveraging that we need: consumers hoard cash they do not spend it. They reduce debt or keep cash in excess of normal requirements. Why? Because of the uncertain environment. The more they hoard the more uncertainty creeps in via increased unemployment. The consequent downward spiral does indeed self-correct, just as the market magic believers argue it will. But the cost is devastating and the time lost is enormous. It may be a decade of lost wealth accumulation if we do not act forcefully.

So we need more stimulus. And we need it now.

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