There's a reason economics is called the dismal science, and weeks like this just give it further meaning. In economics, there is what you see and what you don't. This week we are going to examine the headline data we all see and then take a look for what most observers do not see. Then we'll try to think about what it all really means. With employment, housing, and the ISM numbers, there is a lot to cover. And this letter will print out longer than usual, as there are a lot of charts. Warning: remove sharp objects from the vicinity and pour yourself your favorite adult beverage. This does not make for fun reading.
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Some Really Dismal Numbers
The unemployment numbers this morning were just bad, even though the spin doctors were out in force. Of course we knew that because of census workers being laid off the number would be negative, and it was, down 125,000. But the "bright spot" we were told about was that private payrolls came in at 83,000 new jobs. Let's look at what you did not see or hear.
First, last month's dismal (there's that word again) private job-creation number was revised down from 41,000 to 33,000. So in two months, total private job creation is 116,000 jobs. We need 125,000 jobs per month just to keep up with population growth.
But it is worse than that. The headline number we look at is from the Establishment Survey. That means they call up existing businesses they know about and ask them how many people are working for them, etc. One of the first things I do when the employment numbers come out is look at the birth/death assessment on the BLS (Bureau of Labor Statistics) web site.
For new readers, the birth/death assessment has nothing to do with people dying, but rather is the BLS's attempt to estimate the number of new businesses that have been created or have "died" within the last month, and they use these numbers to adjust the employment total. They use historical, seasonal numbers to create a model from which they make these estimates. There is nothing conspiratorial about the numbers - they have to make an attempt at such an estimate, otherwise the employment number would be badly off. But the birth/death number can skew the totals a lot more than is typically realized.
Take the last two months. Using the birth/death model, the BLS assumes that 362,000 jobs were created somewhere. That is three times the number of jobs in the headlines we read. Those extra jobs were added into the total because that is what the model told them to do. And over a complete business and employment cycle, those numbers will average out to be pretty close to right. But as I said, they can also be misleading in the short term. Let's look closer at some of the details.
The B/D adjustments say that we added 65,000 construction jobs in the last two months, over half the total number of jobs created. Really? US single-family homes set an all-time low sales number this week. Mortgage applications are way down. Home construction is off. Commercial real estate construction is down. Where are those construction jobs?
158,000 new jobs have supposedly been created in the hospitality and leisure industry in the last two months. And that is consistent with what normally happens in summer time. Typically, these are lower-paying jobs. (I worked a few myself while in college.) In the actual numbers, as surveyed, they estimated only 33,000 new jobs in L&H, so the B/D adjustment accounted for nearly all the positive number.
But what happens is that most of those L&H jobs go away in the fall, so then the B/D adjustment goes negative. Further, I am not sure we can assume a typical cycle here, to base the B/D number on.
(One more thing to complicate all this. The headline number we see is seasonally adjusted, but the B/D assessment isn't. And we just won't go there. That's way too much "inside baseball" sort of trivia.)
But look at this chart from my favorite data maven, Greg Weldon (www.weldononline.com). It shows that the number of people planning vacations is way down, dropping by over 35% in the last three years, for the second lowest number ever. Ever.
That is not consistent with a typical hospitality and leisure job-growth pattern. I have three kids working in that field, and the talk is not of robust job creation or lots of overtime. (By the way, my Tulsa readers should go to Los Cabos for some good Mexican food and leave my daughters Abigail and Amanda some really big tips! And make sure they get your name and address.)
Unemployment Went Down?
We were told that the unemployment number dropped from 9.7% to 9.5%. That's a good thing, right? Well, no, not really. The number dropped because the number of people counted as being in the labor force dropped. If you haven't looked for work for four weeks, you are not counted as unemployed. If you add those who were taken off the rolls back in, the unemployment number would have risen to 9.9%. In the past two months nearly one million people have dropped out of the labor market.
If you counted all the people who would take a job if they could find one as unemployed, the unemployment number would be closer to 11%. As an aside, if I have any real beef with the BLS over how they create their data, it is this last point. If you would take a job if you could get one, you should be counted as unemployed. Period.
The Household Survey was rather dismal. (This is where they call households and ask about their employment situation.) The survey showed a loss of 301,000 jobs, or 363,000 jobs if you adjust it to match the Establishment Survey. Not pretty.
Maybe a better way to look at unemployment is to look at the percentage of the total population that has a job. That number has been rising off and on for almost 50 years as more and more women have moved into the labor force. But notice the large drop over the last year - almost 5% of working people in the US have lost their jobs.
The initial unemployment claims 4-week moving average stubbornly refuses to go down any further. It has essentially gone sideways for over 6 months.
If you go back and look at the data from the last 45 years, the current level is typical of recessions.
Earnings Take a Hit
No, not business earnings, which seem to be holding up, but personal earnings. Average hourly earnings dropped 0.1% in June, something that David Rosenberg notes is a 1-in-50 event. The trend is downward, with annual growth of less than 1.7%. Average hours worked were also slightly down.
My friend and Maine fishing buddy Bill Dunkelberg, chief economist at the National Federation of Independent Businesses, has produced his monthly survey, and there was not much to cheer about from a future employment perspective. Over the next 3 months, 8 percent of the businesses surveyed plan to reduce employment (up 1 point), and 10 percent plan to create new jobs (down 4 points), yielding a seasonally adjusted net 1 percent of owners planning to create new jobs, unchanged from May and only the second positive reading in 20 months - but barely so.
From Dunk's email: "Since January, 2008, the seasonally adjusted average change in employment per firm has been negative in every month, with a seasonally adjusted loss of 0.3 workers per firm reported in June for the prior three month period. Most firms did not change employment, 5% (down 3 points from May) increased average employment by 3.4 employees, but 15% (down 5 points) reduced their workforces by an average of 3.3. "Job creation" still hasn't crossed the 0 line in the small business sector. Government (including health care and education) and manufacturing (a large firm activity) has been providing what few jobs are created, weak given the magnitude of employment loss during the recession. And now the elimination of temporary Census jobs will make the picture look more bleak, although more accurate. A few more private sector jobs is not enough, we need 225,000 every month for 3 years to re-employ 8 million workers who lost their jobs and another 125,000 a month to keep up with population growth."
A few more data points from this week, and then let's look at some of the implications. The numbers from the Conference Board survey were weak. The total of people planning to buy a major appliance is at an almost 16-year low. Car sales were low last month, and the survey says they may go lower, as plans to buy a car are down from 6% to 3.7%. In fact, in almost all categories plans to buy were down. Which makes sense, as 17% of people say their incomes are decreasing.
New home inventory is back up to 8.5 months of supply. As noted above, single-family sales hit an all-time low, as anyone who wanted to buy a home did so in order to get the government incentive. Just as with Cash for Clunkers, all we did was bring buying forward; we did not create actual new buyers, at least not in any significant numbers.
Money Supply Concerns
After the explosion in the money supply by the Fed in the depths of the Great Recession, growth in the money supply has gone flat. We recently looked at the fact that M-3 (the broadest measure of money supply) has turned negative for the first time in many decades. Look at the adjusted monetary base, below.
And now let's look at MZM, or Money of Zero Maturity. MZM is a measure of the liquid money supply within an economy. MZM represents all money in M2, less the time deposits, plus all money market funds. MZM has become one of the preferred measures of money supply because it better represents money readily available for spending and consumption. This measurement derives its name from its mixture of all the liquid and zero-maturity money found within the "three M's" (Investopedia). Notice that it too has gone flat, for over a year now.
These charts suggest that deflation is in the wind.
A Central Banker's Nightmare
Let's recap. Unemployment is high and is in reality going higher if you count those who would take a job if they could get one. Incomes are weak. Plans to purchase discretionary items are falling. Housing is likely in for a further drop in prices. The stock market is not exactly booming. Treasury yields are falling, not from a credit crisis or a flight to quality, but because of economic conditions (deflation). Money supply is flat or falling. Prices are under pressure. The list goes on, and all factors are indicative of deflation.
As noted last week, the data suggests we could see weak growth in the last half of the year. Over two-thirds of the past quarter's 2.7% growth was from inventory rebuilding, which surveys seem to show is abating as inventories begin to stabilize.
I was on Larry Kudlow's show (links below) last Tuesday, and he gave me some time to air my views. My main concern, as readers know, is that we may have a weak economy in the latter half of the year and then introduce a large tax increase, which my reading of the economic studies on tax increases suggests will throw us into recession. Recessions are by definition deflationary. (Not to mention what another one would do to unemployment and the stock market!) With inflation at less than 1%, could we see the central banker's nightmare of outright deflation? We very well could. I think that is what the bond market is saying.
How would the Fed react? For an answer, we need to go back to Ben Bernanke's famous helicopter speech of November 2002, entitled "Deflation: Making Sure 'It' Doesn't Happen Here." (By the way, I have always been convinced that his remark about printing presses and helicopters was an attempt at economist humor, which is why we don't get many offers from comedy clubs.)
I did a fuller assessment of that speech in my weekly letter at http://www.2000wave.com/article.asp?id=mwo112802. But I want to pull out a few quotes from the speech. You can read the speech itself at: http://www.federalreserve.gov/BoardDocs/speeches/2002/20021121/default.htm
Let's sum up the helicopter section: You can create inflation by printing a lot of money. But that is not the interesting part of the speech. Quoting from my letter:
"Let's look at what Bernanke really said. First, he begins by telling us that he believes the likelihood of deflation is remote. But, since it did happen in Japan, and seems to be the cause of the current Japanese problems, we cannot dismiss the possibility outright. Therefore, we need to see what policies can be brought to bear upon the problem.
"He then goes on to say that the most important thing is to prevent deflation before it happens. He says that a central bank should allow for some 'cushion' and should not target zero inflation, and speculates that this is over 1%. Typically, central banks target inflation of 1-3%, although this means that in normal times inflation is more likely to rise above the acceptable target than fall below zero in poor times.
"Central banks can usually influence this by raising and lowering interest rates. But what if the Fed Funds rate falls to zero? Not to worry, there are still policy levers that can be pulled. Quoting Bernanke:
"'So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure - that is, rates on government bonds of longer maturities....
"'A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.
"'Lower rates over the maturity spectrum of public and private securities should strengthen aggregate demand in the usual ways and thus help to end deflation. Of course, if operating in relatively short-dated Treasury debt proved insufficient, the Fed could also attempt to cap yields of Treasury securities at still longer maturities, say three to six years.'
"He then proceeds to outline what could be done if the economy falls into outright deflation and uses the examples, and others, cited above. It seems clear to me from the context that he is making an academic list of potential policies the Fed could pursue if outright deflation became a reality. He was not suggesting they be used, nor do I believe he thinks we will ever get to the place where they would be contemplated. He was simply pointing out the Fed can fight deflation if it wants to."
(And now, in 2010, that question might become more than academic.)
With the above as background, we can begin to look at what I believe is the true import of the speech. Read these sentences, noting my bold-faced words:
"... a central bank, either alone or in cooperation with other parts of the government, retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is at zero.
"The basic prescription for preventing deflation is therefore straightforward, at least in principle: Use monetary and fiscal policy as needed to support aggregate spending...." (As Keynesian as you can get.)
Again: "... some observers have concluded that when the central bank's policy rate falls to zero - its practical minimum - monetary policy loses its ability to further stimulate aggregate demand and the economy.
"To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys."
Now let us go to his conclusion:
"Sustained deflation can be highly destructive to a modern economy and should be strongly resisted. Fortunately, for the foreseeable future, the chances of a serious deflation in the United States appear remote indeed, in large part because of our economy's underlying strengths but also because of the determination of the Federal Reserve and other U.S. policymakers to act preemptively against deflationary pressures. Moreover, as I have discussed today, a variety of policy responses are available should deflation appear to be taking hold. Because some of these alternative policy tools are relatively less familiar, they may raise practical problems of implementation and of calibration of their likely economic effects. For this reason, as I have emphasized, prevention of deflation is preferable to cure. Nevertheless, I hope to have persuaded you that the Federal Reserve and other economic policymakers would be far from helpless in the face of deflation, even should the federal funds rate hit its zero bound."
And there you have it. All the data pointing to a slowing economy? It puts us closer to deflation. It is not the headline data per se we need to think about. We need to start thinking about what the Fed will do if we have a double-dip recession and start to fall into deflation. Will they move out the yield curve, as he suggested? Buy more and varied assets like mortgages and corporate debt? What will that do to markets and investments?
Note that last bolded line: "For this reason, as I have emphasized, prevention of deflation is preferable to cure." If he is true to his words, that means he may act in advance of the next recession if the data continues to come in weak and deflation starts to actually become a threat. That is the thing we don't see in all the economic data - the potential for new Fed action. Let's hope that, like the deflation scare in 2002, it doesn't come about. Stay tuned.
"Why don't you reform yourselves? That task would be sufficient enough." - Frédéric Bastiat
It is time to hit the send button. The letter is overly long already. I'll finish with this thought. This financial reform bill should be thrown out and they should start over. So much has been tagged onto this bill that has nothing to do with reform but is all about political agendas. It is also far too vague. Essentially, they create all these new committees or empower the bureaucracies that missed it last time to come up with the actual details of regulation. For all intents and purposes, a small number of unelected individuals will be given almost total control to write new rules overseeing a huge part of our economy. No matter how well-intentioned, this is not something that should be done in closed rooms.
We need major reform, of course. And when are we going to get to Freddie and Fannie, which are totally ignored but will cost the taxpayer the most? Local Congressman Jeb Hensarling has it right. He estimates there are about 3 unintended consequences on every page of that 1,200-page bill.
Oh, the Kudlow links:
I am aggressively working on my new book, The End Game. I hope it is going to a good one, given the hours I am putting in.
Have a great week.
Your wishing he was back in Tuscany analyst,