Friday's Unemployment Report: Our Economic Nightmare Continues

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Friday's "Employment Situation" report from the Bureau of Labor Statistics (BLS) confirmed Thursday's dismal 4Q2012 GDP reading from the Bureau of Economic Analysis (BEA). Our economic nightmare continues.

During January, the "headline" unemployment rate increased to 7.9%, while the "real" unemployment rate (calculated at the 65.8% labor force participation rate when Bush 43 left office) rose to 11.0%. President Obama's $862 billion "stimulus" plan had promised to bring that number down to 5.3% by now. It didn't work.

The broadest measure of unemployment/underemployment, which is the "SGS Alternate Unemployment Rate" published by Shadow Government Statistics, remained at 23.0% in January, its highest level ever. This measure was at 17.6% when Bush 43 left office.

Also last month, America moved another 186,000 jobs away from full employment, to a total of 15.0 million. This made full employment 6.1 million jobs more distant than when Obama took office.

The latest GDP report illuminated why the employment situation isn't improving: the economy isn't growing. Real GDP actually contracted at a 0.1% rate in 4Q2012. Another such quarter and the National Bureau of Economic Research would likely have to declare that another recession has begun. Right now, consumer confidence is at a level normally only seen during recessions.

But wait! The Dow Jones Industrial Average closed above 14,000 on Friday, for the first time since October 12, 2007. Doesn't that mean that things are getting better? No, it does not.

Zimbabwe's stock market soared during 2008, even as the shares traded there were becoming worthless. What matters regarding the future of the economy is the Real Dow, which is the Dow divided by the price of gold.

On Friday, the Dow closed at 14,009.79. However, gold ended the day at $1670.60/oz, putting the Real Dow at 8.15. In contrast, the Real Dow on October 12, 2007 was 18.80, more than twice as high. In fact, the Real Dow is lower now than it was in January 1954, and it is down by more than 80% from its peak, which was reached under Bill Clinton.

The reason that the Real Dow is a good indicator of our movement toward or away from prosperity is that it is a measure of the relative attractiveness of capital investment in GDP - and employment-producing assets, vs. economically barren alternatives such as gold and government bonds.

Prosperity is always accompanied by a rising Real Dow. A falling Real Dow signals economic stagnation. Despite the nominal Dow's impressive close on Friday, the Real Dow is still 18% lower than it was when Bush 43 left office, and it wasn't doing all that well then.

Something is seriously wrong with our economy, and the mainstream economics profession doesn't have a clue what it is. So, let's look for the problem ourselves.

The BEA publishes the basic numbers on both GDP and the physical assets that are used to produce GDP. It is clear from the numbers that it is capital investment that drives economic growth. For the past 60 years, the following relationship has been valid:

GDP = 0.07(residential assets) + 0.48(nonresidential assets)

In other words, adding $100 of residential assets (housing) will increase GDP by $7, while increasing our stock of nonresidential assets (equipment, software, etc.) by $100 will yield $48 of additional GDP. Importantly, it is nonresidential assets that drive employment, productivity, and wages.

Even if it were not obvious from the BEA numbers that capital investment drives the economy, it would be clear from everyday business experience. Physically, capital investment always comes first. You can't hire workers without capital, and tools cost money, which is to say, capital.

More than 100% of our net increase in total employment comes from companies less than 5 years old. Here is the formula for starting a new company: 1) invest capital; 2) hire workers; and, 3) produce a product or service (which adds to GDP). Capital investment decisions drive the process.

It is clear that something has gone wrong with the way that the economy builds its stock of nonresidential assets. The process by which capital is marshaled and channeled into startup ventures has also broken down in some way.

The BEA numbers show that the economy is not doing as good a job of converting gross investment into net increases in nonresidential assets as it used to. Let's look for clues by comparing 1966, a year when both the U.S. economy and the middle class were doing well, with 2009, where both were sinking.

In 1966, real GDP (RGDP) grew by 6.52% and total produced assets increased by 22.2% of GDP. In contrast during the Great Recession year of 2009, RGDP contracted by 3.07% and produced assets declined by 7.3% of GDP.

We were investing less in growth in 2009 than we were in 1966. Gross Domestic Investment (GDI) in 2009 was 15.8% vs. 20.0% in 1966. However, this explains only 14.2% of the difference in capital accumulation between the two years.

Clearly the capital stock we had in 2009 was not as long-lived and durable as what we had in 1966. Capital consumption in 2009 was 13.4% of GDP, vs. only 9.7% of GDP in 1966. This means that our physical assets lasted more than a third longer in 1966 than they did 43 years later. GDI would have to be 37.5% higher today to deliver the same growth rate of fixed assets, and therefore GDP.

However, the biggest difference between 1966 and 2009 was caused by malinvestment. In 1966, we experienced a real gain in the value of our existing capital of 1.7%, while in 2009, America was forced to write off prior malivestments equal to 11.8% of GDP. This write-off caused a permanent loss of about 4% of GDP. This is equivalent to about 5.7 million jobs.

So, what changed between 1966 and 2009 that could cause us to create less durable physical assets and induce massive malinvestment?

In 1966, we had a stable dollar under the Bretton Woods gold standard. In 2009 and the years leading up to it, we had an extremely unstable dollar under Federal Reserve Chairmen Alan Greenspan and Ben Bernanke.

Between the end of 2000 and the end of 2012, the dollar lost almost 84% of its value in terms of gold. This was the main factor in the 80% decline in the Real Dow during this period.

American investors and businessmen do not have lower IQs today than they did in 1966. An unstable currency makes them stupid. An unstable dollar induces both short-term thinking and malinvestment.

The American economy will not grow normally, create jobs normally, and convert investment dollars into real assets normally until we once again have a stable dollar. Until then, our economic nightmare will continue.



Louis Woodhill (, an engineer and software entrepreneur, and a RealClearMarkets contributor.  


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