Reality Catches Up With Jobs, But Not the Fed (Yet)
Friday's "Employment Situation" report from the Bureau of Labor Statistics (BLS) was ugly. Net of revisions to the July and August figures, the monthly increase in the obsessively watched "payroll employment" number was only 83,000. This was far less than the consensus expectation of 201,000.
The BLS "Household Survey" numbers painted an even gloomier picture. Extending its sickening slide under President Obama, labor force participation fell to 62.36%, the lowest level seen in 38 years. This is what made it possible for the "headline" (U-3) unemployment rate to remain at 5.1%, even though 236,000 fewer Americans had jobs.
The number of FTE* jobs fell by 118,000. This, coupled with growth in our working-age population, increased our distance from full employment by 254,000, to 13.9 million.
Averaged hours worked declined, and average wages fell. All in all, September was not a good month for workers.
Yes, September was a bad month for jobs, but it was also "normal," as in "economic stagnation is the new normal."
The Federal Reserve's "GDPNow" model is currently forecasting that annualized real GDP (RGDP) growth during the just-ended calendar quarter (3Q2015) will come in at 0.9%. Even with the "bad" September jobs report (and, it was truly bad), the number of payroll jobs increased at a 1.41% annualized rate during 3Q2015, and FTE jobs rose at a 1.63% rate.
Any time that jobs are increasing faster than output, there will be downward pressure on both employment growth and wages. So, all that happened in September is that economic reality caught up with the BLS numbers.
Unfortunately, economic reality has not yet penetrated through to Federal Reserve Chair Janet Yellen and her merry band on the FOMC**. By all indications, Ms. Yellen still believes that the Federal Funds rate matters (which it does not), and that the Fed's next move should be to "tighten money" (which has been tightening pretty drastically on its own).
The CRB Index** is a good real-time measure of the value of the dollar. This is because the CRB Index is based upon the market prices of a diverse basket of commodities, whose supply and demand fundamentals are carefully modeled by traders. These fundamentals cannot change quickly (e.g., it takes years to bring a new copper mine on line). Accordingly, when the CRB Index changes, it is because the value of the dollar, which is the denominator for all of the CRB Index's constituent commodity prices, has changed.
During 2005, which was America's last decent year for RGDP growth (3.34%) the CRB Index averaged 312.06. At the end of June 2014, it stood at 308.22. So, the real value of the dollar was about the same in June 2014 as it was in 2005.
In the past 9 months, the CRB Index has fallen by 37.14%. This is equivalent to a 59.07% increase in the real value of the dollar. This is a bad thing, because anything other than a stable dollar is a bad thing, at least for the economy as a whole. Here's why.
The reason that the CRB Index closed at 308.22 at the end of June 2014 was because this was the appropriate price, given everything that was known at the time, including about the intentions of the Federal Reserve. So, the 37.14% decline in the CRB Index between then and the end of September 2015 was the result of a series of surprises-surprises that netted out to considerable monetary deflation.
The problem with both inflation and deflation is that when the value of the dollar ends up being much different than what producers were expecting when they made their decisions about investments and pricing, economic damage results. For example, investments in U.S. oil and gas production via "fracking" that made sense when the value of the dollar was at the level of June 2014 will not pay off if the dollar is worth 59% more. And, if such investments were financed with debt, there is the potential for cascading debt defaults.
Since June 2014, the nominal average weekly wages of production and non-supervisory workers have risen by 2.13%. This represents only about a 2.00% gain in real terms against the CPI. However, in terms of dollars valued in terms of the CRB Index, it amounts to a real wage increase of 62.29%.
Obviously, unexpected monetary deflation will suppress both hiring and nominal wages. And, while people and companies whose nominal income has remained constant would have the means to continue buying goods and services at the same rate, they will tend to cut back their spending, because their dollars have become more valuable and the items on offer have not.
By the way, this is why the pundits that are waiting for low gasoline prices to boost consumer spending will be waiting forever. The same higher dollar that suppresses oil prices also suppresses all spending, including consumer spending.
So, the real value of the dollar rises by 59% over the past 9 months, and Janet Yellen wants to raise it even further, by "raising interest rates." What could go wrong?
Actually, a lot could go wrong. This is the reason for the extreme volatility that we have seen in the equity markets recently. During the past 34 trading days, the Dow has seen single-day moves of +619.07 (+3.95%) and -588.40 (-3.57%), with triple-digit moves occurring on 23 of the 34 days.
The real economy changes glacially, not suddenly and violently. Whenever you see abrupt market moves like these, you are seeing the results of Federal Reserve action and inaction.
During the 20 trading days spanning September 1 through September 24, the Effective Fed Funds rate was 0.14% every day. During this period, the Dow, the CRB Index, and the spread between 5-year Treasuries and 5-year TIPS (i.e., 5-year expected inflation) gyrated wildly.
While the Fed Funds rate did not correlate with anything, the movements in the CRB Index were highly correlated, both with each other and with the Dow. The three tend to move up and down together (the correlation is not perfect, partly because the CRB Index ends the trading day at 2:30 PM ET and Dow trading closes at 4:00 PM ET).
This relationship makes perfect sense. There is some amount of monetary deflation that will send the economy over the cliff. This is what happened in 1921, 1930, and 2008. So, when we are heading for the cliff (the CRB Index and 5-year expected inflation are falling) the Dow goes down, and when we veer away from the cliff, (the CRB Index and 5-year expected inflation are rising) the Dow goes up.
We started Friday with a terrible jobs report, and the Dow down 200+ points. By the close of trading, the Dow was up 200.36 points. Obviously, the jobs report did not get better between 9:30 AM EDT and 4:00 PM EDT. What changed is that the world dollar system, on its own and with no help from the Fed, veered away from the deflation cliff. The CRB Index rose by 0.83% and 5-year expected inflation rose to 1.15% from 1.13%.
Drama in the financial markets raises the cost of capital. This suppresses investment, which depresses growth in jobs and real wages. If we want prosperity and stable financial markets, the Fed will have to stabilize the dollar.
With $2.55 trillion in excess reserves in the banking system, it doesn't matter what the Fed does with its Fed Funds target. To stabilize the dollar, the Fed would have to target the CRB Index. A CRB Index of 300.00 (which is close to the average level seen in 2005) would be an appropriate level.
*FTE (full-time-equivalent) jobs = full-time jobs + 0.5 part-time jobs
**Federal Open Market Committee, which is the body that determines the Federal Reserve's monetary policy
***The CRB Index is a commodity price index comprising: Aluminum, Cocoa, Coffee, Copper, Corn, Cotton, Crude Oil, Gold, Heating Oil, Lean Hogs, Live Cattle, Natural Gas, Nickel, Orange Juice, Silver, Soybeans, Sugar, Unleaded Gasoline, and Wheat.