The Economy Isn't Booming Just Because Unemployment Is Low

The Economy Isn't Booming Just Because Unemployment Is Low
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Ever since the Soviets launched a beach ball sized chunk of metal into orbit, the shock has remained part of the American fabric. On October 4, 1957, the Russians placed Sputnik1 on top of a modified ballistic missile design, the R-7 Semyorka, and sent it up into history. For a little more than two months, 1,440 orbits, the Western world could look up at the skies and feel the Communist threat in their own backyards.

The “sputnik moment” is synonymous with a wake-up call though one that deserves the heightened urgency of its own special class. The term has become overused, of course, since politics is the art of getting voters interested in things they don’t understand or don’t really care much about on their own.

When it comes to economy, though, it’s not so much the latter as the former. When it’s not going so well, people don’t have to be told. It’s figuring out why, and whether to stick with it.

For his second State of the Union address, President Barack Obama celebrated the stock market. Despite that, in early January 2011, there was widespread agreement that something wasn’t right. Business cycles had historically clung to a predictable pattern. The economy experiences a shock, contraction develops, and then recovery.

Those were not just banal labels, either. Recovery, in particular, meant something. It followed equally from the contraction. Whatever scale of recession, depth and duration, the recovery which developed would match those qualities. This sort of symmetry came to be believed as inherent.

In late 2010, though, it wasn’t going that way at all. The Great “Recession” had been unusually long and severe, the worst contraction since the thirties. By all expectation, the recovery which followed should have been just as big, pointing in the opposite direction.

Central bankers took their cues from that expectation; their job, as they saw it after having botched the “shock” and contraction of 2008, was simply to limit the downside while waiting for full recovery to begin.

Instead of clear sailing in 2010, there was a flash crash and QE2. There was some progress after 2008 and early 2009, but not nearly enough. This was President Obama’s main message:

“Two years after the worst recession most of us have ever known, the stock market has come roaring back. Corporate profits are up. The economy is growing again.”

The issue was whether “growing again” added up to the same as growth? Clearly not. He continued, “But we have never measured progress by these yardsticks alone. We measure progress by the success of our people. By the jobs they can find and the quality of life those jobs offer.”

Obama called it our generation’s sputnik moment. And he was right.

The dangers of socialism are not orbiting above us today, nor do they stem from some faraway foreign land on the other side of the earth. In 2011, we were supposed to have awakened to the idea that it was building up from the inside. Obama may not have seen socialism for what it was and is, but he knew the dangers of dissatisfaction and what it could do if left unchecked.

And then he left it unchecked.  He didn’t heed his own sputnik moment. Nobody did.

What called off the urgency, or for many people has been taken as a sign of success from it, has been the very things the last President cautioned us about more than eight years ago. The stock market is at record highs, and the unemployment rate is unbelievably low. Why is anyone complaining? It must be illegitimate narcissism fueled by some evil “ism.”

The unemployment rate has formed the basis for a number of sweeping generalizations. The financial system must have been fully restored to working order and therefore the economy completely healed; the former a prerequisite for the latter. In official circles, the unemployment rate vindicates not just QE but those who “courageously” proposed and executed it (as well as the three others in the US).

This single number is supposed to end the debate. Hardly a sputnik moment, then. It’s like President Eisenhower claiming to have matched the Soviets with our own satellite in orbit and then refusing to show anyone video, some pictures, any data at all to corroborate the claim.

For the unemployment rate to be valid several things would follow. There would be consumer price inflation as a result of companies passing along much higher labor costs. An historically tight labor market would force businesses to heavily compete for scarce workers, driving up wages. For the Federal Reserve, that’s the best problem any central bank could ever have.

And that’s what they’ve been saying for more than two years. We launched our counter to sputnik; trust us.

More and more, though, there is the sense not to. Fed officials have already capitulated on consumer price inflation (“muted”) this year. The PCE Deflator, even its core version has come back down to well below the policy target. The period of undershooting has not ended, apparently.

That could still mean a tight labor market. For whatever reasons, maybe companies just aren’t passing along wage increases like the Phillips Curve suggests.

Except, no, there’s actually no evidence the labor market is tight, either. Companies aren’t passing along labor cost acceleration because labor costs are not accelerating.

It’s actually much worse than that. According to the Bureau of Labor Statistics, recent wage data has been more alarming than cooperative. Just this week, the BLS reported that nominal compensation per hour in the private sector rose at an annual rate of 2.6% in Q1 2019 from Q4 2018. More importantly, the 4-quarter average is now just 2.5%, down from a peak of 4.0% reached in Q3 2017.

All the while the unemployment rate has been below 4%, businesses are not overly competitive about workers. Instead, quite the opposite, it appears there has been an increase in slack above what clearly must still remain. Nominal compensation is exactly where this wage explosion would show up – if the unemployment rate was anywhere close to accurate.

Other estimates for labor and wages take a step farther in the other direction. Unit Labor Costs, for one, were basically the same in Q1 2019 as they were in Q1 2018. How is that possible when the unemployment rate has been stuck so far below what Economists and central bankers believe is full employment? And not just for a couple months, for almost four years.

The 4-quarter average annual increase in unit labor costs is now just 0.9%. When the unemployment rate was last around 4% back in 2007, unit labor costs were rising at an average of more than 3%. When the unemployment rate was last 3.7% in early 2000, unit labor costs jumped 4.4%.

Last year was a total wipeout as far as the widespread claim for this labor shortage, and this year has started out even more the wrong way.

Wages and inflation are more esoteric concepts. Income is not. After all, if the economy is booming more people get paid and people already getting paid get paid more. Incomes would truly be robust.

Income growth in 2018 was stuck at about half of what it was in 2014 and now in 2019 there is the hint of recession a quarter of the way through the year. Incomes are down from last year. Not the rate, but in absolute terms.

Real Personal Income excluding Transfer Receipts was $13.76 trillion (seasonally adjusted annual rate) in December. That estimate was boosted a little by a one-time dividend payment. Even so, in January 2019 Real Personal Income was $13.67 trillion. As of the latest figures for March, the same is now $13.65 trillion. This is not a data series where you are supposed to find any minus sign no matter how small, especially not one that spans three months.

No inflation, no wages, and now no income growth. You have to begin to wonder what the unemployment rate might’ve gotten right. How about the financial system’s repair job?

Unfortunately for Jay Powell, it’s not going the way he’d hoped here, either. Forget about all the really complex monetary stuff that actually goes on out there in the real world. The offshore, credit-based footnote dollars and whatnot. What the Federal Reserve does, what we are all taught in Econ 101, is federal funds.

From this one specific part of these vast money markets, that’s how monetary policy is supposed to work. In the textbook it says that through federal funds the US central bank exercises precise control and influence over the US economy. If the financial system has actually been pieced back together after being shot apart during 2008, federal funds should be the most boring, uninteresting part of the whole system.

And right now it is the most interesting, morbidly fascinating indication of how nothing has been fixed. As of Wednesday, the second day of the FOMC meeting, the effective federal funds rate (EFF) was 5 bps above IOER. Five. Above.

That brings EFF to within 5 bps of the upper boundary set by FOMC policy. Late last May and early last June, EFF was also just 5 bps below the upper boundary. In between, to push the effective rate back lower, to increase the distance from being so uncomfortably close to policy violation, the Committee instituted two “technical adjustments” to IOER.

Obviously, these haven’t worked because here we are all over again. In light of that, the FOMC on Wednesday voted for…a third technical adjustment to IOER.

This is (almost) unbelievable for several reasons. First and foremost, these central bankers had studied, planned, and prepped for their so-called exit for years. And I mean years. Once they get to it, it all comes apart like this?

After spending the balance of that year denying this was any problem, the Fed are now studying and prepping a new standing repo facility; essentially admitting that the centerpiece of their exit strategy, IOER, is actually useless (a determination which should have been easily made in 2008 after that experience). In the parlance of monetary policy, their toolkit is too limited.

You have to ask yourself, how can that be? How can it be 2019 and so many years of thinking about all this, the Fed after being shown up by EFF in their own backyard now needs more tools to manage the one thing that is supposed to be crucially second nature to them? The same question to ask approaches it from a different angle: what must they be missing?

The short answer is some required skepticism about the unemployment rate. Again, Economists and central bankers made sweeping generalizations based off of it, important interpretations about how the monetary system was made whole again first which then allowed for full and complete economic recovery.

If you stop taking them at their word, the very idea of a still dysfunctional monetary system leads right into slack in the economy. The unemployment rate isn’t looking so terrific. As Candidate Trump once said in August 2016:

“One in 5 American households do not have a single member in the labor force. These are the real unemployment numbers – the five percent figure is one of the biggest hoaxes in modern American politics.”

This is why in the bond market rate cuts are still being forecast for this year. It’s the same reason President Trump demanded the Fed immediately cut rates by 1%. This week, the FOMC did its best to try to swing a little back to the hawkish side. Not buying it.

A sputnik moment is supposed to be such a slap across the face that it stirs something serious inside the country. Not just a wake-up call but one that removes the boundaries we place on imagination. To begin thinking outside the box, time to really get creative by first questioning how and why things were done in the past. It is total urgency.

That’s not what happened in 2011. An “unexpected” worldwide slowdown emerged following “unexpected” monetary setbacks that year, which the world’s officials met with all the same things they had done before. Ben Bernanke doubled his QE’s. How’s that extraordinary stimulus?

The unemployment rate, though, allowed him and his successors to classify it as a success anyway. Full employment, full recovery.

Economic growth, real economic growth is broad and obvious. You don’t have to be tricked into believing it. Corroborating evidence is easy to find because it is everywhere. Before 2008, the reason we took the unemployment rate at face value was because of how it fit perfectly with all the rest of the data.  

Conservative commentator Mark Steyn wrote nearly two decades ago:

“The problem with the old one-party states of Africa and Latin America was that they criminalized dissent: You could no longer criticize the President, you could only kill him. In the two-party one-party states of Europe, a similar process is under way: If the political culture forbids respectable politicians from raising certain topics, then the electorate will turn to unrespectable politicians.”

In this global economic context, since the last undeclared downturn in 2015-16 we are witnessing something frighteningly similar. The unemployment rate is therefore meant to stifle the debate, to end it before it can ever get started. You can’t call it anything other than full recovery, therefore the very topic is banished from “respectable” discourse. The economy is booming; the great and powerful unemployment rate has spoken. Pay no attention to all that data behind the curtain.

No wonder the threat of the extremes. Steyn was right about the politics. You have to say the economy is awesome even though you know it’s not by your own experience. And that was just 2018. The allure of socialism is so easy to understand when you toss aside that one uncorroborated, misleading stat.

Any young person today, who, by the way, has never seen and felt an actually booming economy, might easily think to themselves, sure, socialism is responsible for huge messes everywhere it’s been done. Quite possibly those messes are less messy than the one we find for ourselves. If this is booming, maybe we should be open to trying something else no matter how risky. If this is the best it can get, why not go back to the drawing board because what we have now isn’t very good.

This is not actually an argument in favor of socialism. It is a realization that we need to wake up. Sputnik’s been orbiting over heads, unanswered, for over a decade. And that’s even before the next downturn gets here.

People already care about the economy, they just don’t know where to begin. Questioning the unemployment rate is the perfect place to start. Like so much of politics, it’s not nearly as difficult as it’s been made out to be. It might get you to the White House.

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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