In trying to make sense of what is going on in the economy, both on Wall Street and Main Street, the most important thing to remember is in the “new normal” paradigm, one cannot use recent historical perspective.
Simply put, in the past five years, the structural changes in the U.S. economy have been so dramatic that today’s economy more closely resembles that of Europe or Japan than it does our own of 2007. As a result, to my way of thinking, a return to 4 percent real economic growth and a 5 percent noninflationary unemployment rate virtually looks impossible.
The underlying data
Despite the disappointing March employment numbers (88,000 net new jobs in the Establishment Survey and -206,000 in the Household Survey), there was a reduction in the unemployment rate to 7.6 percent because nearly 500,000 people “dropped” out of the labor force in March.
Based on this data and using the “old normal” paradigm, it is easy to conclude that there still is a lot of slack in the economy. After all, from an historical perspective the unemployment rate still appears high at 7.6 percent, or 13.8 percent, depending on which measurement you look at.
The underlying emerging facts, however, are quite different.
• In the April 9 Bureau of Labor Statistics release of the Job Openings and Labor Turnover Survey, the number of job openings rose by 314,000 for the month of February, despite the fact that hires were nowhere near that level. This is the second-highest level of new openings since April 2010, and the level of unfilled jobs now stands at 3.1 million, where they were in 2006. That number is up from about 2.2 million in the middle of 2009.
• While volatile month to month, the level of firings is near an all-time low. And, more people are confident enough in their skills and in their job prospects that the level of voluntary quits (an Alan Greenspan favorite) also is at a five-year high.
• On a weekly basis, the BLS issues a series called Initial Jobless Claims, a measure of newly fired or laid-off workers. This series shows a marked downtrend from more than 420,000 per week in the middle of 2011 to under 350,000 in six of the past nine reports; 350,000 per week is about the 2004-07 average.
Interpreting the data
There clearly is a skills mismatch as openings are rising much faster than hirings. The decline in firings and in the Initial Jobless Claims series imply that employers are holding onto their employees. And, the rise in the voluntary quits says a lot about job prospects for those with skills. So, at 7.6 percent, or whatever the actual unemployment rate really is, the labor markets appear to be extremely tight.
Implications of the data
One would never arrive at such a conclusion using the historical perspective of the “old normal.” For the first time in at least five years, we are about to see rising wage rates. This is really good for Main Street, as it will give the working class more disposable income. But, it is not good for Wall Street. Labor productivity has declined during the past nine months due to a lack of new investment from businesses and the inability to find qualified help. As a result, as the cost of production rises, profit margins will get squeezed, and we will see the beginnings of cost-push inflation, as businesses vie for the few applicants with skills. This will not be good for equity prices.
The view from the Fed
In December, with the announcement of 0 percent interest rates and quantitative easing until the unemployment rate reaches 6.5 percent, the Fed has returned to the discredited Phillips Curve concept used in the 1970s under the guidance of then-Fed Chairman Arthur Burns.
The concept was that the unemployment rate could be reduced if there was just a little bit more inflation. Sound familiar to the 6.5 percent unemployment rate and 2.5 percent inflation rate now being targeted?
In the ’70s, the result of this policy was “stagflation,” a term coined to describe little or no economic growth but high inflation. Inflation (measured more accurately then than now) was more than 13 percent, and many readers might remember that it took Paul Volker as Fed chairman and many months of 20 percent short-term interest rates to stop stagflation.
Nevertheless, it appears that today’s Fed is still using the historical perspective of the “old normal” paradigm in thinking that it can get the real economic growth rate back to 4 percent and significantly reduce unemployment without causing inflation.
Emerging facts are telling us that today’s labor and capital market structures are such that real economic growth of about 2 percent and unemployment rates near 7.5 percent are about all that can be accomplished without significant inflation. (Truth be told, the common experience today is that inflation is much higher than the official 2 percent numbers.)
What it means
The dusting off of the discredited Phillips Curve concept clearly indicates that Ben Bernanke is much closer to Burns in philosophy than he is to Volker. I lived through the Burns and Volker eras, and I am sure that someday, someone will say to Bernanke, “When it came to fighting inflation, you were no Paul Volker!”
Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs. Call them at 775-284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.