The L-Shaped Recovery Rolls On
Tuesday, May 10th, 2011
Friday's unemployment report was certainly nothing to write home about. The ballyhooed increase of +268,000 private payroll jobs was met with the reality of a rise to 9% for the unemployment rate and decrease of -190,000 in the household survey, which includes self-employment and small business. The number of people not in the labor force went up by +131,000, not a good thing, and that same figure is more that +2.9 million than last year.
This latest report is still better than those of just a few months ago when the rate was 9.4%. There is, however, another issue. Because of the way the unemployment rate is calculated, it is common for a strongly recovering economy to result in a rising unemployment rate for a short time as more and more people re-enter the workforce. When those workers do, it takes about two or three months to absorb the additional workers before the unemployment rate starts plummeting. This is not why the unemployment rate increased; the labor participation rate is still at 25-year lows, 64.2%. Last year at this time, the unemployment rate was 9.8%, but there are only +290,000 more workers employed today than at that time, and the total workforce is down about -1.1 million.
There are obviously a lot of numbers being tossed around here, enough to make your head spin. So here's the recap: the unemployment rate is lower than it was last year because almost 3x the number of people have left the workforce than the increase in the number of employed workers.
Last Thursday's report of initial claims for unemployment, which occurred after the period covered by the employment report, took a surprisingly bad turn. It jumped +43,000 from the previous week, and reached an 8-month high; the more accurate 4-week moving average was 431,250, +22,250. Just weeks ago, this series was below 390,000. This does not bode well for May's unemployment report. The change was blamed on the damages from recent Midwestern tornadoes as well as the later than usual Easter holiday, which affected the timing of Spring break employment.
Earlier last week, the Institute for Supply Management manufacturing report fell back a small bit, but is still indicating strong growth in this sector. Its non-manufacturing report was another matter. It showed a slowdown in the growth rate for these industries. The flattening out of the services sector may imply cutbacks in some corporate budgets as they pare some of their more discretionary expenses.
Productivity was reported as being +1.6% for the first quarter of 2011, but I prefer using their total output data for nonfarm businesses, which was +3.2%. I believe is a better match for judging future employment and business activity. When productivity is greater than GDP growth, employment growth will be lag or turn negative. This productivity is paying for increased costs of inputs such as raw materials. The productivity is not being used to pay workers, where it should be going, but has somehow escaped them for almost a decade.
Speaking of raw materials and commodities, it was widely viewed that last week's collapse in many commodities, especially silver, which dropped more than 25% in a week, was a sign that the rise in precious metals was just the actions of conspiracy-types, who were finally being punished for an unsustainable rally. Silver, sometimes called “poor man's gold,” was considered undervalued in terms of its relationship to gold, which was one of the reasons for its recent rise. Many traders, as well as unsophisticated investors, who were playing the concerns about inflation and the supposed long-term ratio of gold and silver into profits.
Despite the drop in commodities, the underlying inflationary storyline is still in place. The Federal Reserve has been reluctant to act against the rise in commodities because they feel the prices will be self-correcting, as they were in the late Summer and Fall of 2008. They did not act when commodities were going up then, and they believe that not acting now is the right policy. This is why they have been willing to stand up to the taunts of grocery shoppers when Fed executives have been claiming that inflation was tame.
The growth in the money supply that the Fed has engineered is still underway. Their “QE2” efforts expire in June, and the Fed has indicated that the effort will stop at that time. That's unlikely. First, they have expressed their intentions to replace maturing debt on their balance sheet by buying new debt. This means that they will still be buying bonds, aiming to keep interest rates as low as they are now. QE2 will be with us for quite some time, as a stealth QE3.
The drop in commodities prices in 2008 was part of the credit crisis that led to TARP and other actions to stem the drop in real estate prices. Money was pulled from wherever it was available to cover trading positions: every asset class declined, and there was no safety in diversification. Those conditions are not the case now. The Fed bought many of those bad credit instruments and purposely flooded the markets with more money. Commodities may pull back, but the Fed is unlikely to stop creating money because they still fear deflation. They are fearful that even more mortgages will be “under water” where the mortgage amount is greater than the value of the house it covers. As long as the Fed keeps trying to support the prices of these goods that were purchased a long time ago, there will be misallocations of resources away from the productive actions that create new goods and services. Part of that misallocation heads to where those resources can go most easily: into commodities.
Another aspect of last week's decline in commodities was the realization that with just +1.8% GDP growth in Q1-2011, increases in commodities demand that would make commodities prices rise, was unlikely. This makes the run-up in prices over the last few months look almost fully speculative.
Many of the news reports about silver's decline attributed it to the increase in margin requirements for traders. It seems to me that so much money was made in recent months that taking profits seemed like the logical thing to do, especially in light of the rather disappointing economic news. Fear of inflation alone cannot support a rise in commodities prices in the long term. If there is no demand for the commodities, that means that there is no underlying reason to own them, other than for inflation protection. Since buyers who actually need to take possession of the commodity to use it in manufacturing, things can get a bit rocky. Those precious metals don't always seem so precious, do they?
Some of the inflation indicators may mellow a bit, but we're not done with inflation yet. Don't forget: the real value of wages is still declining. If prices are flat, but wages and incomes decline, it has the same effect as a price increase: things are harder to afford.