Volume 61 | Number 1
It was difficult to decide what tack to take on this week’s economic data. Clearly, almost every report surprised to the upside. The manufacturing ISM for September was stronger than expected at 51.2 (and well above the 45 level that normally marks recessions) suggesting the Japan supply chain disruptions are now behind us. Car sales jumped to 13.1 million at an annual rate in September and chain store sales were better than expected as well implying the consumer is feeling better as well. Construction spending for August was up a robust 1.4% on strong state and local government spending. Most employment measures, including the payroll, household, ADP and initial claims reports, showed steady growth in employment indicating businesses are less worried about a double dip than the financial markets. Yet, while this month’s early data pull us away from renewed recession they do not guarantee that growth is ahead.
The data suggest to us that the economy remains on a knife’s edge. It behaves like a household where only the prime earners has a job, but is wary of losing it. Occasional splurges come when a car must be replaced or back to school necessities purchased. But any shock to their income stream could push the household back into crisis. Say a 2% increase in FICA payments on January 1, or a temporarily lost job from a new government shutdown – or far worse a permanently lost job when the targets of the fiscal austerity imposed by Congress’ super-committee are finally revealed in late November. This economy can continue to muddle through at say 2% growth in the second half of 2011 – but only if the risks of disaster are kept off the table. Businesses will continue to hire cautiously. Lenders will remain tight with a dollar. Breaking out of this malaise will take definitive direction from Congress – a result which seems highly unlikely before the election result is clearer. Upside surprises like a big refinancing initiative from the GSEs or the extension of the payroll tax cut are tied up in an increasingly combative political environment. Potential calamities abound, as reflected in the collapse of Dexia Bank in Europe, the downgrade for Italy, and the renewal of quantitative easing in the UK. Crisis need not be home grown, as the global economy remains on tenterhooks as it tries to achieve a new balance.
First, the Good News
The most bullish sign for the US economy is that interest rates have plunged recently to record lows. For the first time in history, thirty year fixed rate conformable mortgages were available – to those who qualify – at less than 4%. This means that the downtrend in consumers’ financial obligation ratio – a calculation by the Federal Reserve of how much of disposable income households spend on mortgages, rent, car loans and leases, credit cards etc. — will continue to decline for the foreseeable future. Already near the record low in the second quarter, it will move lower still as more consumers refinance and pay down debt. Car sales were 13 million at an annual rate in September – near the strongest of the year. However, they were well below the 17 million plus pace of five to six years ago when car buyers first took out their 60-72 month loans. Thus, roughly four million households have been freed from car payments in the past year. At an average of roughly $600 a month (for an average $28,000 vehicle) that is a huge targeted stimulus. Others have altered their living arrangements or paid down credit cards (often because they could not get more credit.) Bottom line, where consumers relied on trillions in additional borrowing to augment income from 2002-2007, they have benefitted from decline in financial payments of roughly 2.5% of disposable income over the past 2.5 years to sustain buying power. Falling interest rates have meant far more to the consumer than debt reduction. Moreover, even if gasoline prices went to zero it would have a smaller effect on freeing up income. The Federal Reserve’s latest twist offers the potential for another sharp reduction in financial obligations – but only if underwater borrowers are able to exploit the opportunity that has been created.
Now, the Bad News
Given our contention that the fundamental problem in the US is an excess housing supply which threatens the value of the underlying collateral for the banking system, this month’s household employment report reflects some disturbing news about household formation – or the lack of it. Despite a huge 789,000 gain over the past two months, the US labor force remained -0.2% smaller in the third quarter of 2011 than it was in the third quarter of 2010. This continues a trend of disappointing labor force numbers, as the number of people available for jobs declined by -0.2% in each of the previous two years (ending in the third quarter) as well. The post-Lehman collapse in available workers comes after a fairly steady 1.0% gain over the past decade. This is critical because household formation (the increase in year round occupied housing units) averaged roughly 1.1% from the trough in 2001 to the peak in 2007 according to the American Housing Survey. Between 2007 and 2009, the rate of growth slowed sharply to just 1.4% over the two years. If household formation growth remained around 1.1% in early 2008, it would have plummeted after Lehman to say 0.3% in 2009 mirroring the slump in labor force growth. And this makes perfect sense, as it is the young who form the bulk of new households, but they now face the highest unemployment rates and are the most likely to remain in school and out of the labor force.
The concern is that if labor force growth (or even employment growth) tells us something about household formation, then even at a paltry 500,000 housing starts we may still be building more homes than needed by current household formations. Most optimistic models of US growth are based on a reversion to the mean in housing activity. We see nothing in the data that suggests that hope is warranted, and remain convinced that until housing supply – rather than housing demand – is the focus of government policy, the US banking system and our economy will remain mired in the doldrums.
And, We Saved the Worst for Last
There has been a lot of concern about the unusually high number of long term unemployed in this cycle, so we thought it would be useful to put it in some perspective. Eighteen months after the recovery officially started, the share of unemployed out of work over 27 weeks remains almost unchanged at 44%. By this time in previous recessions it had fallen under 20% — indeed it rarely made it over that hurdle for long. Moreover, there is little turnover in this group. Those unfortunate few that have become long term unemployed have remained unemployed. While the median time for unemployment has remained at roughly 20 weeks for the past year and a half, the average duration of unemployment has risen from 33 to 50 months. This means that all of the increase in the average has come from those long timers. As simple calculation assuming the duration of unemployment for those out less than 27 weeks is stable produces an estimate that the duration of unemployment for those over 27 weeks is now 75 weeks – almost a year and a half. And, that is the average. Some have clearly been out much longer. Indeed, this estimate undercounts as some will simply have left the labor force after a long period of fruitless job search.
Nor is there any support for the view that these long timers are only out of work because they are receiving unemployment benefits. We know from the household employment report that the share of long term unemployed is stable at near 45%. Given there has been little change in either the labor force or the unemployment rate over the past year, we also know that the number of long term unemployed reported in the household survey is fairly constant. Indeed, it has increased slightly from 6.15 million to 6.24 million over the past year. Meanwhile, data on continuing claims for unemployment breaks out those receiving basic benefits (the first 27 weeks) and those on state extended benefits or federal emergency programs. This number has been declining steadily as benefits are exhausted, dropping from 5.1 million a year ago to 3.6 million this week. Thus, over the past year the number of long-term unemployed not receiving benefits has increased by over 1.5 million (roughly 25% of all long term unemployed). There simply are no jobs for these unfortunates, in part because long term unemployment has become a signal to potential hirers to pass over these applicants.
One consequence of this long term unemployment conundrum is that it means the effective unemployment rate is probably closer to 6.8% — the 9.1% official rate reduced by 25% to reflect the excess of unemployable long term unemployed. Indeed, in discussions with many employers, it seems the labor market is acting more like it would with an unemployment rate of 6.8% — albeit a steady 6.8%. Annual wage gains remain around 2%, somewhat ahead of core inflation, which would be unusual at a 9.1% unemployment rate. Firms say that the supply of skilled workers is thin despite the fact that the pool of long term unemployed contains many skilled workers. In fact, the current unemployment rate for every level of education is roughly double what it was back in 2007. There has been no skew toward more unskilled unemployed. It simply seems that workers of all skill levels who have been out of work for long periods of time are undesirable. As distressing as this observation is, it forces us to wonder out loud whether spending limited government resources on retraining these workers is an efficient use of funds. It might be cheaper to offer packages that buy them out of the labor force with retirement/disability/dependent care subsidies and allow the unemployment rate to fall to 6.8%.
As with the housing problem, it may be more a case of addressing labor supply, rather than labor demand, which is most cost effective for government. We posit that the difference between depressions and recessions is the difference between too much supply and too little demand. Policies designed to absorb the temporarily overbuilt inventories which cause recessions simply don’t work to resolve long term overinvestment in capital stock that causes depressions. Nor is there much history to look at, as it has been war which traditionally has led to the destruction of capital and identification of the unfortunate few who won’t work again in the resolution of past depressions. Protectionism, trade wars, and competitive devaluations are often less violent preludes to shooting wars. Consolidation into more uniformly regulated trading blocs (dominated by the winner’s rules) is the usual outcome of war. Maybe we should try that without the shooting first this time. Someone tell the politicians.