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Jobs growth steady but slow

November's jobs report shed no new light on the labor market situation. November's 147K new private sector jobs was in line with what we've been seeing on average for the year to date and for the past three years. It's slightly more than the 130K new jobs per month that need to be created just to keep up with the long-term average growth of the labor force, which is about 1% a year, so if things continue at the same pace the unemployment rate can decline very slowly from here. It's only declined faster because the labor force has grown very little for the past four years, which in turn is a function of many people deciding to "drop out." The current 1.5% per year pace of jobs growth is unlikely to translate into anything more than 3.5% real economic growth, assuming productivity growth continues to run at the 1-2% per year pace we've seen in recent years. That's OK, but it still adds up to the weakest recovery ever.


Note the relatively steady growth of private sector jobs as measured by the Establishment Survey (blue line). Both surveys show that the economy has created about 5 million jobs over the past two years. Also note that there is absolutely no sign here of anything like a recession. Jobs growth may be disappointing, but it is still definitely positive.


After declining from 2008 through early 2011, the labor force has resumed a 1% annual pace of growth over the past year. But it is still more than 5 million below where it could have been if long-term trends were still in place.


The November report provided more confirmation that the public sector workforce is no longer shrinking. Despite declining jobs in the past few years, public sector employees have not suffered nearly as much as their private sector counterparts over the past decade: private sector jobs are only now back to where they were in early 2002, whereas public sector jobs have risen on net by 1 million (almost 5%). It's still the case that  the best job security and the best pay and benefits can be found in the public sector.


Thanks to below-trend growth in the labor force and the relatively tepid growth of jobs, the economy has fallen farther behind its long-term growth trend than at any time in modern history. This is the weakest recovery ever. Fewer people working means the tax base is a lot smaller than it could be, and that is main source of a shortfall in tax revenues. Faster economic growth, powered by faster job creation, is the key to shrinking the fiscal deficit from the revenue side. Raising tax rates will only risk retarding the rate of growth. Are you listening, Mr. Obama?


The Fed is doing all it can to promote faster growth, by purchasing on net about $1.5 trillion worth of MBS and Treasuries in the past four years. So far, however, there is no sign that they have managed to increase the pace of jobs growth. Their main accomplishment has been to satisfy the world's almost insatiable demand for risk-free short-term securities, which in turn has been driven by fear of sovereign defaults, a double-dip recession, the expectation that massive federal deficits will inevitably result in a huge increase in tax burdens, and concerns that monetary stimulus could prove to be very inflationary. As the chart above shows, the market's current expectation for inflation over the next 10 years is 2.5%, which is pretty much average. But it's nowhere near the deflationary levels that most Keynesian models have been predicting given the economy's weak recovery and the unprecedented output gap that currently exists.


The chart above is a more sensitive measure of inflation expectations. The blue line shows that the bond market expects inflation to average a little over 3% during the period 2018-2023. That's not very frightening, but it does suggest that what's driving the rise in equity prices over the past year or so is inflation expectations rather than growth expectations. The Fed has absolutely succeeded in snuffing out any deflationary threat, but instead of boosting jobs growth, they have merely boosted the market's confidence that future cash flows to U.S. businesses will be rising by at least 2.5-3% per year, even if the economy posts very weak growth.

The negative real yields on TIPS, which are at or close to all-time lows, are a clear sign that the market expects future economic growth to be dismal. At the same time, the inflation expectations built into TIPS and Treasury prices say that the market expects inflation to be at least as high in the future as it has been in the past. Growth expectations are falling, while inflation expectations and equities are rising. Translation: equities are behaving more like inflation hedges these days, than like barometers of real growth expectations.

UPDATE: Nobel prizewinner Edward Prescott comes to a similar conclusion regarding the current 13% "output gap" that I show in the fourth chart of this post. See his op-ed in the 12/12/12 edition of the WSJ: "Taxes Are Much Higher than You Think." Increased tax and regulatory burdens, coupled with increased income redistribution schemes, likely explain why the gap is so large.

Households' balance sheets continue to improve

Household net worth rose $4.5 trillion in the first nine months of this year, according to the Federal Reserve, driven by strong gains in financial assets and rising real estate values.


Household net worth is still about $2.5 trillion shy of its Q3/06 peak of $67.3 trillion, but the recovery from the recession lows has been significant.

Notable year to date progress (rounded):

Savings deposits +$200 billion
Corporate equities +$1,070 billion
Mutual fund shares +$900 billion
Pension fund reserves + $900 billion
Real estate +1,150 billion

No doubt about it, things are getting better.

Claims settle back down

Sandy disrupted the East Coast economy, but things are getting back to normal. There are still headwinds, however, in the uncertainty surrounding the fiscal cliff, and in the increased tax burdens that will come with ObamaCare.


The chart above of seasonally adjusted first-time claims for unemployment shows how dramatic the disruption caused by Sandy was. It's taken about 4 weeks for things to get back down to where they were.


Arguably, the most important development on the claims front is the ongoing decline in the number of people receiving unemployment insurance. On an unadjusted basis, almost 19% fewer people (about 1.1 million) are receiving unemployment compensation benefits than were a year ago. This is a positive development because it is creating incentives for people to find and accept job offers. On the margin, this will help promote the labor market adjustments (e.g., lower wages) that are necessary for the unemployed to find new jobs where they can be once again productive. When there is a surplus of labor, reducing its cost is a tried and true way of reducing that surplus.


Unfortunately, there has been an uptick in announced corporate layoffs since the November elections. With ObamaCare now on track to be implemented, businesses are taking steps to avoid the extra tax burdens that will come with it, and that means layoffs and downsizing. In addition to layoffs, many companies are taking steps to convert full-time to part-time workers to avoid incurring the burden of having to provide healthcare coverage or incurring the penalty for failing to do so. For some companies at least, this extra cost would otherwise put them out of business. For a quick summary of how all this works, see this article by FreedomWorks.

I suspect that we will see claims moving back up and layoffs increasing somewhat in the coming months, and that is going to slow the economy's modest forward progress. I'm hopeful it won't be by enough to create another recession.

Still more mixed economic news

The manufacturing sector has weakened, but residential construction and car sales are strong, and the service sector continues to expand. Capital goods orders are down, but nondefense factory orders are up. This is the sort of mixed news that is consistent with an economy that continues to grow at a relatively slow pace, beset by continued headwinds. We're not at risk of recession, but neither is it likely things are going to improve much in the near future. In the meantime, markets continue to be braced for the worst, with hardly anyone calling for conditions to improve meaningfully.


The November ISM non-manufacturing composite index was up only marginally (from 54.2 to 54.7), but it exceeded expectations (53.5). The chart above shows the service sector business activity index, which jumped from 55.4 to 61.2. No sign here of anything like a recession, and you could even spin this into an outright positive, given that conditions in the service sector must have been negatively impacted by the Sandy disaster.


The service sector employment index, shown above, was disappointing. It's not terribly weak, but it suggests that businesses are not optimistic enough about the future to increase their hiring today.


As the chart above shows, the service sector in the U.S. is doing a lot better than in the Eurozone. Europe is really struggling, but at least things are deteriorating further.


The ADP estimate of November private sector jobs growth was a bit weaker than expected (118K vs. 125K), but it was a bit better than current expectations for Friday's payroll number, which calls for 93K new private sector jobs. With last month's revisions to its estimating model, we can have more confidence in the ADP number's ability to track the BLS's number, but in any event, there is little reason for cheer no matter which number proves correct. The economy continues to add jobs, but at a relatively slow pace.


This chart of factory orders is updated with data released today, but it's old news by now. Nevertheless, October nondefense factory orders beat expectations (0.8% vs. 0.0%). A few months ago it looked like this series was headed into a recessionary decline, but now we find that orders are up 2.8% over the past year, and they have grown at an annualized 4.1% pace over the past six months. Slow growth on average, but not anything like a recession.


So is all this mixed news (some areas strong, some areas weak, overall growth likely to be modest) a reason to be pessimistic? Well, that depends on what the market is braced for. If the market were priced to expectations of a stronger economy, then the recent news would be a disappointment. But as the chart above suggests, I think the market has been braced for even weaker news. The real yields on all TIPS out to 20 years are negative, and 5-yr TIPS real yields are at all-time lows of -1.5%. That means that investors in TIPS are guaranteed to lose 1.5% of their purchasing power over the next 5 years, and that only makes sense if investors believe that the real yields on alternative investments are going to be miserable (i.e., better than -1.5%, but likely much lower than anything we've seen in the past). My chart suggests that TIPS are priced to the expectation that real growth in the U.S. will be roughly zero over the next several years. So even if the economy only manages to eke out 1-2% growth, that it is better than what the market is braced for.

This has been an enduring part of my forecast outlook for the past four years. I've consistently argued that equities were likely to rally even though economic growth likely would be sub-par (i.e., lower than one would ordinarily expect given how deep the last recession was), because I thought the market was priced to very pessimistic assumptions about the future. And indeed, equities and most risk assets have enjoyed handsome returns even though economic growth over the past several years has been a meager 2%.

Tax shares update

The IRS recently released data on individual income taxes, and the Tax Foundation has nicely summarized the data, and I've put the data in the chart below. The story hasn't changed: upper-income earners continue to pay a hugely disproportionate share of total income taxes.


In 2010, it took $370K adjusted gross income to make it into the top 1% of income earners, and they paid almost 40% of all federal income taxes. The top 5% of income earners made at least $162K and paid almost 60% of all federal income taxes. The top 10% paid made at least $17K and paid a little over 70%. The top 25% included all those making $69K or more, and they paid over 87% of all federal income taxes. Meanwhile, the bottom 50% of income earners (those making $34K or less) paid only 2.4% of all federal income taxes, and the vast majority of them either paid no income tax or received money on net from the IRS.

One other important thing to note is that the share of total income taxes paid by the top 10% of income earners today has risen by 40% since the early 1980s, despite the fact that the top income tax rate has been cut in half. This is powerful evidence that the tax code remains highly progressive despite big cuts to top tax rates.

Let's talk "fairness:" The top 10% of income earners in this country already pay over 70% of federal income taxes, and the top 1% (the rich) already pay almost 40%. Is that not enough? Almost half of those who work pay no federal income taxes. Is that fair? Is it healthy for so few to pay so much, and for so many to pay nothing? When almost half the population has no skin in the game, and another quarter pay only a very small share of total taxes, it is easy to demonize or exploit the rich—it's called the "tyranny of the majority."

These are very sobering statistics. Instead of asking the rich to pay even more, we should be thinking about how everyone should pay at least something. Just paying your social security taxes doesn't count, because in theory—if not in practice, since the rich will undoubtedly subsidize the social security income of a great many people in the future when social security revenues fail to cover expenditures—that is money you will get back when you retire. Income taxes, in contrast, go into the general fund. 

UPDATE: The chart below shows the share of total income earned by each of the groups in the chart above. Not surprisingly, top income earners make a large share of total income. However, if you compare the two charts, you see that the share of total taxes they pay is much larger than the share of income they earn. Our tax code is very progressive no matter you look at it. In 2010, for example, the top 1% of income earners made 19% of the country's total adjusted gross income and paid 37% of total income taxes. The top 5% earned 34% of total income and paid 59% of total taxes. The top 10% earned 45% of total income and paid 71% of total taxes. The top 25% earned 68% of total income and paid 87% of total taxes.



Car sales surge


November car sales blew past already-strong expectations (15.46M vs. 15M). Part of the strength was due to a recovery of sales lost in October due to Sandy, but still, this is positive news. This has got to be the biggest V-shaped recovery of any sector since the onset of the Great Recession. Sales are up over 70% from their early-2009 low, for an annualized gain of 15.5%. Wow.

Unexpectedly strong sales create positive knock-on effects throughout the automotive and related industries. They also reflect an easing of credit conditions, and greater confidence on the part of lenders and consumers. As such, they are unvarnished good news.

The dollar is so weak that it might be good news

No matter how you look at it, the dollar is very weak—very close to its all-time lows. If the value of the dollar says anything about the world's confidence in the U.S. economy, the message is quite pessimistic. The only good thing to be said is that there is a lot of bad news that is priced into the dollar. It might be tough for things to get much worse.


This chart, with data as of October 2012, is arguably the best measure of the value of the dollar vis a vis other currencies. It is trade-weighted and inflation-adjusted. The "Broad" measure uses a basket of over 100 currencies, while the "Major Currencies" index compares the dollar to 7 currencies: the Euro, Canadian dollar, Japanese yen, UK pound, Swiss franc, Australian dollar, and the Swedish krona.

What it says is that a dollar today buys less overseas than at almost any time in modern history. (Although the Fed's calculation starts in 1973, in the prior decade the dollar was on average about 10% higher.) The dollar is scraping the bottom of the barrel these days, no question.

A very weak dollar is very likely the result of weak demand for dollars (relative to other currencies) combined with a generous supply. Demand for dollars is weak because there are many causes for concern: the weakest recovery ever, the dismal outlook for growth, the fiscal cliff, the prospects for heavier regulatory burdens (e.g., Obamacare), and the prospect of trillion dollar deficits for as far as the eye can see.  The value of the dollar is also a function, of course, of Federal Reserve monetary policy. Since the dollars' peak in 2002, the Fed on average has been quite generous in its willingness to supply dollars, as evidenced by the length of time that real short-term interest rates have been negative.

The charts that follow show my attempt at estimating just how weak the dollar is against individual major currencies.


With all the problems in the Eurozone (e.g., recessions in many countries, extremely high unemployment, the threat of major sovereign defaults), and the non-negligible risk that those problems lead to the end of the Euro, it is telling that the Euro is still relatively strong—10-15% overvalued by my calculations—vis a vis the dollar. It shouldn't be hard for the dollar to beat the euro, but it hasn't been able to clear that very low bar.


The yen has been the strongest of all the major currencies for decades, thanks to very tight monetary policy and very low—and often negative—inflation. Recent weakness in the yen owes much to the Bank of Japan's renewed efforts to loosen monetary policy and stop deflation. Yet the yen continues to largely shrug off the fact that Japan's public sector deficit is still deep in double-digit territory, and the economy has posted very weak growth in recent years. Still, today the yen is only 40% overvalued against the dollar by my calculations. By comparison, it was 90% overvalued at its brief peak in 1995.


The pound remains overvalued—by about 20% according to my calculations—despite the dismal performance of the U.K. economy—worse even than that of the U.S.. Real GDP in the UK is still 3% below its pre-recession high, and growth has been mostly nonexistent for the past two years. Moreover, industrial production has not increased at all from its recession lows. Inflation in the UK has averaged 4% per year for the past three years. In a word, the UK suffers from outright stagflation. Again, it is telling that despite these gloomy conditions, the dollar is still relatively weak against the pound.


After decades of dismal performance relative to the US dollar, the Canadian dollar has almost never been as strong as it is today—about 30% overvalued vis a vis the US currency according to my calculations. Canada is riding a commodities boom, and its housing and financial markets have been much healthier than their US counterparts, thanks to the absence of housing subsidies and the relatively low level of government meddling in the housing market. Canada is even managing to reign in public sector spending, thanks to smart incentives that reward key bureaucrats for reducing spending. Stronger economic fundamentals have allowed the Bank of Canada to avoid slashing short-term rates to zero, thus giving the currency the added advantage of higher yields than can be found in the US.



Thanks largely to booming demand for its raw materials, the Australian economy has grown almost 3% per year over the past three years, and the Reserve Bank of Australia has not had the need to lower short-term rates to zero. With monetary policy arguably tighter than in any country save the possible exception of Japan, and with confidence in the economy still relatively strong, it is not surprising that the Aussie dollar is almost 57% overvalued vis a vis the US dollar—making it the strongest of all the major currencies relative to the dollar.

If there is any silver lining to the dark cloud that overshadows the US dollar, it is that market expectations are very pessimistic. Lots of bad news is priced in. It's even possible that the market is braced for the news that the US is going to fall off the so-called "fiscal cliff." Although I hesitate to say it, it might even be the case that if Washington fails to come to an agreement by the end of the year, and taxes shoot up and spending sequesters kick in, the result could be less bad than is already expected.

After all, we've had many years now of reckless fiscal policy: almost four years without a budget being passed by the Senate, trillion-dollar deficits, a federal debt that has more than doubled as a % of GDP in the past five years, and reckless management of the public debt that has shortened Treasury maturities to an all-time low at the precise time that interest rates have also reached all-time lows. If Congress and the president finally run up against some limits, however arbitrary they may be, this might not be such a bad thing after all.

I should add that I'm not at all optimistic that we'll avoid the fiscal cliff. Obama is dug in on his demand for sharply higher tax rates on the rich, even though that doesn't stand a prayer of plugging the gaping federal deficit or strengthening an already weak economy. The Republicans stand on firmer ground, insisting on not raising taxes for anyone while at the same time making a credible effort to rein in the growth of entitlement spending, since that avoids creating negative incentives for growth; after all, economic growth is the only thing that holds out the promise of significantly reducing future deficits. Obama seems determined to risk a cliff fall, in the belief that he can pin all the blame on the Republicans and thus strengthen his hand in the future. But does he really want to cripple the economy just for personal gain, threatening his last chance at creating a growth and prosperity legacy?

I wish I had a crystal ball. In the meantime, my only source of comfort is all the pessimism that is to be found in market prices.

Mixed economic news

Today's reports paint a picture of an economy that is struggling, but not likely sinking into recession.


The ISM manufacturing index slipped below 50, but as the chart above suggests, that is still consistent with an economy that is growing at a modest 2% pace. Moreover, some of the weakness was undoubtedly Sandy-related, and should be reversed in coming months.


The Eurozone economy is still shrinking, but manufacturing conditions have improved somewhat on the margin in recent months. This is not a picture of strength, of course, but it does appear to rule out a free-fall. 


After being a significant drag on the economy for most of the past six years, construction is now a bright spot. Residential construction is up at a very impressive 33% rate in the past six months, and has risen almost 20% in the past year. It's only a small part of the overall economy (2.6%), but this is a very welcome development. At this rate, residential construction could be adding one-half to one percentage point to annual GDP growth for the foreseeable future.


It's also encouraging that industrial commodity prices have been strong in the past month, as this chart of the CRB Raw Industrial Spot Commodity Index shows. At the very least this suggests that global economic activity is firming, and that provides important support for the U.S. economy. This index is comprised of hides, tallow, copper scrap, lead scrap, steel scrap, zinc, tin, burlap, cotton, print cloth, wool tops, rosin, and rubber, and as such is not likely to be driven by speculative activity.

Auto sales, to be reported later today, are likely to show renewed strength in the aftermath of the Sandy disruption, with a gain of at least 10% over the past year.