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Jobs growth is still moderate

A month ago, I downplayed the weakness in the March jobs report (Jobs report more noise than signal), suggesting that future revisions could easily wipe out the apparent weakness, which seemed suspect. That's exactly what happened with the April report. Thanks to sizable revisions to the past few months and a stronger-than-expected April gain, jobs growth is once again back to where it has been for the better part of the last few years. Jobs are growing at a moderate rate of about 2% per year, or roughly 190K per month. Nothing has changed: we're still in a disappointingly slow-growth recovery, but it is definitely a recovery and there is no sign of any emerging weakness.


The above chart compares the level of private sector nonfarm employment as measured by two different methods: the widely-followed Establishment Survey and the lesser-known Household Survey. The latter is notoriously more volatile than the former, but the two tend to track each other over time and now is no exception. The private sector has added between 6.5-6.8 million jobs since the post-recession low in employment according to these surveys. In the past two years, the establishment survey shows that private sector job gains have averaged 194K per month.


The above chart shows the 6-mo. annualized growth rate of private sector jobs according to the establishment report. Here we see that the current growth rate is not very different at all from what it has been the past few years. It's also about the same as we saw in the last economic expansion phase in the mid-2000s. Nothing remarkable has happened, except that there are still several million fewer people working today than there were at the peak in 2008. It's a tepid recovery, but a recovery nonetheless.


What stands out most about this recovery is the huge decline in the labor force participation rate (the proportion of the population that is either working or looking for work), shown above, which began in earnest in the latter half of 2009 and shows no sign yet of reversing. If the participation rate were back at 66%, where it was before the Great Recession hit, there would be at least 10 million more people in the labor force; instead, they have given up looking or decided to retire.


The chart above is another way of looking at the dramatic shortfall in the growth of the labor force.


The chart above compares the unemployment rate, which is now down to 7.5%, with the burden of government spending, measured as federal spending relative to nominal GDP. The correlation between the two is impressive, to say the least, especially since 2008. There are two things going on here: 1) lower unemployment means less spending on automatic stabilizers, and 2) a smaller burden of government  frees up resources for the private sector, which is then more able to hire people.

On balance, the April jobs report maintains the status quo ante. There have been no major changes to the health of the economy, which likely continues to grow at a sub-par, 2-3% rate.

Claims: it just doesn't get much better

The number of people getting laid off these days is very close to as low as it is ever going to be. U.S. businesses have just about completed their adjustment to the new realities set in motion by the Great Recession. The adjustment chapter of this business cycle is closing, and now the focus turns to the growth and expansion chapter. So far it's not very exciting at all; quite dull in fact. But the stage is set for some impressive growth if Congress can get the right policies in place. What's needed: continued cutbacks in government spending; entitlement reform; reduced regulatory burdens; lower and flatter taxes; and yes, repeal of Obamacare. 



The first chart above shows the seasonally adjusted level of claims, which has reached a new post-recession low. The second chart shows the actual level of claims, which hasn't been this low at this time of the year since 2007. Claims might drop a bit more by the end of the year, to around 250K, but it's unlikely we'll see anything lower. 


The number of people receiving unemployment insurance has been falling at a 20% annual rate for over six months. In the past year, almost 1.3 million more people are either working or have an increased incentive to find and accept a job. This is a very healthy change on the margin.


Announced corporate layoffs have been very low for over 3 years.

If there is one important message here it is that based on very timely data (weekly claims, reported with less than a one-week lag) there is absolutely no sign of any sudden economic weakness or impending recession. This economy is highly likely to continue to grow, even if at a relatively slow rate. In the absence of recession, and with continued growth very likely, it is very unlikely that corporate profits are going to sag, or that corporate cash flows are going to dry up. Equities and corporate bonds thus look very attractive relative to the almost-zero yield on cash.

The Fed is trying hard to encourage people to take on more risk, and the data coming from the economy makes a compelling case. If Congress could get its act together we'd be off to the races.

Dollar update: still weak but improving

Measured in inflation-adjusted terms against other currencies, the dollar remains quite weak from a long-term historical perspective, but on the margin it is improving somewhat. This is consistent with monetary policy being "highly accommodative," as the FOMC today noted in its statement, and with a general lack of confidence in the U.S. economy's ability to thrive relative to other economies.


The chart above shows what is arguably the best measure of the dollar's strength vis a vis other currencies. The blue line is the Fed's calculation of the inflation-adjusted level of the dollar against a very large, trade-weighted basket of currencies, and the purple line shows the same measure but against only a basket of major trade-weighted currencies. As should be obvious, the dollar is still very close to its all-time lows by either measure, but it has picked up somewhat in the past year or two. 


The chart above compares the dollar to the euro (blue line) and to my calculation of the Purchasing Power Parity of the dollar/euro exchange rate (the rate which theoretically would make the prices of goods and services in the Eurozone roughly equal to those same prices in the U.S.). I note that the euro has been declining somewhat against the dollar for the past several years, with the result that it is less "overvalued" than before. This implies that an American tourist in the Eurozone would find that prices are on average about 15% more expensive than in the U.S. At its peak in early 2008 (1.58), I calculate that the euro was overvalued against the dollar by about 38%.


As the chart above shows, the yen has weakened rather dramatically since last November, and is now only 17% overvalued relative to the dollar. The yen is still strong, but much less strong than it was at the beginning of last year, when I calculate that it was about 50% overvalued. The Bank of Japan has taken aggressive measures to reverse the deflationary pressures that have been a drag on the economy for the past few decades, and that essentially required that the yen weaken from its very strong levels of early last year. The 60% surge in the Japanese stock market since mid-November is a good sign that this shift in policy has been effective, and that the outlook for the Japanese economy is improving.


If there is anything notable about the chart above, it is the downward slope of the PPP value of the pound vis a vis the dollar that began about 4 years ago. This is the product of higher inflation in the U.K. than in the U.S., and this deteriorating fundamental is gradually undermining the value of the pound in favor of the dollar. Unless the Bank of England takes steps to tighten monetary policy, I would expect the pound to continue to weaken against the dollar for the foreseeable future. I note that since short-term interest rates are quite similar in the U.K. and the U.S., the pound is trading relatively flat in the forward markets, making a short pound/dollar position relatively inexpensive to establish.


The Aussie dollar remains one of the strongest currencies in the world. I calculate that American visitors to Down Under are shocked to discover that things cost about 50% more than they do here. The continued strength of the Aussie dollar, combined with the still-elevated level of most commodity prices, suggests that global demand for commodities—and by inference the health of the global economy—remains strong. 

Note that in all of these charts the dollar remains weak (i.e., undervalued relative to its PPP). What improvement there has been amounts to the dollar becoming somewhat less weak on the margin. That ties in with my view that what has been driving equity prices in the U.S. higher is not a rising tide of optimism, but a receding tide of pessimism. Conditions here are still miserable (e.g., high unemployment, slow growth, huge regulatory and tax burdens), but they are better than the market has been expecting. 

Lackluster manufacturing report

Today's ISM manufacturing report was lackluster. Nothing to cheer about, nothing to fret about. It suggests the economy is still plodding along at a 2% growth rate.


The ISM manufacturing index met expectations, but as the chart above shows, it is consistent with overall economic growth of only 2% or so.


Export orders softened, but remain reasonably healthy. The New Orders index rose marginally, but remains relatively soft.


Manufacturers' plans to increase hiring also softened, and now point to very slow growth going forward. There's a widespread lack of confidence and an unwillingness to invest revealed her.


Conditions in the Eurozone are still weak, but they don't appear to be deteriorating further.

We're stuck in a slow-growth world. Doomsters will undoubtedly use the airplane analogy to suggest that with economies moving along at just above stall speed, they are vulnerable to collapse. I don't think that analogy is valid: what causes economic collapse is not slow growth, but major mistakes in fiscal and monetary policy, whose consequences are poorly understood and for which markets are almost totally unprepared. Today there remains an abundance of skepticism about fiscal and monetary policy, and a widespread shortage of optimism.

If anything, markets have been blindsided by recovery. Four years ago, no one expected that conditions today would be as good as they are. Conditions are far from ideal, of course, but they are much better than expected.

Global equities continue to recover


Yesterday, according to Bloomberg, the market capitalization of the world's equity markets reached a new post-recession high of $56.2 trillion. That's up 120% from the March 8, 2009 low, for a gain of over $30 trillion. Those brave enough to own equities over the past four years have seen their wealth increase by more than $30 trillion. 30 TRILLION dollars.

Four years ago, markets were priced to something akin to Armageddon. The world financial system was on the verge of collapse, and almost 60% of global equity market cap had gone up in smoke in just over a year. Credit spreads were priced to wholesale bankruptcies. The global economy was widely expected to be in a depression/deflation for years. Global trade had collapsed: U.S. exports had fallen 25% in the previous 8 months. U.S. vehicle sales had dropped by over 40%. Housing prices had plunged by a third.

Today, instead witnessing the ruin of the-world-as-we-knew-it, we fret that the U.S. economy is experiencing its weakest recovery ever, and that the Eurozone economy is still in a mild recession. Governments everywhere are struggling to impose austerity measures, and the focus of central banks is shifting to how they will exit Quantitative Easing, not whether they should do more. We've come a long way in just four years.

Government is shrinking, and that's good

The U.S. economy grew at a somewhat disappointing 2.5% annualized rate in the first quarter. However, if we exclude the first quarter decline in government spending (mostly related to cuts in defense spending), the increase was a more respectable 4%. This is an under-appreciated story: the private sector is doing reasonably well (much better than the GDP number suggests), even though the public sector is shrinking. In fact, it's probably more accurate to say that the private sector is doing OK because the public sector is shrinking.


The advance estimate of GDP growth for the first quarter was less than the economy's long-term average growth rate of about 3%. As the chart above shows, the economy is thus slipping further and further below its trend. This continues to be by far the weakest recovery in modern history. 


As this next chart above shows, federal government spending has been flat for the past several years, and it has declined in the past several months, mainly due to declining defense spending. This has contributed to  reported GDP growth coming in below expectations, but is that really a bad thing?



The first of the two charts above shows how much federal spending relative to GDP has declined in the past 3-4 years.  The second chart shows the dramatic reduction in the federal deficit that has resulted from flat to lower spending and increasing tax revenues: the federal deficit has collapsed, from a high of 10.5% of GDP to only 5.75% today. These are arguably the biggest under-appreciated economic facts of recent years. Since federal spending is not growing, the federal government is shrinking relative to the economy at a fairly rapid pace. Since the economy is growing, especially the private sector, tax revenues are rising much faster than overall economic growth. Combined, these two developments have resulted in a major decline in the burden of the federal deficit.

Four years ago, no one forecast that this would happen, much less to this extent. What we see here is not only unprecedented but totally unexpected, and that is a big—and very positive—change on the margin.

There are more lessons here. The huge increase in spending that began in late 2008 and continued through 2009 utterly failed to stimulate economic growth. As I've pointed out before, that's because the stimulus spending was all about income redistribution:

Fully 63% of the "stimulus" spending was income redistribution in disguise (i.e., tax benefits and entitlements). And if you reclassify things such as education, housing assistance, and health as transfer payments, then over 75% of the $840 billion allocated to "stimulus" was essentially income redistribution. Only 8%—$65.5 billion—went for transportation and infrastructure (i.e., the "shovel-ready" projects that would put American back to work). Not a dime went to increase anyone's incentive to work harder or invest more.

Since spending all that extra money failed to stimulate growth, it should not be surprising that the reduction in government spending relative to the size of the economy in the past few years has failed to materially weaken growth. We've been on a growth path of roughly 2% per year for the past several years, despite the big swings in spending relative to GDP:


Why the slow growth? I think the recovery has been very sub-par for a variety of reasons. For one, government transfer payments and government spending in general do little if anything to grow the economy. The government is an inefficient allocator of economic resources, and big spending inevitably entails crony capitalism (e.g., Solyndra), corruption, and waste. Transfer payments create perverse incentives, rewarding those who don't work and penalizing those who do. In other words, one reason the economy has been expanding slowly is because we've been wasting scarce resources in a big way, starting with the big "stimulus" spending of 2009. Two, the expansion of the size and scope of government has also entailed huge new regulatory burdens (e.g., Frank-Dodd), and the looming introduction of Obamacare has created great uncertainty among many small businesses since it threatens to significantly increase their costs. For example, small businesses with fewer than 50 employees face huge marginal cost increases if they expand, since they would be forced to either pay a stiff penalty or provide costly insurance to their employees. With businesses unwilling to expand, millions of the unemployed have confronted the dearth of new jobs and decided to drop out of the labor force, hence the relatively high level of unemployment.

Unfortunately, even though the burden of government (i.e., spending relative to GDP) is declining—thus giving more breathing room to the more productive private sector—government-induced headwinds are scheduled to increase significantly next year if Obamacare is fully implemented, and that has already been holding the economy back. Also, it's likely that entitlement spending will increase in the next several years due to aging baby-boomers. So while the recent and ongoing decline in the burden of government spending augurs well for future economic growth, the gains are likely to be muted unless regulatory burdens are reduced and entitlement programs are reformed.

If there is a silver lining to this big-government cloud, it's the growing realization that Obamacare is not going to work as advertised. Max Baucus' decision to not run for re-election in Montana next year is likely due at least in part to his fear that Obamacare will be a train wreck. Since I don't see how Obamacare can work well, much less be implemented on time, I think there is a reasonable chance that before the end of this year Congress could decide to postpone its implementation for at least a year. That could be a very positive development.

Housing prices continue to firm


As the above chart shows, housing prices according to both the Case Shiller index and the Radar Logic index are up about 10% in the past year. The Case Shiller index is now at a post-recession high. Prices have been relatively flat for the past four years, and on the margin they are showing rather impressive strength.


The chart above shows the Case Shiller home price index adjusted for inflation. Real home prices according to this index have yet to post net gains since the recession, but they are down fully 37% from their 2006 highs. If the prices of houses was a bubble, it has certainly burst. Four years of consolidation is enough to warrant the supposition that housing prices are more likely to rise than decline in the years to come.


As the chart above shows, housing prices and rents are coming back into line, after prices shot up to unreasonably high levels. Owner's Equivalent Rent is an important component of the CPI, and is used instead of housing prices; that served to insulate the CPI from the housing price runup in the early 2000s, and from the housing price collapse that followed.

Lots of evidence here to support the notion that housing prices have fallen enough to equilibrate demand and supply. When coupled with the fact that new home construction has almost doubled in the past two years, the housing market recovery appears to be well underway.

What energy efficiency tells us about healthcare

In a recent post, Mark Perry noted that last year "America had the most energy-efficient economy in US history." He has a nice chart showing how much less energy (total energy) it takes today to produce a unit of GDP. This is such a big, untold story that I thought I would piggyback on his post and highlight how much less crude oil and petroleum products it takes to produce a unit of GDP, and what this tells us about a potential solution to the problem of healthcare. 


This first chart shows that U.S. economy consumed the same amount of oil last year as it did in the late 1970s. This, despite the fact that the economy today is 133% larger than it was back then. The U.S. economy has more than doubled in size over the past 33 years, but it consumes the same amount of oil.

 
This next chart shows the ratio of oil consumption to GDP. From the peak in the early 1970s, U.S. oil consumption per unit of output has fallen by an astounding 61%. 


The other nice thing to note on the energy front is that U.S. crude oil production has jumped 47% in the past four years. In the past year alone, crude production is up by almost 20%, thanks mainly to new fracking technology. Crude production is surging, but our consumption of crude is not, thanks to ongoing gains in energy efficiency. 


All of this is symptomatic of a very dynamic economy. As the above chart shows, the real price of crude oil is very expensive from a long-term historical perspective. Rather than suffocating the economy, very expensive energy has sparked incredible conservation efforts, technological innovation (e.g., fracking) and efficiency gains, with the result that energy today consumes just under 6% of the average person's consumption, a little less than the average of the past 50 years.


The point here is that over time our economy responds very impressively to changing prices and fundamentals. There are lots of headwinds working to slow economic growth in recent years (e.g., government spending as a % of GDP is relatively high, regulatory burdens are exceedingly high, many millions have dropped out of the labor force, corporations are reluctant to reinvest their profits, and Obamacare threatens to disrupt almost one-sixth of the economy), but that's not a reason to give up hope.


This last chart highlights the huge contrast between spending on healthcare and energy. The energy market is largely deregulated, and responds dynamically, as shown in the previous charts, to rising prices. The healthcare market, in contrast, is highly regulated and distorted by the tax code (which only allows employers to deduct healthcare costs, thus resulting in a system where almost no one pays for their healthcare expenses out of pocket—otherwise known as the third-party payer problem), and it has not responded at all to rising costs. Because of oppressive government regulations and regulatory structures, the healthcare industry has not been able to innovate or implement the kind of efficiencies that the energy market has. Market forces are suppressed, and innovation therefore has been largely suffocated.

If we want real improvement in healthcare, we need to restore market forces to the healthcare market. A few examples: Change the tax code so that everyone can deduct healthcare expenses. Encourage employers to turn the choice of healthcare coverage over to the employee—if everyone bought their own policy, the portability "problem" would cease to exist. Allow insurance companies to compete by selling policies across state lines. Eliminate government-mandated benefits which inflate policy costs and discourage innovation and consumer choice.