Who's On Unemployment?

A couple of months ago, Barry Levinson channeled his inner Abbott and Costello to explain the Bureau of Labor Statistics' (BLS) estimates of our labor force and the number of jobs. Levinson is an interesting guy - an Academy Award winner responsible for some great films like Diner and Rain Man. Yet, if this routine is any indication, a non-economist with a remarkable grasp of economic statistics.

To set this up, this past Friday's BLS report gave the world's stock markets a boost when it reported that non-farm payrolls spiked 243,000 higher, almost twice the consensus expectation. Unfortunately, few investment analysts (and even fewer economic/financial journalists) get much past the headline numbers. If they did, the fact that the "labor participation rate" (percentage of our population that is employed) fell to 63.7% from 64.0% would call into question that estimated 243,000 increase in jobs. But Abbott and Costello explain it so much better:

COSTELLO
I want to talk about the unemployment rate in America.

ABBOTT
Good Subject. Terrible Times. It's 9%.

COSTELLO
That many people are out of work?

ABBOTT
No, that's 16%.

COSTELLO
You just said 9%.

ABBOTT
9% Unemployed.

COSTELLO
Right 9% out of work.

ABBOTT
No, that's 16%.

COSTELLO
Okay, so it's 16% unemployed.

ABBOTT
No, that's 9%...

COSTELLO
WAIT A MINUTE. Is it 9% or 16%?

ABBOTT
9% are unemployed. 16% are out of work.

COSTELLO
IF you are out of work you are unemployed?

ABBOTT
No, you can't count the "Out of Work" as the unemployed. You have to look for work to be unemployed.

COSTELLO
BUT THEY ARE OUT OF WORK!!!

ABBOTT
No, you miss my point.

COSTELLO
What point?

ABBOTT
Someone who doesn't look for work, can't be counted with those who look for work. It wouldn't be fair.

COSTELLO
To who?

ABBOTT
The unemployed.

COSTELLO
But they are ALL out of work.

ABBOTT
No, the unemployed are actively looking for work... Those who are out of work stopped looking. They gave up. And, if you give up, you are no longer in the ranks of the unemployed.

COSTELLO
So if you're off the unemployment roles, that would count as less unemployment?

ABBOTT
Unemployment would go down. Absolutely!

COSTELLO
The unemployment just goes down because you don't look for work?

ABBOTT
Absolutely it goes down. That's how you get to 9%. Otherwise it would be 16%. You don't want to read about 16% unemployment do ya?

COSTELLO
That would be frightening.

ABBOTT
Absolutely.

COSTELLO
Wait, I got a question for you. That means they're two ways to bring down the unemployment number?

ABBOTT
Two ways is correct.

COSTELLO
Unemployment can go down if someone gets a job?

ABBOTT
Correct.

COSTELLO
And unemployment can also go down if you stop looking for a job?

ABBOTT
Bingo.

COSTELLO
So there are two ways to bring unemployment down, and the easier of the two is to just stop looking for work.

ABBOTT
Now you're thinking like an economist.

COSTELLO
I don't even know what the hell I just said!

The Economics of Abbott and Costello
Barry Levinson
Huffington Post
November 28, 2011

For anyone not familiar with Abbott & Costello's "Who's On First" routine:
Who's On First

Nihon e Youkoso

Last Wednesday, the Federal Reserve concluded its latest monetary policy meeting with the announcement that the Federal Open Market Committee (FOMC) "currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014."

We believe they could have saved a lot of words by simply quoting the title of this post which, we are told, is Japanese for "Welcome to Japan."

Nonetheless, precious metals and common stock investors around the world rejoiced over the FOMC's announcement. We believe they are mistaken. This is no cause for celebration. We are now mired in a classic liquidity trap. Japan has been stuck in such a trap for a couple of decades. What the Fed is telling us is that, like Japan, they are out of ammunition and hope that everyone will hurry up and start spending money so the economic weakness will not extend beyond 2014.

Good luck with that.

The problem is that consumers have little incentive to borrow and spend. In fact, if anything, the suggestion that rates will remain "exceptionally" low for an extended period of time means there is absolutely no rush. They've got a year or three before rates will begin to rise and they need to lock something in. Moreover, those who are living off of CD, money market and/or bond interest are seeing their income streams crushed. Not only would they have no interest in borrowing to spend, they are cutting spending to match their shrunken income.

No, the global economy remains in the early stages of a deleveraging process. The McKinsey Global Institute recently released a detailed report on debt and deleveraging. Please peruse the Executive Summary, or Full Report (in pdf, Kindle or e-book versions) and draw your own conclusions. One of ours is that the deleveraging around the globe remains in its very early stages. Here in the US, consumers are likely in only the third or fourth inning of this ballgame.

Another problem with the revelation that the economy will remain exceptionally weak for an extended period of time is that it suggests the global economy could be at greater risk of another recession, one that might even be as large or larger than '08-'09. In fact, that is the conclusion drawn by the World Bank in its 2012 Economic Outlook released a week or two ago. To quote:

"Importantly, because this second crisis will come on the heels of the earlier crisis, for any given level of slowdown its impact at the firm and household level is likely to be heavier. In the event of a major crisis, activity is unlikely to bounce back as quickly as it did in 2008/09, in part because high-income countries will not have the fiscal resources to launch as strong a countercyclical policy response as in 2008/09 or to offer the same level of support to troubled financial institutions.”

Reaching a similar conclusion are the extremely bright folks at Hoisington Investment Management, who wrote in their recently-published Fourth Quarter Review and Outlook:

In highly indebted countries, governments have expansively taken resources from the private sector through taxing and borrowing. This leaves the private sector with less vigor to produce jobs and increase productivity, and subsequently wealth for its fellow citizens. This theory, which dates back to David Hume's essay Of Public Credit published in 1752, is now being played out in real time in the United States. We judge that when an economy is expanding in such meager fashion it is exposed to an increasing frequency of recessions. We expect such a recessionary event to emerge in 2012.

We continue to suggest that investors maintain cautious - or even hedged - equity exposure. Bonds are preferred to stocks at this time.

Press Release
Board of Governors of the Federal Reserve System
January 25, 2012

New York Fed Research
"Liquidity Trap"

McKinsey Global Institute
Debt and deleveraging: Uneven progress on the path to growth
Charles Roxburgh, Susan Lund, Toos Daruvala, James Manyika, Richard Dobbs, Ramon Forn, and Karen Croxson
January, 2012

World Bank
2012 Economic Outlook

Hoisington Investment Management
Quarterly Review and Outlook
Fourth Quarter 2011

"Tough Choices"? Puhleeze

In the end the shutdown drama was but a farce.

After overseeing an unconscionable 27% increase in spending over the past three years, our elected politicians (both parties, both houses and the White House) are positively triumphant about their impressive ability to forge an agreement that prevents a shutdown of "nonessential" government services.

Yawn.

It can be no wonder that the standing ovation for which it appeared the politicians were so fervently expectant was not forthcoming. The budget cuts to which they eventually agreed totaled $38 billion.

That sounds like a meaningful amount of money.

Until you consider the entire budget totals $3.8 TRILLION.

Said another way, our leaders nearly trampled each other racing to add $800 billion to the budget but then turned a mere $38 billion reduction into a celebrity death match.

Maybe Cafe Hayek said it best (hat tip to follower Panna):

Suppose that in a mere three years your family’s spending – spending, mind you, not income – jumps from $80,000 to $101,600. You’re now understandably worried about the debt you’re piling up as a result of this 27 percent hike in spending.

So mom and dad, with much drama and angst and finger-pointing about each other’s irresponsibility and insensitivity, stage marathon sessions of dinner-table talks to solve the problem. They finally agree to reduce the family’s annual spending from $101,600 to $100,584.

For this 1 percent cut in their spending, mom and dad congratulate each other. And to emphasize that this spending cut shows that they are responsible stewards of the family’s assets, they approvingly quote Sen. Harry Reid, who was party to similar negotiations that concluded last night on Capitol Hill – negotiations in which Congress agreed to cut 1 percent from a budget that rose 27 percent in just the past three years. Said Sen. Reid: “Both sides have had to make tough choices. But tough choices is what this job’s all about.”

What a joke.

For another (but no less critical) view of the "comic book budget squabble", see Clive Crook's column in today's Financial Times.

What A Joke
Don Boudreaux
Cafe Hayek
April 9, 2011

A Debt Disaster Behind a Comic Book Squabble
Clive Crook
The Financial Times
Monday, April 11, 2011

The Fed and The Long Run

I used to hurry a lot, I used to worry a lot
I used to stay out till the break of day
Oh, that didn't get it,
It was high time I quit it
I just couldn't carry on that way - The Long Run by The Eagles (1979)

Kansas City Federal Reserve President Thomas Hoenig gave a speech last week at the London School of Economics. What we heard as we read the speech was that Hoenig believes the Fed is focused too much on the short term effects of its policies and insufficiently on the longer-run unintended consequences. One quote stands out:

"A Swiss central banker once advised me that the duty of a central banker is to take care of the long run so the short run can take care of itself."

Thomas Hoenig is a voting member of the Federal Reserve's Open Market Committee. As such, he has been something of a lone voice in the wilderness lately by speaking - and voting - against the Fed's unusually accomodative interest rate stance as well as the second round of 'quantitative easing.' He has repeatedly shared his reasoning which we summarize as follows: Emergency measures taken during the credit crisis were necessary but continuing the emergency measures after the credit crisis passed invites adverse unintended consequences in the long run.

In fact, Hoenig takes a few moments during his speech to point out that it was the long-run unintended consequences of the Fed's overly-accomodative interest rate policy beginning in 2003 that fueled the massive credit expansion and housing boom. From his speech (which is well-worth reading):

"The crisis has sometimes been described as a “perfect storm” of unfortunate events that somehow came together and systematically undermined the financial system. Such events included, for example, weak supervision and a misguided national housing policy. While these factors certainly contributed to the severity of the crisis, monetary policy cannot escape its role as a primary contributing factor."

Moreover, in giving another example of long-run unintended consequences, Hoenig lays the recent rapid increase in commodity prices (and we would add to that the resulting unrest in the Middle East/North Africa) at the feet of the Fed's current overly accomodative policies.

The good news is the "long run" is not here yet. The Fed still has time to remove what Hoenig calls "highly accomodative" policies and replace them with merely "accomodative" policies.

As the Eagles sang
Well, we're scared, but we ain't shakin'
Kinda bent, but we ain't breakin'
in the long run

Also see: Hoenig Blames Fed for Rising Prices
Vivien Lou Chen
Bloomberg
March 30, 2011

Japan's Nuclear Emergency

As the weekend passed and the news of Japan's nuclear emergency continued to worsen, it was difficult not to become completely despondent. In an effort to help assuage those kind of feelings, we wanted to share a very good but very short piece on the topic published Monday by Roubini Global Economics (a source we hold in high regard).

A couple of ironies pointed out by the author, RGE analyst Mikka Pineda:
1) This year marks the 25th anniversary of the Chernobyl nuclear disaster.
2) Fukushima's 40-year-old reactors were due for decommissioning at the end of this month.

We took some consolation in RGE's opinion that Fukushima will likely be a level 5 event on the International Nuclear and Radiological Event Scale (INES). The scale runs from 0 to 7 with Three Mile Island at five and Chernobyl history's only seven.

In understanding the levels of radiation being talked about, we found the EPA's publication Radiation Risks and Realities to be helpful.

What's Up With Inflation?

Well, it's not up.

We have had several conversations with clients recently about inflation - or, more specifically, the lack thereof.

Those conversations often have a conspiratorial undertone suggestive of an effort on the part of government officials to hide the true rate of inflation. The implication appears to be that 'they' don't want 'us' to know how bad inflation is getting.

First, let's recount the latest statistics. Two weeks ago we received the latest inflation data. The headline numbers seemed a bit worrisome because they were stronger than recent averages, suggesting that inflationary pressures are on the rise. For most of 2010, reported monthly inflation rates have been around 0.2%. December and January were, however, both 0.4%.

Upon further inspection it is clear that spikes in energy (+2.1%) and food at home (+0.7%) were the outliers that caused the bump in the headline CPI rate. Confirming this is the "core" CPI rate which was up a mere 0.17% in January after a 0.1% reading in December.

We know - "how can you ignore food and energy?!" We are not ignoring them. But, by the same token, we can not ignore rent, hotels, autos, home prices and medical care services, all of which are either in disinflation (falling rates of inflation) our outright deflation (falling prices). Moreover, there is a reason analysts look at both the headline and "core" rates of inflation. Food and energy are notoriously volatile. Spikes in food and/or energy prices have signaled something like 360 of the past two bouts of inflation. (we kid)

Let's talk pricing power. In the latest business outlook survey by the Philadelphia Fed, 60% of respondents said they have held or will hold their price increases to 2% or lower. No sign of pricing power (inflation) there.

Let's talk personal income. Organized labor is famously losing its clout. While layoffs have moderated and payrolls are growing (modestly) again, wage growth has again come to a standstill. February's report (released today) showed no change from January in either hourly wages or the number of hours worked. In fact, unit labor costs have declined for the past six quarters. Without wages rebounding, it is highly unlikely that energy or food price increases will last more than a few months or maybe quarters.

Let's be clear - we respect the risk of inflation and have indeed placed hedges in client portfolios in the event of a sudden return of inflation. However, such positions are currently sized only to be "starter" positions to which we will add as we believe the outlook favors doing so.

The Fed is, in fact, actively seeking inflation. But despite pushing the funds rate from 4.5% to 0%, expanding its balance sheet by more than $1.5 TRILLION, boosting US money supply (M2) by $1.2 trillion, US government debt exploding $4.8 trillion higher, and billions of dollars of direct investment into the nation's largest banks, AIG, GM and Chrysler. . . this is where we find ourselves.

Barely eking out positive inflation numbers.

Good News! China No Longer Largest Holder of Treasury Debt

Bad news: the US Federal Reserve is.

Despite not even reaching the halfway mark of its latest round of bond-buying, the Financial Times is reporting that the Federal Reserve has surpassed China as the world's largest holder of US Treasury securities. (link below)

Based on weekly data released on Thursday, the New York Fed's holdings of Treasuries in its System Open Market Account, known as SOMA, total $1.108bn, made up of bills, notes, bonds and Treasury Inflation Protected securities, or TIPS.

According to the most recent US Treasury data on foreign holders of US government paper, China holds $896 bn while Japan owns $877bn.

The article quotes TD Securities strategist Richard Gilhooly:

By June [the Fed] will have accumulated some $1,600bn Treasury securities, likely to be in the vicinity of China and Japan's combined holdings."

We wish we could feel some sense of pride about this #1 ranking. Unfortunately, what would make us proud continues to get kicked down the road: namely a return to policies that focus incentives on competition instead of consumption. In fact (since we mentioned it), we wholeheartedly embrace and support the President's State of the Union reference to "out-innovate, out-educate and out-build" other nations.

Yet we hasten to point out that we can not do this so long as government policies are obsessed with incenting citizens to out-consume the rest of the world.

Fed Passes China in Treasury Holdings
Michael Mackenzie
Financial Times
February 2, 2011

PS - Don't you find it silly that UK journalism still refuses to acknowledge the existence of the number "trillion"? They continue to insist on referring to a trillion as $1,000bn. Sheesh.