Labor Pains

This being Labor Day, it seems the right day to review the status of the US labor market.

Last Friday's employment report was expected to be yet another in a long line of lousy reports. Analysts' consensus expectation was that there would be a paltry increase of 44,000 jobs during the month. Financial markets cheered when the release hit the news wires early in the morning that there were actually 67,000 jobs added in August. From our perspective, this employment report was mixed, at best. Consider that the entire gain in jobs came from part-time positions. Moreover, the broad "U6" unemployment rate rose to a four-month high of 16.7% (16.5% in July).

Our point is not that the employment report was abysmal, it was not. But in the context of the other recent economic data, there is nothing here that offers any "new" hope. In fact, when one considers that the April gain in payrolls was +247,000, the July (+107,000) and August numbers (+67,000) suggest a disturbing trend.

Nothing we have seen in the economic data of the last couple of years suggests any change to our view that We Are Japan. We are trapped in a deleveraging process while policymakers are in denial, scrambling to incent us to leverage up.

Let's oversimplify this for the sake of understanding. For purposes of illustration, let's say the 'natural' rate of US GDP growth (i.e. the rate that would be present absent any unusual distortions) is 4% per year. Roughly thirty years ago, we discovered the magic of leverage and began using it extensively for more and more 'stuff' - i.e. houses, cars, summer homes, furnishings, vacations, etc. In doing so, we were able to create another 2% per year of GDP "growth" through the use of debt that became progressively easier to acquire (lower and lower standards) and service (lower rates and easier terms). Thus, GDP growth ramped up to 6% per year.

But at some point, the ponzi finance collapses on itself. The last available borrower has reached his/her limit. Now, it would be really nice if we could all then just be comfortable with all that 'stuff' we bought and the rate of GDP growth can merely slip back to its more normal 4% per year from that debt-accelerated 6%.

If only it were that painless. We set ourselves up for production that feeds a 6% growth monster. If that growth is not there, capacity has to be shed. Jobs will be lost. Mortgages and car payments stop being made. Home values based on an ever-increasing supply of easy money don't just stop going up, they begin to fall precipitously. As they do, more and more mortgage payments stop getting made and the negative feedback loop accelerates. Until that excess leverage has been repudiated, the "new" normal rate of GDP growth is 1% or 2% per year, not 4%.

Unlike a normal recession, a deleveraging process takes years. Many years. You don't get rid of that excess debt in a few months. Japan is 20+ years into their process, and counting.

What can we do about it?

By now you know our advice with regard to your personal finances: basically minimize non-essential expenses and pay off your debt. But we also need our policymakers to stop with the quick fixes aimed at restarting spending. The deleveraging process will not be denied and the "solutions" implemented so far have done nothing more than bring forward spending that would have happened anyway, delaying the process.

What we can do about that is elect strong leaders who will make the tough (read: "unpopular") choices that will lay the foundation for the resumption of growth. The way to do that is to vote mindfully. Vote for candidates or incumbents who understand the difference between a recession and a deleveraging process (the latter also known as a "depression").

We would suggest the following for policymakers and those who are candidates:

Regulatory Reform - the current round of so-called "financial reform" is a joke because it a) did not even mention the two biggest financial black holes - Fannie and Freddie; and b) it allowed naked credit default swaps to continue.

Entitlement Reform - the Social Security system is bankrupt, whether anyone wants to admit it or not. It is time to increase the retirement age to 70 and look for additional measures that will restore confidence in this 'safety net'.

Fiscal Reform - Since no one can make the tough choices, implement an across-the-board spending cut followed by several years of a freeze. Oh, and did we mention stop flushing money down the toilet trying to incent folks to spend? No more cash for clunkers, appliances, NOTHING. All it does is suck forward a few months of spending and then we are right back where we were.

Tax Reform - Tax policy should encourage long-term, productive investment. Incentives should be provided to develop targeted industries such as alternative energy and biomedical technology. Additionally, a meaningful portion of the Bush tax cuts should be allowed to live on and unless you want to handicap a good portion of our country's growth engine (small businesses), the income limit for those tax cuts is a lot higher than $250,000.

This November, ignore the hyperbole of the campaign machines and vote intelligently. This is not a "left-wing/right-wing", Democrat/Republican", nor "liberal/conservative" issue.

Elect strong leaders who will put this country back on the path to economic recovery.