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Economy on the Skids

by PETER MORICI

Today, the Labor Department reported the economy added only 18,000 payroll jobs in December, after posting an 115,000 gain in November. Economists expected a 70,000 gain in December, and these jobs data are the strongest evidence so far that the economic expansion is grinding to a halt.

These jobs gains indicate economy did not enter a recession in the fourth quarter of 2007. The economy added 101, 000 jobs per month, as compared to 93,000 and 139,000 in the third and second quarters, respectively.

Nevertheless, the subprime mortgage crisis is biting and the economy is headed south. Jobs growth is much less than the 115,000 necessary to keep even with labor force growth at one percent a year. Slow jobs growth, along with the shortages of mortgage and business credit, declining home prices and residential construction, and falling industrial production, indicate the risk of a recession for 2008 is high.

Weak holiday retail sales and slow automobile sales indicate high gasoline prices and the subprime crisis are finally slowing down consumers. The impact on the economy is exacerbated by the woes of the Detroit Three automakers.

Rising prices for energy, metals and other materials are pushing up inflation, but the Federal Reserve can do little to curb rising prices. Robust growth in China and elsewhere in Asia is pushing up energy and raw material prices, and the Fed could only marginally affect these pressures by constraining U.S. growth.

Federal Reserve will aggressively cut interest rates to combat the U.S. slowdown; however, these efforts may prove insufficient to head off a difficult recession. Credit markets are suffering a crisis of confidence, and the business community and investors have lost confidence in the Federal Reserve and Treasury Department’s ability to deal with the crisis

The Federal Reserve is in crisis, because its mix of policies addresses an old style recession, one premised on inadequate consumer demand but solid financial institutions. This recession has its origins in questionable banking practices and a breakdown of investor trust in the integrity of Wall Street’s most venerable banks and investment houses.

The stuff of blackboard economics, taught by Ben Bernanke back at Princeton and this professor at Maryland and Maine, just won’t get the job done.

The housing sector is already in recession, in large measure, because the market for mortgages-back bonds has broken down.

The subprime meltdown reveals fundamental structural flaws in the U.S. banking system. The write downs at Citigroup, UBS and others indicate that bankers have been overvaluing mortgage-backed securities. Mutual funds, U.S.-state run money market funds for municipalities, pension funds, insurance companies, and individual investors that trusted Citigroup and other banks now hold worthless paper. Consequently, the market for mortgage-backed securities has evaporated.

Trust is the scarcest resource on Wall Street.

The whole chain that creates financing for mortgages has been corrupted from loan officers to banks that bundle loans into securities, to bond rating agencies like Standard and Poor’s who demand payments from banks instead of charging investors to evaluate mortgage-backed securities.

The Federal Reserve and Treasury need to prod the private banks to reform lending practices, and to encourage to bond rating agencies to return to investor financed ratings.

Weak Wage Growth and Unemployment

Construction, manufacturing and retail trade displayed weakness, indicating growth slowed significantly in the fourth quarter.

Wages increased a moderate 7 cent per hour, or 0.4 percent. Moderate wage and strong labor productivity growth should help keep core inflation in check, and this should help abate Federal Reserve concerns about core inflation as it navigates the fallout from the subprime crisis.

Overall, the pace of employment growth indicates the economy is expanding much more slowly than the 4.9 percent annual GDP growth posted in the third quarter. Fourth quarter growth should post at less than 1.0 percent.
The unemployment rate rose to 5.0 percent in December. However, these numbers belie more fundamental weakness in the job market. Discouraged by a sluggish job market, many more adults are sitting on the sidelines, neither working nor looking for work, than when George Bush took the helm. Factoring in discouraged workers raises the unemployment rate to about to 6.8 percent. As the economy slows further this figure will likely exceed 8 or even 9 percent.

The bottom line is that labor markets remain slack enough to keep wage increases down. Productivity growth should accommodate those increases and rising energy prices, the Federal Reserve can focus on managing the credit crisis and staving off a recession, if that is possible.

Further interest rate cuts are a virtual certainty.

Manufacturing, Construction and the Quality of Jobs

Going forward, the economy will add some jobs for college graduates with technical specialties in finance, health care, education, and engineering. However, for high school graduates without specialized technical skills or training, jobs offering good pay and benefits remain tough to find. For those workers, who compose about half the working population, the quality of jobs continues to spiral downward.

Historically, manufacturing and construction offered workers with only a high school education the best pay, benefits and opportunities for skill attainment and advancement. Troubles in these industries push ordinary workers into retailing, hospitality and other industries where pay often lags.

Construction employment fell by 49,000 in December after falling 37,000 in November. Housing continues to tank, but the big job losses were nonresidential construction. This is a terrible indicator for future GDP growth.

Durable goods manufacturing lost 20,000 jobs, owing to the auto industry’s woes and broader competition from Asian imports, benefiting from undervalued currencies and other subsidies, limits employment.

In December, manufacturing has lost 31,000 jobs, and over the last 89 months manufacturing has shed more than 3.4 million jobs. Were the trade deficit cut in half, manufacturing would recoup about 2 million of those jobs, U.S. growth would exceed 3.5 percent a year, household savings performance would improve, and borrowing from foreigners would decline.

The dollar remains too strong against Chinese yuan, Japanese yen and other Asian currencies. The Chinese government artificially suppresses the value of the yuan to gain competitive advantage, and the yuan sets the pattern for other Asian currencies. These currencies are critical to reducing the non-oil U.S. trade deficit, and instigating a recovery in U.S. employment in manufacturing and technology-intensive services that compete in trade.

PETER MORICI is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.

 

 

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PETER MORICI is a professor at the Smith School of Business, University of Maryland School, and the former Chief Economist at the U.S. International Trade Commission.

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