Today, the Labor Department reported the economy lost 17,000 payroll jobs in January. These poor jobs data are the strongest evidence so far that the economic expansion is grinding to a halt.
The economy is in recession mode. This is fresh evidence that the Federal Reserve has been behind the curve. The stimulus package may ease the pain but it comes too late to head off the debacle. Much stronger action, especially with regard to deteriorating credit markets, is needed.
The Labor Department reported a slight decrease in the unemployment rate to 4.9 percent. Factoring in the decline the number of adults participating in the labor force, the unemployment rate is closer to 6.7 percent.
Weak holiday retail sales and slow automobile sales indicate high gasoline prices and the subprime crisis have slowed down consumers. The impact on the economy is exacerbated by the woes of the Detroit Three automakers. Car sales are down and continuing to shift toward smaller vehicles, which favors imports.
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 are pushing up energy and raw material prices, and the Fed could only marginally affect these pressures by constraining U.S. growth.
The Federal Reserve’s aggressive interest rates cuts will have a limited effect, and the stimulus package is likely to arrive too late to head off a recession. The real value of the stimulus package will be to lessen the impact of whatever slowdown or recession the economy endures.
The Federal Reserve is in crisis, because its mix of policies addresses an old style recession, one premised on inadequate 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 housing sector is already in recession, in large measure, because the market for mortgage-backed securities has broken down. At this time, banks can only write conforming loans that can be sold to Fannie Mae or held on their balance sheets. The bond market will not accept mortgage-backed securities underwritten by the major Wall Street banks, and this significantly curtails the market for subprime securities.
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 bond rating agencies to return to investor financed ratings. Unfortunately, Henry Paulson and Ben Bernanke have been shy to do this. That is why the stock market has not been much moved by recent interest rate cuts.
Weak Wage Growth and Unemployment
Construction, manufacturing and retail trade displayed weakness, reflecting significantly slower GDP growth.
Wages increased a moderate four cents per hour, or 0.2 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. What problems the Fed faces in the core will be pass through from higher energy and food prices, which its policies can little affect.
The unemployment rate was 4.9 percent in January. 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 6.7 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 likely.
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 27,000 in January. This is a terrible indicator for future GDP growth.
In December, manufacturing lost 28,000 jobs, and over the last 90 months manufacturing has shed more than 3.4 million jobs. Were the trade deficit cut in half, manufacturing would recoup at least 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.