Yesterday, the Labor Department reported the economy lost 49,000 payroll jobs in May, after losing 28,000 jobs in April. My published forecast was for a 50,000 loss.
Governments added 17,000 jobs and private sector employment fell 66,000. Businesses have become too pessimistic about the outlook for the economy, and the capacity of the Bush Administration and Federal Reserve to manage it. While exports remain strong, domestic demand is weak and shows few signs of recovering.
The Labor Department reported a sharp increase in the unemployment rate to 5.5 percent in May from 5 percent the previous month. The situation is even worse than this jump indicates. A large number of adults have left the labor force in recent years. Factoring in the decline in the number of adults participating in the labor force, the unemployment rate is closer to 7.0 percent.
Five straight months of job losses are the strongest evidence yet that the economic expansion has slipped into a recession of uncertain depth and duration.
Weakening consumer spending and slow automobile sales indicate high gasoline prices and the subprime crisis have slowed down consumers. Along with weakness in housing and nonresidential construction, slowing consumer spending and automobile sales are causing businesses to trim investments in new capacity and hiring plans.
Exports are lifting sales and employment in commodities and basic industrial materials, but overall a weaker dollar against the euro and other currencies and the resulting increase in exports are not enough to save the economy from recession.
Treasury and Federal Reserve Policies Aggravating Inflation, Recession Risks
Rising prices for food, energy, metals, and other materials are pushing up inflation, and U.S. energy, Treasury exchange rate and Federal Reserve policies are exacerbating problems and contributing to the likelihood of a recession followed by a period of slow growth.
The ethanol program is pushing up food prices, and robust growth in China and elsewhere in Asia are pushing up energy and raw material prices. The Fed could only marginally affect those pressures by constraining U.S. growth through higher interest rates.
China is controlling domestic prices for gasoline and other refined products, subsidizing oil imports with the dollars it obtains through its purchases of U.S. dollars to sustain an undervalued yuan, and increasing demand for oil more rapidly than it is contracting in the United States. The combined dynamic of U.S.-Chinese integration and Chinese intervention in currency and oil markets is to drive up exports and growth in China, drive up gasoline and other energy prices in the United States, and slow growth and increase unemployment in the United States.
Treasury’s inaction regarding China’s policy of buying dollars for yuan to sustain an undervalued currency permits China to continue to subsidize manufactured exports and oil imports, and expand its purchases of oil more rapidly than the United States reduces imports. This is pushing up the international price of oil, gasoline and diesel prices, cushioning the Chinese economy from the U.S. economic slowdown, and exacerbating the economic slowdown in the United States.
The Federal Reserve’s aggressive interest rates cuts have had a limited effect on GDP and employment growth, and the stimulus package is not large enough to compensate for rising gasoline prices and the meltdown in the credit and housing markets.
The stimulus package at $152 billion is hardly enough to offset higher gasoline prices, and less than half as large as the losses taken by the major New York banks and their customers on subprime securities. The stimulus package is lessening the pain imposed by soaring gas prices and flagging domestic demand for U.S.-made goods and serves, but it is insufficient to head off a recession.
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.
Federal Reserve regulators, apparently lacking appreciation for the gravity of these problems, have focused mostly on urging banks to raise new capital without effective parallel efforts to reform bank business models and practices. Often, new capital has been provided by sovereign wealth funds or private equity firms, which lack sophistication in the intricacies of commercial and mortgage banking and demand few changes in bank management policies. The result is sophisticated buyers of fixed income securities, such as insurance companies, remain unwilling to accept loan-backed securities from the banks. The market for mortgage backed securities issued by commercial banks has evaporated.
The housing sector has been in a recession for months, in significant 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 less than prime securities.
The whole chain that creates financing for mortgages and other consumer loans 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..
The economy is sailing through dangerous, unchartered waters, and Henry Paulson and Ben Bernanke, the helmsmen, seem confused and unsteady, adding to pessimism about the outlook for U.S. GDP growth and jobs.
The Fed’s inadequate response to the credit crisis is undermining the exchange for the dollar against the euro. Cheap dollars permit Europeans to bid up the price of oil, further pushing up U.S. gasoline prices and exacerbating the U.S. economic slowdown.
The bottom line, Treasury and Federal Reserve policies toward China and the banks are manufacturing higher oil prices, inflation and recession.
It is no small wonder the economy is hemorrhaging jobs.
Weak Wage Growth and Unemployment
Construction, manufacturing, finance, and retail trade displayed weakness, reflecting significantly slower GDP growth.
Wages increased a moderate five cents per hour, or 0.3 percent. Moderate wage and strong labor productivity growth should help keep core inflation in check, and this should help abate Federal Reserve concerns about nonfood and nonenergy price inflation, so-called 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 food and energy prices.
The unemployment rate was 5.5 percent in May. 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 7.0 percent. As the economy slows further this figure will likely exceed 8 or even 9 percent.
Overall, the pace of employment growth indicates the economy is contacting. Second quarter growth in GDP should be in the range of negative 0.4 percent. Ford and GM have announced further production cutbacks and builders have an 11 month supply of unsold new homes. Auto production and housing starts should not improve much until the fourth quarter, at least, and those conditions will feed into the rest of the economy. The jobs outlook should not markedly improve until at least the second half of this year.
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 and college graduates with only liberal arts diplomas, 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 34,000 in May. This is a terrible indicator for future GDP growth.
Manufacturing has lost 26,000 jobs, and over the last 97 months manufacturing has shed more than 3.7 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 the 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.