Friday, December 7, 2012

Jobs growth steady but slow

November's jobs report shed no new light on the labor market situation. November's 147K new private sector jobs was in line with what we've been seeing on average for the year to date and for the past three years. It's slightly more than the 130K new jobs per month that need to be created just to keep up with the long-term average growth of the labor force, which is about 1% a year, so if things continue at the same pace the unemployment rate can decline very slowly from here. It's only declined faster because the labor force has grown very little for the past four years, which in turn is a function of many people deciding to "drop out." The current 1.5% per year pace of jobs growth is unlikely to translate into anything more than 3.5% real economic growth, assuming productivity growth continues to run at the 1-2% per year pace we've seen in recent years. That's OK, but it still adds up to the weakest recovery ever.

Note the relatively steady growth of private sector jobs as measured by the Establishment Survey (blue line). Both surveys show that the economy has created about 5 million jobs over the past two years. Also note that there is absolutely no sign here of anything like a recession. Jobs growth may be disappointing, but it is still definitely positive.

After declining from 2008 through early 2011, the labor force has resumed a 1% annual pace of growth over the past year. But it is still more than 5 million below where it could have been if long-term trends were still in place.

The November report provided more confirmation that the public sector workforce is no longer shrinking. Despite declining jobs in the past few years, public sector employees have not suffered nearly as much as their private sector counterparts over the past decade: private sector jobs are only now back to where they were in early 2002, whereas public sector jobs have risen on net by 1 million (almost 5%). It's still the case that  the best job security and the best pay and benefits can be found in the public sector.

Thanks to below-trend growth in the labor force and the relatively tepid growth of jobs, the economy has fallen farther behind its long-term growth trend than at any time in modern history. This is the weakest recovery ever. Fewer people working means the tax base is a lot smaller than it could be, and that is main source of a shortfall in tax revenues. Faster economic growth, powered by faster job creation, is the key to shrinking the fiscal deficit from the revenue side. Raising tax rates will only risk retarding the rate of growth. Are you listening, Mr. Obama?

The Fed is doing all it can to promote faster growth, by purchasing on net about $1.5 trillion worth of MBS and Treasuries in the past four years. So far, however, there is no sign that they have managed to increase the pace of jobs growth. Their main accomplishment has been to satisfy the world's almost insatiable demand for risk-free short-term securities, which in turn has been driven by fear of sovereign defaults, a double-dip recession, the expectation that massive federal deficits will inevitably result in a huge increase in tax burdens, and concerns that monetary stimulus could prove to be very inflationary. As the chart above shows, the market's current expectation for inflation over the next 10 years is 2.5%, which is pretty much average. But it's nowhere near the deflationary levels that most Keynesian models have been predicting given the economy's weak recovery and the unprecedented output gap that currently exists.

The chart above is a more sensitive measure of inflation expectations. The blue line shows that the bond market expects inflation to average a little over 3% during the period 2018-2023. That's not very frightening, but it does suggest that what's driving the rise in equity prices over the past year or so is inflation expectations rather than growth expectations. The Fed has absolutely succeeded in snuffing out any deflationary threat, but instead of boosting jobs growth, they have merely boosted the market's confidence that future cash flows to U.S. businesses will be rising by at least 2.5-3% per year, even if the economy posts very weak growth.

The negative real yields on TIPS, which are at or close to all-time lows, are a clear sign that the market expects future economic growth to be dismal. At the same time, the inflation expectations built into TIPS and Treasury prices say that the market expects inflation to be at least as high in the future as it has been in the past. Growth expectations are falling, while inflation expectations and equities are rising. Translation: equities are behaving more like inflation hedges these days, than like barometers of real growth expectations.

UPDATE: Nobel prizewinner Edward Prescott comes to a similar conclusion regarding the current 13% "output gap" that I show in the fourth chart of this post. See his op-ed in the 12/12/12 edition of the WSJ: "Taxes Are Much Higher than You Think." Increased tax and regulatory burdens, coupled with increased income redistribution schemes, likely explain why the gap is so large.


Gloeschi said...

Scott, even Keynesian poster child Krugman ("The Forgotten Millions", IHT/NYT 12/6/2012) claims the output gap is "only" $900bn (or roughly 5.5% of GDP). Would you be so kind and elaborate where you get your 13% from? Thank you.

Dr William J McKibbin said...

The full US jobs "recovery" is nowhere in site -- said another way, economic recovery in the US is unlikely to materialize in the coming 20-30 years -- what investors should be focusing on instead is how to build and protect their estates in an economic environment of long-term stagnation or decline -- I refuse to wait for a recovery to make more money, and frankly, I simply do not trust the big government Democrats or military-industrial Republicans will do what is necessary to save the US economy -- let's throw the towel in on a recovery, and focus instead on how we can profit in coming years regardless of the state of the US economy.

PS: I still believe that a strong recovery will occur in the US in 30-35 years, so long-term investors will be handsomely rewarded for acquiring dividend and rent-earning equities now -- but, it's doubtful that the US will experience a meaningful recovery in the coming 10-20 years -- it's time to pursue investment plans that do not rely upon a US recovery in the next couple of decades.

Scott Grannis said...

Is it not obvious from the chart?

brodero said...

There are 3 leading indicators inside
the payroll survey...all positive..there are 3 leading indicators inside the household survey...also all positive...

Benjamin said...

"The chart above is a more sensitive measure of inflation expectations. The blue line shows that the bond market expects inflation to average a little over 3% during the period 2018-2023."--Scott Grannis

Is this supposed to read 2013-2023? Typo?

Also, the Cleveland Fed has an index of inflationary expectations, now trending into all-time record low territory.

Do you no like the Cleveland Fed index, and why?

From their website:

"News Release: November 15, 2012
The Federal Reserve Bank of Cleveland reports that its latest estimate of 10-year expected inflation is 1.53 percent. In other words, the public currently expects the inflation rate to be less than 2 percent on average over the next decade."

If the Cleveland Fed is right, then is the market expecting modest real growth in years ahead? Along with historically low inflation?

Dr William J McKibbin said...

The market is expecting near zero inflation and near zero growth (i.e., 0 +/- 2%) for at least the next 30-50 years -- significant real growth will not to be found in the US in the near to mid-term -- if economic growth does spurt above about 2%, the Fed will immediately deflate the economy -- if inflation touches 2%, the Fed will discretely inflate the economy -- the number one goal of both US fiscal and monetary policy over the coming decades will be to protect and guard US global borrowing capabilities, upon which the entire Federal economy (e.g., defense and entitlement spending) are predicated -- my advice is to forget growth and search for value -- dividend and rent-earning equities are clearly en vogue -- keep front of mind that making money on inflation and/or growth is a losers' game -- making money on dividends and rent is the winners' game -- I also believe that real working wages will take at least a 75% hit over the balance of the century as real wages regress to global norms -- the world's ever growing populations result in an abundance of unskilled labor, which will demographically drive down global wages indefinitely -- to avoid wage regression to global norms, move with determination into world-class skills that will position you for premium wages in the global economy -- higher education in other than science, technology, engineering, and mathematics subjects (STEM) is unlikely to return premium wages -- bonds are a horrible deal because yields are near zero, though I plan to move into bonds once yields go double-digit -- go for dividends and rent earning equities -- anyone without dividends, rents, or premium wages is destined for poverty -- we as the adults in society need to get the word out about the risks of just "getting by" in the new economy -- our children need to be warned in particular -- the world is heading into dark times that are likely to last at least a century -- only the top 1% stand a chance -- everyone else should be under cover or running for their lives...

Gloeschi said...

"Is it not obvious from the chart?"

I assume that is your answer to my question (see above).

So it is 13% because there is a green 13 and an arrow in your chart? Any chance you could substantiate your claim in any other way?

Thank you.

Scott Grannis said...

The "gap" is the difference between where real GDP is today and where it could have been if the economy had followed its 40-yr growth trend. Real GDP today would have to be 13% larger than it is today. What we have today is a "shortfall" of roughly $2 trillion. Assuming, of course, that the long-term trend growth path of 3.1% per year is still valid. Getting there would require that the labor force participation rate return to its 2007 level, and unemployment decline significantly.

William said...

The decline in equity P/E ratios during the past year or so may be the rational behavior of investors to the realization that the future value of capital gains and dividends to them will decrease with an increase in their tax rates.

Gloeschi said...

re: output GAP

Paul Krugman put the output gap in a recent article ("The Forgotten Millions", IHT/NYT Dec 6) at $900bn.

The CBO put the output gap around $800bn ("The Budget and Economic Outlook: Fiscal Years 2012 to 2022, page 28, Figure 2-1, January 2012).

I am simply interested what the source of your 13% is. Thank you.

marmico said...

FRED graph of real GDP and CBO potential real GDP. The gap is 6-7%.

DeLong on the collapse of potential GDP.

Gloeschi said...

@marmico: thanks, very helpful.

Rick said...

@Gloeschi: Scott's calculation is obvious. He takes the average annual growth rate in real GDP from 1966 to present and plots it as a constant YoY benchmark against which to measure the actual annualized growth rate of real GDP as reported by BEA. If US real GDP has risen each year at an annual rate of 3.1%, it would be 13% higher than the $13.638 trillion number that was the second revision for 3Q real GDP reported by BEA late last month.

Krugman uses a different calculation.

@marmico: the FRED graph measures potential GDP as estimated by the CBO. That is a different calculation than Scott's application of the 45 year average annual growth rate of real GDP.

In the end, everyone is arguing over the number - not the truth. In the past 4 fiscal years, the federal government has spent an amount of money that approximates the entire current dollar GDP of the US as reported two weeks ago. In order to do so, it has borrowed $5 trillion of that total amount. What has the nation received in return for this policy?

About $1.3 trillion of current dollar GDP growth of which $328 billion represents real growth in GDP. Source is the BEA's latest spreadsheet of historical current and real dollar GDP.

marmico said...

@marmico: the FRED graph measures potential GDP as estimated by the CBO. That is a different calculation than Scott's application of the 45 year average annual growth rate of real GDP.

Thanks for the tip, Rick. ROTFLMAO