Unemployment as a Lagging Indicator: Not This Time 25 comments
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The conventional wisdom filling the CNBC airwaives and the financial media these days is that unemployment is a lagging indicator. On this basis, the likes of Larry Kudlow and Jim Cramer, notably, dismiss continuing job losses and the burgeoning unemployment rate as essentially irrelevant.
Not only is that shibboleth completely at odds with empirical economic data, but it masks the very real potential of a weak or non-existent recovery for the foreseeable future. See recent comments by Mohammed El-Erian of PIMCO and David Sokol, chairman of a Berkshire Hathaway subsidiary and a top advisor to Warren Buffett. That Kudlow and Cramer blithely ignore the unabated growth of the unemployment rate (notwithstanding the decline in job losses) and the correlative decline in buying power and from underemployment is, minimally, intellectually dishonest and dangerous.
Let's look at the so-called "rationale" underlying the "lagging indicator" myth. In the past, when the economy suffered an economic downturn or recession, job cuts ensued to rationalize expenses with income and to minimize the immediate blow to profitability. When the economy started to recover, job growth returned but at a much gradual pace than jobs were previously shed.
Therefore, the notion was formulated that when the rate of job loss begins to slow, we are closer to a bottom or turnaround in the economy even though the unemployment rate continues to increase. But, this type of thinking inherently implies both that (i) a reduction of job losses (though still increasing) will likewise slow the rise of the unemployment rate, and (ii) those who are unemployed will be able to return to the workforce at or near their prior compensation levels. Unfortunately, both of these premises are questionable at best in the new reality of the current economic climate.
For the month of May, non-farm payrolls fell by 345,000, while the unemployment rate climbed to 9.4%. So, even though payroll losses declined by 159,000 compared to April losses of 504,000, the unemployment rate increased by 0.5%, from the April rate of 8.9, or 0.2% above consensus estimates.
How can the unemployment rate increase at a faster rate than the decline in jobless claims? Easy. The number of newly unemployed encompasses a much larger group of people than those experiencing job losses, and the number of newly created jobs each month is unable to keep apace with the continuing surge in the number of unemployed.
Let's further analyze the May numbers to illustrate this phenomenon. The total number of unemployed persons rose to 787,000, representing more than a 440,000 increase of such persons above actual payroll losses.
At first blush, the math doesn't seem to make sense. One would surmise that if job losses were 345,000, the number of newly unemployed would be the same or roughly comparable. But, as alluded to above and explained below, the rate of unemployment is not limited to only those persons actually losing their jobs.
Instead, the unemployment rate is designed to include all unemployed whether or not they are receiving unemployment benefits or became unemployed as a result of losing a job.
For example, the unemployment rate includes the growing numbers of self-employed who are now searching for third-party employment. It includes those who have resigned or otherwise left positions without qualifying for unemployment benefits. It also includes new entrants to the workforce who are actively seeking work. Therefore, even if there were no new net job losses, the unemployed would still have risen by the 440,000 with a corresponding increase in the unemployment rate.
In my view, an increase of 787,000 unemployed is not anything to write home about as positive or irrelevant. It does not signal an end to the recession; rather, it demonstrates just how deep the recession really is and how long it will take for the economy to recover. Because a strange, though not wholly unexpected outcome, is occurring. As the unemployment rate skyrockets, more new job seekers are entering the market further increasing the unemployment rate. Why? Because if a household's income is adversely affected by a job loss, other currently non-employed members of that household will also be searching for work to make up the shortfall.
But the unemployment rate, though a more reliable economic indicator of the future health of the economy than measuring only monthly job losses, does not even attempt to measure the effect of underemployment on buying power. Underemployment occurs when someone assumes a position below their potential earning power based on prior employment and marketable skills. Numerous examples abound of this sort.
Take the job losses in the banking industry and the manufacturing sector. Many of those now unemployed in those fields previously were earning substantially more than currently available jobs are paying, whether or not in the same sector, given their qualifications and experience. Consequently, while the unemployment rate is job neutral meaning that a replacement job at a lower wage or salary is treated the same from a statistical point of view as one who replaces a lost job with a new position at a similar rate of prior compensation, the economic reality is quite different. Disposal income is significantly diminished along with buying power. There are simply fewer dollars to spend for fewer goods by fewer people.
The point being that because of the fundamental restructuring of the U.S. economy since last fall, which is likely to continue for some time, the overall unemployment rate is likely to remain high regardless of a reduction of monthly job losses. And the prospects for economy recovery will indeed affected by the adverse consequences of such unemployment on buying power regardless of those who are stubbornly unwilling or unable to differentiate the current recession from every other one since the Great Depression.
Disclosure: No positions
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Unemploymment has and is likely to remain a lagging indicator but in the current environment it could remain at stubborningly high levels while the economy begins to reovery at an anemic pace. Growth in consumer and governement spending can give rise to a weak recovery with high levels of unemployment.
Not desirable but factually possible.
Economic reality in the U.S. is stark. You can't have increased employment any time soon in this environment. All industries are retrenching, not expanding. Who will do the hiring? Job losses may be slowing now because the economy is shrinking to its new normal, but the deflation of the last bubble is not finished, and the losses will accelerate again when the downturn resumes.
Companies don't start laying off until we are well into a recession. That occurs because we don't know that actual beginning month of a recession until several months later. For example, Dec 07 was not pegged as the start until summer of 08. As such, once a recession starts, inventories build up that are not getting sold. Once companies realize that's occuring, they then have to not only adjust to the reduced demand levels, but need to go well past that demand to eliminate excessive inventories.
At the back end of a recession, companies will typically not begin to rehire until they clearly see that demand is on the rise, i.e. after the recession has passed. In the meantime, they use overtime to increase production back to the demand level. Thus, unemployment cannot go down until we well into a recovery - as companies base hiring decisions on historical demand, which is an after the fact indicator.
IF you want to use labor data for a real-time indicator of what is happening in the economy - start watching for significant increases in overtime staffing. Once that starts occurring, then improvement in the labor markets will follow. But don't attempt to judge the future of the economy based on unemployment data - you will be operating 6 - 9 months behind what is actually happening every time. And that is a great way to loose money if you are an investor.
First, if you want to make the argument that unemployment isn't a lagging indicator, back it up with historical evidence. Find a recession where unemployment turned before GDP (good luck with that!).
Second, the household survey simply showed that there were more people looking for jobs (ie, young people or 2nd household earners who weren't previously employed) than before. That could actually be a sign of increased confidence. Many people stopped looking for jobs because there weren't any (think housewives whose income might not be needed). The fact that they are looking for jobs now implies that they may be seeing more job openings.
The reality is that the drop in job losses was a huge positive and bears are getting desperate to put a negative spin on it. This article is proof positive of that.
On Jun 08 10:34 AM Sunnsea wrote:
> The graph that Steve Lisman of CNBC showed this morning included
> "unemployed", "discouraged" and "part-time" workers by economic necessity.
> The true rate at the moment combining these categories is at 18%
> or more. The graph went back to the mid-90s and showed a 9 to 10%
> 2001 rate growing to 12% or so after 9/11, a slight drop from 2004
> to 2006 to around 8% and of course now. We have not had a full-employment
> economy in decades, maybe since 1968-9. At that time there were 3
> or 4 jobs for every worker. Can't have that now, can we.
Shibboleth also has two possible meanings: a flowing stream, or a head of grain. I also suspect that it was the name of a local town or village of that time.
So to the author: What sortof usage did you intend for Shibboleth in this article? It seems very out of place.
Michael - Right on! "Kudlow and Cramer intellectually dishonest".
On Jun 08 09:27 AM Glen L. wrote:
> I feel sorry for the college and high school graduates entering the
> workforce this summer. How many will find jobs in this climate? And
> how many who can't find work will swell the numbers of the unemployed
> when the June stats come out?
>
> Economic reality in the U.S. is stark. You can't have increased employment
> any time soon in this environment. All industries are retrenching,
> not expanding. Who will do the hiring? Job losses may be slowing
> now because the economy is shrinking to its new normal, but the deflation
> of the last bubble is not finished, and the losses will accelerate
> again when the downturn resumes.
On Jun 08 12:06 PM Stephen Kanitz wrote:
> In April the US government hired 90.000, state intervention, which
> is distorting your analysis. The comeback is 90.000 stronger than
> it seems.
The key difference now is that those who lost their jobs with this economic crisis will not necessarily find comparable jobs once the economic deterioration stops. Many of the lost jobs are being/will be off-shored, unless of course the government takes measures to discourage off-shoring of jobs. Otherwise, unemployment will stay high, and there will be no economic recovery to the pre-crisis levels. The question that remains is whether the job loss rate will diminish and the economy will reach a plateau at a lower than the pre-crisis level, or whether the high unemployment that will prevail for a long time will have a negative spiraling effect on the economy.
Watch out what you wish for.
Unlike other recession since the Great Depression, we are experiencing a fundamental shift in employment trends. Many jobs in the financial industry, the automobile industry and other sectors are not coming back regardless of the time period. This is different from prior recession where people would eventually find comparable jobs for comparable pay. I don't think that is true this time around.
On Jun 08 12:14 PM Fitz919 wrote:
> I noticed you used the word Shibboleth in your article. Most readers
> don't have a clue about the significance of the word Shibboleth.
> The word was used as a pronunciation test in the Old Testament.
> Those who couldn't say the word correctly were immediately executed
> for being spies. The test was performed in a mountain pass, and
> therefore became the first ever "password". See Judges 12: 4-6.
>
>
> Shibboleth also has two possible meanings: a flowing stream, or a
> head of grain. I also suspect that it was the name of a local town
> or village of that time.
>
> So to the author: What sortof usage did you intend for Shibboleth
> in this article? It seems very out of place.