The Unemployment Rate Illusion

You have probably heard the term 'money illusion'. I want to coin a new related term called 'unemployment rate illusion' because I think it is significant in light of some of the things David Rosenberg said earlier Wednesday about the unemployment rate in the U.S.

Wikipedia’s definition of money illusion is good:

In economics, money illusion refers to the tendency of people to think of currency in nominal, rather than real, terms. In other words, the numerical/face value (nominal value) of money is mistaken for its purchasing power (real value). This is a fallacy as modern fiat currencies have no inherent value and their real value is derived from their ability to be exchanged for goods and used for payment of taxes.

The key here is that behavior changes in accordance with the nominal numbers used as economic signposts in an economy. This is one reason why governments are often accused of manipulating their economic statistics in order to present a more regime-friendly face (see here and here).

The parallel of money illusion to unemployment rate illusion is that a higher posted rate of unemployment can have a serious negative impact on consumer confidence and personal consumption (think balance sheet recession). All else being equal, higher unemployment rates mean lower confidence and consumption. So, a lower unemployment rate is a better unemployment rate as far as incumbent politicians are concerned.

Now, you don’t have to be a conspiracy theorist and think that the government is deliberately suppressing the unemployment rate to understand what I am about to say. You just have to understand economic cycles in the context of the note from David Rosenberg Wednesday.

What I am talking about is the second paragraph of a quote I highlighted (bolding added):

But in a nutshell, to be calling for a 12.0-13.0% unemployment rate is meaningless except that it is very likely going to be a headline grabber. The most inclusive definition of them all, the U6 measure of the unemployment rate, which includes all forms of unemployed and underemployed, is already at 17.5%. The posted U3 jobless rate that everyone focuses on is at 10.2% (though if it weren’t for the drop in the labour force participation rate, to 65.1% from 66.0% a year ago, the unemployment rate would be testing the post-WWII high of 10.8% right now). The gap between the U6 and the official U3 rate is at a record 7.3 percentage points. Normally this spread is between 3-4 percentage points and ultimately we will see a reversion to the mean, to some unhappy middle where the U6 may be closer to 15.0-16.0% and the posted jobless rate closer to 12%. This will undoubtedly be a major political issue, especially in the context of a mid-term elections and the GOP starting to gain some electoral ground.

Let me put this quote in unemployment rate illusion terms:

• People pay attention to the posted U-3 rate of unemployment. Right now it is 10.2%, which is high.
• However, it could be much higher – 10.8% – because a lot of people aren’t getting counted. They are dropping out of the labor force and artificially suppressing the labor force participation rate. This will change when recovery takes hold as a better economy brings back those discouraged workers.
• It’s even worse than that because, U-6, the most comprehensive rate of unemployment is sky-high at 17.5% and much higher relative to the posted rate than is normal. Even if U-6 declines to 15-16.%, using a normal gap to the posted rate gets you a posted rate of 12-13%. Nothing has changed, discouraged workers have re-entered the labor force. It is unemployment rate illusion.
• If people see 12-13% in 2010, they will be floored, angry, and looking for someone to blame. As Democrats control Washington, they will get the lion’s share of the blame and lose big time in 2010.
• Making matters worse, this is the kind of shock that causes people to put their checkbooks away and go home for the night a.k.a sending us into a double dip recession.

This is a case where unemployment rate illusion is definitely not a good thing.

What to do?

Well, if you’re the President, you have to under-promise and over-deliver. President Obama has been doing exactly the opposite. Of course people are going to be angry when you promise 8.0% unemployment and instead we get 10.2%. Right now, Obama should be talking about 13% unemployment.

Moreover, Obama needs to throw his weight around. He should be telling people publicly,

my policy team is telling me that if we don’t get what we want through Congress, this fragile and unsatisfactory recovery will crumble and we will see 13% unemployment or much worse. And it will be the Republicans fault that this happened.

Then he should turn to the Republicans and say,

give me everything I want or the economy will crumble and I will make sure you get the blame.

Remember, that’s what Hank Paulson did and it worked brilliantly (a 777-point implosion in the Dow helped). What is the Republicans’ BATNA (best alternative to a negotiated agreement)? Nothing.

If you’re a Republican you should continue on the same course. Obama shot himself in the foot in January and February by not taking the Hank Paulson approach. Now, you get to label him a ‘socialist’ or anything you want. And you get to tell people that stimulus is budget-busting pork designed for the Democrats’ union buddies that doesn’t work and bankrupts America. It’s been working so far. Given the fact employment is likely to rise to a post-Great Depression high, why wouldn’t you continue on the same path? Don’t fix what’s not broken.

…coming soon to a TV screen near you.

Comments

[Value Added]

The only efficacious option open to Obama that would have a substantial net positive impact on our economic direction, is to slash government spending and implement massive tax cuts. That would disburse cash liquidity throughout the economy, as contrasted with propping up Wall Street, as the stimulus funds have done. However, since that involves *less* government, *less* "wealth redistribution", and *more* power to individuals - all of which run contrary to his philosophical underpinnings - that's not going to happen!

2009 Nov 12 07:07 AM

[Leftfield]

There are proliferating numbers illusions covering declines and they represent the declining standards in our society, not least of which is of truth. The politicians in office generally are the ones who told the prettiest lies; put the heaviest coat of lipstick on the pig that is our situation in the US. This allows for politically favorable, but false outcomes. It has led to the garish multi-$trillion rewards for failure with bonuses for the richest among us.
It is a mystery why the parties don't take the tacks you suggest in the article. Maybe each party's positions are so warped and ludicrous that those would stand the scrutiny of even the American public.

2009 Nov 12 08:05 AM

[Leftfield]

(wouldn't stand the scrutiny)

2009 Nov 12 08:07 AM

[Formyx]

Ultimately, we get the President illusion as well. Obama plays the part and looks more presidential and competent than many of his predecessors and so people ignore results and motives and stick with him because of a speech he delivered in Cairo, etc.

2009 Nov 12 08:14 AM

[The Geoffster]

There is one group of people whose unemployment would be beneficial to the economy. They are called Congressmen.

2009 Nov 12 08:50 AM

[tripleblack]

[quote]Well, if you’re the President, you have to under-promise and over-deliver. President Obama has been doing exactly the opposite. Of course people are going to be angry when you promise 8.0% unemployment and instead we get 10.2%. Right now, Obama should be talking about 13% unemployment.

Moreover, Obama needs to throw his weight around. He should be telling people publicly,

my policy team is telling me that if we don’t get what we want through Congress, this fragile and unsatisfactory recovery will crumble and we will see 13% unemployment or much worse. And it will be the Republicans fault that this happened.

Then he should turn to the Republicans and say,

give me everything I want or the economy will crumble and I will make sure you get the blame. [quote]

This is precisely what Obama did back when he was threatening us with the 8% Unemployment boogie man. Video of him doing this will be run next to new video doing the same thing with 13%, and it will not work quite the same way. This particular trick has no legs for repeated cycles.

Politically, his best bet is to back off the incredibly expensive things he has almost a trillion dollars set aside for in the goody bags of the Stim Bill, 2009 Budget, ObamaCare, etc, etc, and start stealing ideas from the Republicans instead of his own "greatest hits" collection.

He would be stronger playing the part of a President who DID the right thing, rather than just trying to extend the snow job past the current election cycle.

2009 Nov 12 09:00 AM

[Old Trader]

"you get to tell people that stimulus is budget-busting pork designed for the Democrats’ union buddies that doesn’t work and bankrupts America."

Isn't this, in fact, true?

2009 Nov 12 09:29 AM

[TCK]

I personally saw about 30 of the jobs Obama created.

They were standing outside "Home Depot" hoping people would need help installing their landscaping purchase !

2009 Nov 12 10:16 AM

[Wildebeest]

U6 doesn't include >5 mill people who claim they want a job. These people show up in Table A13.

The 17.5% is a seasonally corrected number, actual number is 16.3% but then add 3.3% onto it -- the people who want a job but aren't included in U6. 19.6% becomes your more realistic number for un + under employment.

2009 Nov 12 10:42 AM

[notsosmart]

figure about 20% for all who want to work full time & cant find a job.some will never work again.lets see what happens in the 1st quarter of '10 re retail.how many shops will close?how much of the christmas help will add to unemployment?you cant believe the gov figures.

2009 Nov 12 11:01 AM

[John Galt]

As Tripleblack pointed out, Obama already did this...

"President Barack Obama warned on Thursday that failure to act on an economic recovery package could plunge the nation into a long-lasting recession that might prove irreversible, a fresh call to a recalcitrant Congress to move quickly."

Obama said that if we didn't pass his stimulus, that we may "never recover" from this recession. A little extreme wouldn't you say?

Your assumption would be correct if you believed his policies would actually work. That would mean that you would be throwing economic history out the window as you embrace keynesian economics.

He campaigned to "rebuild our infrastructure" and with 787 billion dollars he had a chance to do just that. The fact is that his stimulus was a gigantic transfer of wealth from the future to present... for what? Was he building "bridges instead of bombs", or was he putting a band-aid on failed state budgets for a year?

Obama thought he was being conservative when he warned that if we didn't pass his bill we might hit 8% unemployment, but the economy as fared far far worse than the experts predicted.

And now, instead of keeping a focus on the economy, he tries to jam through unpopular health care legislation and a cap & trade tax while his party has the votes. What's bipartisan about that?

Rather than presenting his plan differently to the public, he should have taken a different course of action all together. The stimulus plan was a joke. In fact the first stimulus plan from Bush where he just handed all qualifying people a check worked better in many ways.

How long before stimulus plan 3?

2009 Nov 12 11:59 AM

[Mr. Big]

This world economy is full of illusions.... and the greatest illusions of them all are perpetrated by the Federal Reserve and the U.S. government. And the fact that we can't peek around the curtain allows them to get away with it.

Treasury yields are a great big illusion. They have been so distorted that it makes one wonder why anyone would ever buy the bonds at current prices under the current environment. Makes no sense.....unless you look behind the curtain and see the truth. The truth may be that our government may be "spicing up" the low-yielding bond offerings to the major global players by offering....oh I don't know..... (military secrets?).... (designs from the patent office on Intel's latest prototype chips?).... (space shuttle blueprints?).... (Patriot missile systems?).... who knows?

Perhaps then, a 0.8% yield on a 2-year bond that depreciates from a weakening USD would be not such a bad deal afterall?

Just thought I'd add my 2 cents, now that we're on the topic of conspiracy threories...

2009 Nov 12 12:29 PM

[Donald Ingram]

Edward - Good post. I would only add that the BLS statistics vis a vis the birth/death model are a complete fallacy.

Facts: Under/unemployed at +22% (shadowstats) with one in six on food stamp relief. Personal bankruptcies up, foreclosures still high, CRE loans/mortgages failures mounting, bank failures continue, city/county/state budget crises, reduced tax receipts, devaluing dollar, mounting government debt, money printing continues at a fast pace.

Recovery? Where? Those that believe the government and freely drink the kool-aid are being led by their nose down the path to destruction.

2009 Nov 12 01:06 PM

[bogoMIPs]

Great work, Edward. keep it up! If I had one suggestion though, it would be that you could also point out the SGS numbers in direct contrast to BLS lies.

+10 Donald Ingram.. you are right on target. The only question is when if ever, this ignorant populace will roll over and realize the massive con job that the Obama administration is perpetrating upon them and everyone in this country

2009 Nov 12 02:08 PM

[ryanclarke]

Thanks for the unemployment comments. To let readers know, I have a B.S. in mathematics and an M.S. in electical engineering ... as well as two patents ... #7499155 and one yet to be issued . The banks will not loan based on the IP property I currently own. So my job is trading the markets. I did well last year. This year I missed the March bottom and have chosent to "sit it out" in regards to the bull market currently in action. If I want a job I could have one ... at the local community college ... where I can be an "adjunct" professor and be paid a total of about $5000 to teach one class in a basic enginnering course. There are no private engineering sector jobs in the U.S. as there are no private engineering companies left in the U.S. except INTC, DELL, HPQ, MSFT, APPL, etc. ... the small company private engineering jobs are gone ... either to another country or by an H1-B visa holder who will work 80 hours a week for $60,000/year. It should be obvious to all readers ... if the U.S. Demo/Repub/Ind/Liberta... elite told the truth ... the U.S. would have defaulted on the U.S. treasury debt years ago.

2009 Nov 12 02:27 PM

[401KMAN]

There has been a lot of "labor dumping" in the US as ryanclarke points to. Many middleclass jobs have been lost to outsourcing or bringing in cheap skilled labor.

Shovel-ready jobs do not put engineers or software designers back to work.

2009 Nov 12 04:55 PM

[Mr. Big]

Just wait until millions of state workers lose their jobs as places like California crumble under a fiscal mountain of deficits....

2009 Nov 12 05:25 PM

[Homer II]

Mr Big has the right vision. Add Michigan, New York, Massachusetts and several other Blue states to your list.

I think the big imaginary political pendulum in the sky has hit the left side of its oscillation and is now bearing down hard on the rightward swing.

2009 Nov 12 06:25 PM

[Al-USA]

This situation of mass unemployment is no good. Nothing good can come of it. I mean, capitalism is being discredited by its own actions.

To make matters worse, in the Obama administration the question of how to eliminate mass unemployment has become a non-issue. This portends great political shocks and upheavals in the near future to the detriment of both failed political parties: Democrats and Republicans.

2009 Nov 13 01:51 AM

[proxyjoe]

John Galt said. "..or was he putting a band-aid on failed state budgets for a year?"

Dumb question: Shouldn't this sort of federal expense be a matter of record? Or can Obama/congress hide/bury this?

2009 Nov 16 01:13 AM