Beyond non-farm payroll growth lies overall employment. The latest Bureau of Labor Statistics data revealed that those in employment fell in June by a massive 445,000. This drop wiped out the number in employment since January of this year, leaving +11K in employment. Within that number was also a fall in full-time employment.
The June data also revealed that average nominal earnings fell slightly. When inflation is considered as well, real earnings, which have been maintained in the last couple of months, fell sharply.
To put this into context, consider that the richest and biggest group of consumers are US wage- and salary-earning employees in full-time employment. This group exludes all types of self-employed and part-time workers and underpins the housing market; the demand for credit; the automobile and durable goods markets; and form a key contributing source of income for the US tax base and future pension pots. In addition, the group's spending on imports provides an important source of income for the rest of the world.
The sheer size of the group (about 100 million) with the highest average earnings of the world has made it not only the US but the world’s engine of growth.
A simple measure of the power of this engine is to look at the estimated total real earnings for the group. The closest current estimate can be derived from using median real earnings per person (average up to date data not available) multiplied by wage and salary earners in full-time employment. The number excludes self employed individuals (hence based on 100 million wage or salary earners) and is a pre-tax income value. This estimate of total earnings per week for full time employees in all sectors and industries in the US is presented in the chart below.
[Click all to enlarge]
Source: Calculated from US Bureau of Labor Statistics (BLS) data (see chart below)
As the chart above shows, weekly earnings for this group were:
- Around $34 billion a week during 2001-04.
- Rising to $36 billion per week until mid-2008.
- Dropping to about $34 billion by the end of 2009.
- A small bounce in 2010.
- Since then a sharp decline in 2011, to about $32 billion per week.
The chart below splits out the two components of the engine of growth, stating the full-time employment and real median weekly earnings data separately.
Source: BLS series id LES1254466800 and LES1252881600
As can be seen from the above chart:
- Between 2001 and mid-2004, a slight rise in real earnings was reinforced by rising full-time employment/
- Between mid-2004 and mid-2006, a fall in weekly earnings was offset by a rise in full-time employment.
- Between mid-2006 to the end of 2007, both earnings and fulltime employment rose.
- The significant fall in full-time employment between 2008 to early 2009 was partially offset by a rise in median earnings but total estimated earnings for the group fell, as shown in the previous chart.
- In the last three quarters of 2010, real earnings steadied while full-time employment rose.
- In 2011, both real earnings and full time employment have fallen, with a significant drop in real earnings in Q2.
Change in estimated full time earnings and real personal expenditures
What matters to the US economy is that personal incomes are turned into personal expenditure on US goods and services, as measured by real personal consumption expenditure (PCE). The chart below shows the monthly change in real US PCE since Feb 2008. As can be seen, both April 2011 and May 2011 were negative.
Source: US Bureau of Economic Affairs data
The chart below presents the quarterly change in real PCE with the quarterly change in estimated total US earnings of the full-time employed. Percentage changes in real PCE have generally been higher than change in total earnings of the full-time employed. This is not surprising, as PCE is also driven by the self-employed, part-time workers, those not in work, and the retired -- all groups that are increasing in size (but all of which are smaller than full-time employees). In addition, using the median earnings value to calculate real earnings might underestimate total earnings if average earnings are rising faster than median earnings.
What the graph shows is that as earnings from full-time employed turns significantly negative, real PCE falls in due course. As the graph above shows, we already have had month-on-month falls in real PCE in April and May 2011. Given the divergence between the real PCE and earnings trend in Q1 2011 already, real PCE in this quarter is very likely to turn negative.
Source: calculated from US Bureau of Economic Affairs and US Bureau of Labor Statistics data
The bigger picture: A new US economy with an old engine
I started this analysis by stating that the total real earnings by the US full-time employed was the engine of growth, particularly since this income underpinned PCE, the housing market, the demand for credit, the auto market and forms a key element of the US tax base and future pension pots. Real income growth requires moderating inflation (which we seem to have), but also growth in nominal incomes ahead of inflation, which the US does not have at present. Should nominal incomes begin to increase faster than inflation, these “second round effects” would likely trigger a tightening of monetary policy to prevent the higher wages from feeding into inflation.
In simple terms, like most central banks, the US Fed is looking for employment growth as the key component in the domestic engine of growth to power PCE growth. The prospect for a future improvement in employment growth in turn depends on economic growth (increase in real GDP). GDP growth could occur from other sectors, with a lot of hope in the economic recovery being pinned on export led growth. Will the rest of the world pull the US economy along the recovery road?
The table below presents the quarterly average growth rate for each of the main components of US GDP for three periods. The first column provides data on the “old US economy," driven by PCE. The second column provides the same data roughly covering the recent recession and reflects the “transition period” to the new economic structure. The third column presents the recovery period since Q1 2010 based on the new US structure. Each period is discussed in turn.
Between 2001 and 2007, GDP grew by an average 0.65% per quarter. PCE during that time grew at a quarterly rate of 0.74%, a faster pace than GDP growth. Gross private investment was slower than GDP growth. Real exports grew faster than real imports on average, and at a faster rate than GDP on the whole, reflecting increased internationalisation of the US economy and world trade in general. Similarly, real government expenditure grew at a rate far less than GDP on average. In summary, PCE and export growth were the main drivers of GDP growth during that period, ending up as far bigger components of GDP at the end of the period than at the beginning.
Quarterly average growth rate
2001 Q1 to 2007 Q4
2008 Q1 to 2009 Q4 (6 Quarters)
2010 Q1 to 2011Q1 (5 quarters)
Gross Private Investment
Looking at the second column of data, US GDP posted a quarterly average growth rate of -0.18%, and private sector investment declined very sharply at -2.27% per quarter. Imports, driven by the US income decline, also fell at a faster rate than GDP, at -0.56% per quarter on average, somewhat cushioning the US recession but playing a role in transmitting the US recession to other parts of the world.
Also during the recession period, exports grew marginally on an average quarterly basis, at 0.07%. With imports declining and exports increasing, The US ended the recession more export focused, a strong positive for the economy. The anti-cyclical nature of government expenditures during a downturn is also reflected in the data, with a quarterly growth of 0.65%.
What stands out is that while PCE fell during the recession, it did so at a slower pace (-0.09%) than GDP as a whole. As a result, the transitioned economy ended up, relatively speaking, with PCE, exports and government expenditure being far more important components of GDP than going into the recession. In particular, PCE and not just exports ended the recession as being even more significant components of GDP. Remember also that both PCE and exports were already increasingly important drivers of growth pre-recession.
The recovery period (last column) reflects how the “new US economy” has performed. To date, GDP quarterly growth has been 0.45%. PCE has grown at a pace (0.54%) ahead of GDP and so continues to increase in importance as a source of GDP growth overall. Investment has begun to recover, but with a quarterly rate below the recession/transition period, remains well below its pre-recession level and therefore relatively less important as a source of growth in the new economy.
Encouragingly, exports have grown faster than even the pre-recession period, reflecting that the US economy appears indeed to be more export led than the old economy. Against this, however, is import growth with an average quarterly rate of 1.88%, outstripping export growth and regaining ground lost during the recession. Once again, US income growth appears to be the important driver here.
With imports linked to US income growth, and PCE growing to date, this has been not only a drag on the US recovery, but an important source of growth for the rest of the world. US export growth can only advance if emerging economies and the EU continue to post growth in their GDP, employment and real incomes. The EU is also in a position of decelarating growth, weakening real incomes and looking to exports as a source of sustained recovery. Those exports will be aimed at the US as well as emerging economies in competition with US exports.
While growth in emerging economies is positive, it remains export led, aimed at the US and the EU. A fall in real total US full-time earnings (first chart), which appears to be turning strongly negative recently, will put downward pressure on emerging market incomes as US imports are likely to follow the drop.
In emerging markets, increased consumer spending and investment growth is meant to take up the slack and provide a source of demand for US exports. Yet, that source of growth will take some time to filter through to US jobs and higher incomes.
US real government expenditures, while elevated compared to earlier periods, are set to fall in the coming year or more; the deficit fuelled growth in government spending has to be reversed. The prospect for this to be a further source of growth remains weak and more likey is a source of short term decline in GDP in the short run.
This leaves private investment in the US, mainly from large corporates and the small business sector. Despite repaired or cash rich balance sheets, these companies need to see US full-time employment and real earnings growth on the domestic front to support and sustain PCE, and for any commensurate growth in imports to filter back as higher demand in their export markets, in order to make longer term commitments to real investment projects.
In summary, the new US economy, despite being more export focussed, remains at heart an economy driven by PCE which in turn ultimately depends on people in full-time jobs with rising real incomes. As PCE has gained in importance compared with the pre-recession period, so has the reliance on this engine of growth. Until emerging markets significantly expand their consumer and industrial demand, it will remain so.
The biggest news on Friday, for me, was the massive decline in employment. The data also revealed that full-time employment and real incomes fell. Behind Friday's seemingly minor uptick in overall unemployment of 0.1% to 9.2% and “transitory” inflation pressures, lies a US and world economy still very reliant on US real total income by full-time employees as the world’s engine of growth. This engine has two transmission mechanisms that power US GDP growth: PCE in the US and import growth that indirectly and with delay, feeds back as support for the increasingly important export sector.
The drop in the estimated total real income amongst US full-time employees in 2011 has occurred at a rate not even seen during the recent, deep recession of 2008-09, and appears to be at a lower level than even the beginning of 2001. The corresponding fall in real PCE in the last two months also lends support to the view that the "soft patch" in Q2 2011 is very soft indeed.
The world’s biggest engine of growth has stalled. A look at the bigger picture suggests no obvious factors are set to restart it soon. The fastest area of US GDP growth is private sector investment. If that begins to falter in anticipation of further declines in US employment and real incomes, government spending cuts and faltering world demand, the US may well be headed for another recession.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.