Today's column will conclude my look at how the emerging "two economies" phenomenon has distorted the official statistics investors and citizens look to when gauging the economic health of their countries.
The period following the Second World War is considered by many to have been a golden age for the North American middle class. There was a large manufacturing sector, and governments were investing in national infrastructure. Unionization of the workforce was much more prevalent and defined benefit pension plans were quite normal. Workers often remained with their employers for decades, while a single breadwinner could provide for an entire family.
Some observers glorify that world for the prosperity it accrued, others argue that, long-term, the economy of that era was unsustainable. Whatever your take on it, the point of the following article is that, for right or wrong, that world no longer exists for the vast majority of North Americans.
In the 1950s and 1960s when officials spoke about "employment", they referred to the preceding conditions, at least for the most part. "Unemployment", then, was typically understood (if not specifically defined) as the absence of a long-term, full-time job, typically offering benefits and a pension plan.
The post-war period unfolded, and as the 60s melted into the 70s, and the 70s into the 80s, this conception of employment was changing, albeit gradually. Automation slowly wreaked havoc on manufacturing jobs, while increased foreign competition and trade exposed companies' underlying competitiveness issues. Demand increasingly grew for more technically skilled workers and diminished for the unskilled. As a result, we now understand employment much differently today than in years past.
Yet, most observers in government, media, and even the central banks still discuss "employment" and "unemployment" in the aforementioned parlance of years gone by. This needs to stop.
The Golden Age: If We Only Knew Then...
When the Second World War ended, the world was truly an odd place. Much of Europe, Japan, and South East Asia lay in ruin. Countries like Germany, France, Italy, and Japan - traditional economic powerhouses - faced hardship and decades of rebuilding. Other countries, like the US, Canada, and Sweden, which had largely escaped the massive destruction of war were in an enviable position.
In 1945, the US represented roughly 50% of global GDP, as the industrial and economic infrastructures of most other developed nations had been bombed, strafed, or otherwise pulverized into oblivion. Millions of productive-age young men returned from the fronts maimed or crippled; millions more did not come home at all. Even with the Marshall Plan, it would take at least two decades before much of Europe regained its economic and industrial footing.
Those were largely good times for North American workers, by and large, even for the relatively unskilled. Granted, resource sectors still experienced ups and downs as they always do, but manufacturing played a steady role in the economy, accounting for over 30% of US employment during those post-war years. Massive public infrastructure projects, like the Interstate and Trans-Canada highway systems, meant construction also provided additional productive, well-paying jobs that provided middle-class incomes even for those without high school diplomas.
Moreover, as the chart below shows, from 1943 to 1957, union-membership reached a plateau of about 35% of the US private sector workforce.
Source: Los Angeles Times
Beginning with automakers, who faced demands for retirement plans from the UAW, workers were provided defined benefit pension plans. Other sectors would follow. By the 1950s, 41% percent of US private sector workers had some kind of defined benefit pension plan. This begat the "30 and out" mantra, whereby many working-class youngsters could find employment with large firms and quite possibly retire in their 50s, provided they lived within their means and remained with the same company.
This was the era in which our current perceptions about "employment" and "unemployment" were forged. A job actually referred largely to a steady, livable income, implying full-time hours, and benefits. Obviously, all was not rosy for everyone, as income gaps and poverty existed then, as now, but varied lifelines to the middle-class existed in relative abundance for the least skilled members of society.
As the 1950s gave way to the 60s, there was all the optimism in the world that living standards would continue to improve for each generation, and that the working classes, even the least skilled, would share in that rising tide. Historically, both with nations and with individuals, golden ages come to be perceived as normal, and tragically the temporariness of the most precious of good times can get lost in the moment.
North America's golden age would be ultimately doomed, ironically, by the success of the post-war reconstruction. Already, by the late 1950s, West Germany had dug itself from the rubble of wartime and emerged as the new powerhouse economy of an emerging Continental European economy (see here), even while the "victorious" UK, interestingly, experienced an economic decline. The European Common Market and other free trade initiatives increased continental trade and export growth soon followed.
By the 1960s, Japan reemerged as an industrial giant, too. During that decade, led by autos, Japanese exports grew at an average pace of 18.4% annually! Even the oil shock of the 1970s proved only a temporary blip, as higher oil prices eventually increased the demand in North America for smaller, more efficient, and more reliable autos, something Japan happened to specialize in.
By 1979, partly due to superior competition from West Germany and Japan, Chrysler required a US $1.5 billion bailout from the US government to remain in business. This would be its first.
The 1970s also saw the rise of the so-called "Asian Tigers", specifically South Korea, Taiwan, Hong Kong, and Singapore. These economies rose to prominence largely thanks to idiosyncratic mixes of manufacturing, exports, and banking. Later that same decade, a certain Deng Xiaoping ascended to power in China, espousing a more pro-Western, pro-Capitalist approach to modernizing his country, though few paid much attention at the time.
If your humble author was a cynical curmudgeon (which he most assuredly is not), he might say that a hungry and ambitious world was discovering the grueling, hard-won path to economic success precisely amid the two decades when North American youth and pop culture were embracing "sex, drugs, and rock 'n roll". But we won't go there.
Yet foreign competition is only one part of the story, as it happens. Technology and automation have replaced and continue to replace jobs once held by human beings. This is hitting the working classes and the low skilled in particular.
This trend is actually accelerating. Recent data suggest that since 2000 85% of US manufacturing job losses were due to automation, leaving only about 15% attributable to offshoring (see here).
If you see a theme developing here then you are paying attention, dear readers. As reported in MIT Technology Review, it's not so much that technology is destroying jobs per se, but rather it's destroying particular kinds of jobs. Manufacturing and other low skilled jobs have especially been gutted by the rise of machines.
The following chart shows the almost perfectly straight downward slope of manufacturing's share of US employment since 1953 (blue line), even as industrial production (red line) increased quite steadily.
Source: St. Louis Federal Reserve Bank
This vividly demonstrates the productive power of technology and automation, both for good and ill. This is not exclusively a US phenomenon, either. In the last 40 years, the percentage of Canadians employed in manufacturing has fallen from 22.5% to just 10% (see here).
It is here that our "two economies" world raises its head once again. The modern economy, as we know, is producing demand for workers with high skill sets, excellent literacy, and technical training. To be sure, there has always been demand for such labour. However, the accompanying demand for low skilled labour has steadily vanished since the 1950s. We see this today in the harsh split between the top 40% and bottom 60% of earners.
To further complicate matters, the rapidly inflating cost of education is closing yet another path to the middle class, so much so that US college enrollments are actually declining, even as student debt load continues to rise (see here).
A booming technology and innovation economy largely masks the depressing prospects for the less skilled. Whom is to blame, and what (if anything) should be done about this trend I will leave for another discussion, but we should fool ourselves no longer.
An Antiquated Unemployment Rate
A job just ain't what it used to be! In fact, "job" has lost much of its meaning in recent decades. According to Forbes, the "gig economy" now accounts for 34% of the US workforce (and is expected to rise to 43% by 2020), while in Canada just over half of workers 25-54 years of age do not have permanent and/or full-time jobs (see here).
As for that "full employment" situation in the US, well, there is considerable controversy as to the legitimacy of that claim. The drop in the US labour participation rate is well documented, and cannot be exclusively attributed to retiring baby boomers (see here). Jim Clifton of Gallup, meanwhile, points out that the term "employed" can refer to working a mere one hour per week or receiving a minimum of $20 in income.
Now, such extreme examples would not have been relevant in the 1950s, or even the 1980s, but today they're not as extreme. When using the U6 unemployment rate, which at least attempts to account for the "involuntarily" part-time employed the 2017 rate jumps to just over 8% in contrast to the more widely reported U3 rate of 4%.
Source: Federal Reserve Bank of St. Louis
For this reason, some have suggested using a gage that subtracts the U3 rate from the U6 rate. The reason being that the closer to zero the difference is the closer the economy is to full employment since it would imply that discouraged workers are returning to the workforce, and the underemployed are finding full-time work (see here).
I would agree that the aforementioned approach to determining full employment is superior to what is currently done. However, such tweaks do not reflect the reality that most well-paying sectors that once employed lower-skilled workers have all but disappeared. In essence, there is a growing underclass that, while technically "employed" insofar as it has work, is not enjoying "employment" in the sense that it once was, i.e. permanent, full-time jobs, that provide benefits and pay a middle-class salary.
When gaging the health of the economy comparing the unemployment rate from 2018 to that of 1988 simply makes no sense, let alone comparing it to the unemployment rate from 1958. And this says nothing with regard to the growing difficulties pollsters have reported in gathering data using fallible voluntary surveys, as Canada's Global News reports.
How the Central Banks View the Unemployment Rate
Earlier this month Federal Reserve Chairman, Jerome Powell addressed the current economic climate and what is reported as record low unemployment, saying "historically rare pairing of steady, low inflation and very low unemployment is testament to the fact that we remain in extraordinary times" (see here).
This, of course, was an implicit reference to the (in)famous Phillips Curve, used by the Federal Reserve for decades, and continues to be used today. It posits that lower unemployment should lead to higher inflation, since a low unemployment rate implies increased leverage for workers making wage demands, creating higher costs for firms and eventually higher prices for consumers.
With all due respect to Mr. Powell, while I agree that we live in an "extraordinary time" I don't believe it is for the reason he believes. As we have seen, the unemployment rate is in itself a tricky figure to measure, and controversial. But its greatest weakness comes from the "two economies" that have emerged, particularly in North America, since the 1950s.
The Phillips Curve first appeared on the scene in 1958. It seemed to fairly accurately describe economic forces for about two decades. However, the 1970s saw a time when high inflation was accompanied by growing unemployment, and the curve's predictive validity came under fire.
Just as importantly, almost from the moment, A.W.H. Phillips published his famous study, union membership was beginning its slow decline to current levels, as my first chart above shows. Regardless of one's views on organized labour, it is indisputable that reduced unionization means workers typically have less leverage than when collectively bargaining for wages and benefits.
For example, government employees represent the last bastion of the defined benefit pension plan, now almost unheard of in the private sector, and it is no coincidence that the former also tend to be more widely unionized.
The plunge in private sector unionization since the 1950s should have obvious implications for usefulness of the Phillips Curve. But the problems do not end there.
During the 1950s, as I showed, manufacturing began its decline as a major employer of low-skilled labour. In addition, the "gig economy" really took off in the late 1990s and early 2000s part-time and temporary employment now accounts for increasingly large portions of the workforce, especially (but not exclusively) for the low-skilled. Thus, while in recent decades unemployment rates have often compared well to historical rates, they are no longer measuring the same thing.
This presents a problem for interest rate policy. The most recent Fed Beige Book (see here) cites strong demand for high-skilled labour, as would be expected, given the low official unemployment rate. However, there is also growing demand for unskilled labour, like "restaurants and retailers". This, too, is to be expected and is not in itself a bad thing.
The problem arises from the fact that these jobs do not provide middle-class incomes. Yes, many North American jurisdictions have raised minimum wages, and some companies, like Starbucks and Amazon, have increased their starting wages. However, these increases do not compare to the kinds of wages that most manufacturing positions, for example, once paid.
As the New York Fed recently reported, "traditional middle-skill workers have seen their jobs disappear; forcing more U.S. workers to take lower-wage jobs" (see here). Worse, they also concede that those who end up in minimum wage jobs are now likely to stay there, and the odds of moving up the career ladder for minimum wage workers declines the older the employee. This is another problem because as Statistics Canada reports, the average age of minimum wage workers is increasing (see here).
All this supports the observation that there are now indeed "two economies" and that an increasingly permanent underclass has consolidated since the 1950s.
The "extraordinary times" that Fed Chairman Powell refers to do not seem so "extraordinary" now. The low rates of reported inflation make perfect sense given the shrinkage of a middle-class from whence rising wages should pressure prices.
So what is a central bank to do? An "overheating" job market for high-skilled workers may well justify tighter monetary policy, at least if one accepts current policy-setting paradigms. However, tighter policy may prove to be a body-blow for an underclass that barely, if at all, earns a livable wage. Even if tightness in the low-wage economy eventually produces those much-feared modest pay increases, the fact remains that said workers will not suddenly explode into the ranks of the middle-class as a result. They will still only represent the afterglow of a once-prosperous consumer-class that no longer exists, and likely never will again.
Recently Chairman Powell has signaled that his incarnation of the Fed, like that of his predecessors, still views the Phillips Curve as a key consideration when setting rate guidance. Many, including your humble author, believed (or at least held out hope) that the new regime would perhaps step back from its tightening schedule. We were apparently wrong, as continued tightening appears to be with us at least another 12 months.
Most investors see the biggest implications from continued tightening in terms of how it will affect bond yields and stock prices. These are certainly genuine considerations. However, other considerations may be slipping below the radar.
As I showed in my two most recent articles, many segments of the "other economy", i.e. the 60% constituting the lowest earners, is running up record amounts of consumer debt, often to simply pay the bills. Moreover, I also demonstrated that cost-of-living increases are hitting this underclass more acutely than the upper 40% of earners, and more acutely than CPI would suggest.
It's not clear how much higher rates can go without breaking the backs of large swaths of low-income earners.
Recent data (see here) suggest a mixed picture. US consumer FICO scores are actually looking strong, especially compared to their post-crisis 2009 lows. However, consumer debt has grown every consecutive quarter now for over four years and has once again reached a new nominal record high (a record originally set in Q2 2008).
Meanwhile, the aforementioned student loan crunch is growing worse even in the face of falling enrollments. Bloomberg reports that increasingly "analysts worry that the next generation of graduates could default on their loans at even higher rates than in the immediate wake of the financial crisis".
Thankfully, credit card delinquency rates in the US are still quite low at 2.93%, at least when compared to their peak 2009 level of 6.7%. Following the financial crisis, delinquencies declined to a low of 2.12%. Since then, however, the trend has been climbing higher, as the current rate attests, though still not high enough to cause widespread alarm. Similarly, in Canada, delinquency rates are slightly higher at 3.02% but recent reports warn they are expected to climb to 3.63% next year.
Thus, we cannot dismiss the effects of a potentially destabilizing rising rate environment in the US and beyond. The Congressional Budget Office is already predicting slower growth for 2019, while the IMF is cutting growth forecasts globally. Slowing economies around the world, from Germany to Brazil, seem to corroborate this somber view.
It is a good bet that we are in the latest stages of the current economic expansion. In other words, it's not going to get better. All signs suggest we are at a turning point, and a recession is statistically overdue. The growing debt loads of consumers - especially the lower 60% - despite an "extraordinary" job market, to quote Chairman Powell, should be factored into your macro picture.
There is one other important consideration, dear readers: namely, how the growing political backlash from a growing underclass may continue to affect the world's economies, and our money. But I'll leave that for my next article.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.