Thoughts From The Frontline
Time to Bring Out the Howitzers
It is now common to use the term bazooka when referring the actions of
governments and central banks as they try to avert a credit crisis. And this
week we saw a coordinated effort by central banks to use their bazookas to head
off another 2008-style credit disaster. The market reacted as if the crisis is
now over and we can get on to the next bull run. Yet, we will see that it wasn't
enough. Something more along the lines of a howitzer is needed (keeping with our
WW2-era military arsenal theme). And of course I need to briefly comment on
today's employment numbers. There is enough to keep us occupied for more than a
few pages, so let's jump right in. (Note: this letter may print long, as there
are a lot of charts.)
Employment Up But Not Enough
The headline number is that 120,000 new jobs were created in November, in line with estimates. That total is the sum of 140,000 jobs from the private sector coupled with the now usual loss of 20,000 jobs in the government sector. But when we look at the details, things are not as upbeat.
First, the good news: the US economy is
continuing to grow. As I have said for quite some time, the US should not fall
into a recession unless it is pushed by something from beyond our shores, which,
sadly, I expect (details below). However, we are nowhere near the typical
recovery pattern. By this time into a recovery we are usually making new highs
on the employment front. As everyone knows, we are millions of jobs from that
level.
And my friend Bill Dunkelberg, the Chief
Economist of the National Federation of Independent Business, sends us these
headlines today from his own survey:
· AVERAGE EMPLOYMENT PER FIRM ROSE
· HARD TO FILL JOB OPENINGS INCREASED,
UNEMPLOYMENT DOWN
· PLANS TO CREATE NEW JOBS NEARLY
DOUBLED
The net change in employment per firm
wasn't much different from zero, but it did have a plus sign in front of it for
the first time in nearly half a year. On average, owners reported increasing
employment an average of 0.12 workers per firm. Seasonally adjusted, 14 percent
of the owners added an average of 3 workers per firm over the past few months,
and 12 percent reduced employment an average of 2.9 workers per firm. The
remaining 74 percent of owners made no net change in employment (47 percent
hired or tried to hire and 35 percent reported few or no qualified applicants
for positions, both figures up 4 points).
The percentage of owners cutting jobs has
returned to "normal" levels (even in a great job market, over 300,000 file
initial claims for unemployment, i.e., they are fired or laid off). And the
percentage of owners adding workers (creating jobs) continued to trend up.
Reports of new job creation should pick up a bit in the coming months.
(I spent last Sunday with Bill, and we
outlined our new book on creating jobs and employment. Our goal is to finish it
in record time and have it out next spring.)
120,000 jobs is not quite enough to keep
up with the growth in the population. Along with positive revisions to previous
months, we have now averaged about 114,000 a month for the last 6 months. But
then why did the headline unemployment number fall to 8.6%?
.
That is a very large drop for one month. The simple answer is that the number of people looking for a job fell by 315,000. And the number of people counted as not in the labor force (a different measure) swelled by 487,000 to a record 86.5 million.
.
That is a very large drop for one month. The simple answer is that the number of people looking for a job fell by 315,000. And the number of people counted as not in the labor force (a different measure) swelled by 487,000 to a record 86.5 million.
Again, for new readers, you are not
counted as unemployed if you have not looked for a job in the last four weeks.
Let's look at a chart from the St. Louis Fed database that shows the number of
citizens not in the labor force. What we see is a rise from 77 million in 2007
to 86.5 million today. Part of that can be explained by population growth, but
it would be less than half of the increase of almost 10 million people not
considered to be in the labor force.
If we looked at a chart of those counted
as being in the labor force, we would see that it is roughly where it was back
in 2007, yet there has been working-age population growth of at least (my guess)
5 million. And the next chart shows the number of people that are actually
employed, private or government, full- or part-time. What we see is that the
number of people working is about where it was 8 years ago.
That is not a pretty chart. What all that
means is that unemployment would be closer to 11-12% if we went back to the
labor force of just a few years ago and adjusted for population.
Let me quickly note, too, that if we went
back to the unemployment measurement basis of a few decades ago, the numbers
would be closer to what I suggest above. Counting unemployment the way it is
currently done allows whoever is in charge to publish numbers that look better
than they are in reality on the street. I expect Republicans to point this out
in the next election cycle, although if they get into office they will have to
live with that analysis when it comes back to haunt them in four years. Because
as the next chart shows (from my friend Lance Roberts of Streettalk Advisors in
Houston), we need job growth of about 400,000 jobs a month to get back to the
long-term trend by 2020. This shows the employment-to-population ratio, which
has dropped by 6% since 2000, falling precipitously since the beginning of the
recession. We have never had such strong employment growth, and are unlikely to
get it as we reduce government spending, which we must do.
This shows above all else why the #1 issue
for the coming elections will be jobs. The US economy is looking more and more
European all the time in terms of unemployment numbers. If the course is not
changed, it will make any real recovery back to what we think of us "normal" for
the US highly problematic.
Let's quickly look at a few other problems
in this employment report. The work week was unchanged at 34.3 hours (and was
down 0.2 hours in manufacturing). Aggregate hours were up just 0.1%. Average
hourly earnings were off 0.1%, leaving the three-month average at -0.1%. For the
year, hourly earnings were up just 1.8%. When the Great Recession began, they
were rising at a 3.4% annual rate.
.
Aggregate payrolls were up just 0.1% for the past month. The decline in unemployment was concentrated among the shorter durations, with almost all of it among those jobless for 14 weeks or less. Those unemployed for 99 weeks or more rose 143,000 to 2.0 million, very close to an all-time high. The mean duration of unemployment rose to 40.9 weeks, a record. (Hat tip The Liscio Report.)
..
Aggregate payrolls were up just 0.1% for the past month. The decline in unemployment was concentrated among the shorter durations, with almost all of it among those jobless for 14 weeks or less. Those unemployed for 99 weeks or more rose 143,000 to 2.0 million, very close to an all-time high. The mean duration of unemployment rose to 40.9 weeks, a record. (Hat tip The Liscio Report.)
This does not bode well for consumer
spending. Any growth of late has come from a reduced savings rate, as income is
barely keeping up with inflation; and if you look at the inflation we "feel" in
healthcare, food, and energy, then the average consumer is losing ground. This
also means any recovery is only one external shock away from slipping back into
recession.
.
Finally, the "quality" of the new jobs is
not what we would like. More and more people are taking lower-paying jobs. We
saw 105,000 jobs in retail, temporary, and food services out of the total of
120,000. Many of these are seasonal and will fall off in the next quarter. (Let
me hasten to add that I am not being derogatory of food-service jobs. They are
important and are hard work. I have two kids who are employed in the
food-service world, and most of my kids, and your humble analyst, have been
employed in various food-service jobs at one time or another. Without those jobs
some of my kids might be moving back home! So, the next time you're out, leave a
bigger tip than normal if it's deserved. Your wait person is someone's kid!)
.The World Slips into Recession
.
How fragile is the recovery? The rest of
the developed world is either in recession or soon will be.
This next chart is from friend Prieur du
Plessis of Plexus Asset Management in South Africa. Notice that every major
region is slipping into contraction except the US. (http://www.investmentpostcards.com/2011/12/02/global-manufacturing-pmi-saved-by-the-u-s/)
Now, let's look at more details, provided
by SISR (sadly, I lost the email of the person who provided this, so I can't
credit him). It shows that outside of the US and Canada, the rest of the
developed world is watching their PMI (manufacturing production) numbers go into
contraction. Of the emerging world, only India and South Africa are growing.
Notice that the contraction in both Germany and France is getting worse month by
month.
Source: Markit Economics, SISR
How long can the US resist a global
slowdown? My answer would be, for longer than you might think, absent the
potential shock coming from Europe. But the above data does set the stage for
the rest of the letter.
.Central Bankers of the World, Unite!
.
Now, a few quick observations. This was
truly a global effort by the central banks of the world (the US, Europe, Japan,
Switzerland, Canada, and China). But then, what else did you expect them to do?
Their main tool is to provide liquidity, and that is what they promised. They
lowered the cost of coming to the "window" and certainly lowered the "shame"
factor in doing so. Going to the central bank could be seen as a sign of
weakness and, at higher rates, banks might be reluctant to do so. At the new
rate it is reasonably economical, and the central banks have signaled it is more
than OK.
Second, this effort also included China,
which cut its bank reserve requirements by 0.5%. David Kotok pointed out to me
something unusual about this. Normally, China makes it moves with a number
ending in "7," like 27 or 47, as 7 is good luck. For those paying attention,
this was China's way of saying "We are part of the team," rather than acting on
their own, as they usually do. Now, it makes sense that if you include Canada in
the "club" you should include China.
The stock markets of the world went into
an ecstatic frenzy, capping off a very positive week. But I would remind my
enthusiastic friends of a few things. Let's look at what really happened. We
just recovered from a very over-sold condition and are still down almost 7% from
this summer.
And this has happened before. Let's rewind
the clock to October of 2008, deep in the credit crisis. This is a report from
Jim Lehrer of PBS:
"JIM LEHRER: World stock markets staged a
comeback today. They did so as key governments moved to support troubled banks.
On Wall Street, the Dow Jones industrial average scored its largest point gain
ever, soaring 936 points to close above 9,387. The Nasdaq was up more than 194
points to close at 1,844. Overseas, stock indexes rose 8 percent in Britain, 11
percent in France and Germany. Markets across Asia also shot higher, including a
gain of 10 percent in Hong Kong.
News of
European efforts to end the banking and credit crisis helped ignite the rally.
On Sunday, nations that use the euro agreed on coordinated steps. Today, Britain
was first to act. It was followed by Germany, France, Spain, Portugal, Austria,
and the Netherlands."
The good news is that this week's action
may (and I emphasize may) help stave off a true bank credit crisis on the order
of 2008. That is, if the central banks of the various European countries follow
through (more on that below). The real problem was best summed up this week by
Mervyn King, the governor of the Bank of England, speaking at the press
conference to launch his Financial Stability Report.
"Many European governments are seeing the
price of their bonds fall, undermining banks' balance sheets. In response,
banks, especially in the euro area, are selling assets and deleveraging. An
erosion of confidence, lower asset prices and tighter credit conditions are
further damaging the prospects for economic activity and will affect the ability
of companies, households and governments to repay their debts. That, in turn,
will weaken banks' balance sheets further. This spiral is characteristic of a
systemic crisis.
"Tackling the symptoms of the crisis
without resolving the underlying causes, by measures such as providing liquidity
to banks or sovereigns offers only short-term relief. Ultimately, governments
will have to confront the underlying causes... The problems in the euro area are
part of the wider imbalances in the world economy. The end result of such
imbalances is a refusal by the private sector to continue financing deficits, as
the ability of borrowers to repay is called into question.
"The crisis in the euro area is one of
solvency and not liquidity. And the interconnectedness of major banks means that
banking systems, and hence economies, around the world are all affected. Only
the governments directly involved can find a way out of the crisis..." (Hat tip,
Simon Hunt.)
.Time to Bring Out the Howitzers
..
If the problem were one of liquidity, then
this week's action would be enough. But the problem is solvency. The majority of
European banks are insolvent. They own too much debt of sovereign countries that
are going to have to reduce their debts. There is a growing number of analysts
who are realizing that even Italy may have to reduce its debt burden. I have
highlighted the problems faced by Belgium. And how about Spain, and Portugal?
.
What this action does is give the ECB the
dollars it will need to loan to the various national central banks, so they can
loan to their insolvent banks. Will they bail them out, or nationalize them? The
answer depends on the country and its voters. But absent recapitalizing their
banks, there will be a credit crisis that will affect the whole world.
.
The amount of debt that will have to be
written off and the loan portfolios reduced, as well as new capital raised, is
daunting. As I have noted previously, the need is for around €3 trillion.
.
Writing off so much debt in the midst of a
recession, coupled with austerity moves, will be massively deflationary for the
eurozone. But Merkel and the German Bundesbankers have made it clear that they
will not be part of any "printing press" action that is not coupled with serious
commitments for balanced budgets. Even in the face of a recession.
Which makes it quite strange that the ECB
has been tightening in terms of money supply the past year. Notice in the graph
below that M1, M2 and M3 are all in negative territory. (Chart from the London
Telegraph.)
The ECB under Trichet was apparently
fighting inflation. He raised rates and let his inner Bundesbanker take control.
Maybe with the rate cut and the new head of the ECB, Mario Draghi, we can see
signs that the ECB may in fact act to ease. This is from my friend Dennis
Gartman, writing this morning:
"Turning to the ECB, the new President,
Mr. Draghi, has obviously taken on the most difficult of jobs and we've no
choice but to admire him for the audacity necessary to take on a role such as
his especially at a time such as this. Yesterday, Mr. Draghi made a statement
that we find tectonic-plating-shifting-like in nature when he said firstly that
the ‘Downside risks to the
economic outlook have increased.'
"They have indeed, and we've no problem
with what he said for that is indeed the truth. Then, however, the plates
shifted when he said, noting that the ECB's mandate, that price stability is to
be maintained ‘in both
directions.' In other words, the ECB's mandate forces the authorities to
be concerned about deflationary risks as well as those inflationary.
"Did you hear the plates shifting? You
should have for they have indeed shifted. Draghi's warning was that the
authorities are just as concerned about deflation as inflation and that monetary
expansion is to be considered just as has monetary contraction.
"So we are now or shall soon be faced
with a monetary and political union that is manifestly different than that which
the original united nations had signed up for AND we have a central bank intent
upon fighting deflation as strongly as it has fought inflation. These are the
attributes of a regime intent upon weakening, not strengthening, its currency in
order to strengthen the economy and to save the union if at all possible."
.
The coordinated central bank action will
make dollars available to the ECB, which will in turn loan them to the national
central banks, which presumably will loan them to their in-country banks, taking
lower-quality collateral than the ECB (which under the rules they are allowed to
do). Given the deflationary pressures that are the natural result of a recession
and deleveraging/default, they can print a lot of money without igniting too
much inflation. But I agree with Dennis; I just don't see how they can do so
without seeing the valuation of the euro fall rather smartly.
.
Merkel and Sarkozy have told us they will
meet Monday and announce a plan on December 9, when the full eurozone meets.
Forget bazookas, this needs the equivalent of a howitzer. They are seemingly
intent upon rewriting the treaty, which is the only way that the Germans will go
along with any major ECB action. But by my reckoning, a few hundred billion, or
even a trillion, is not major action, at least not on the level of what will be
needed.
.
The price for German acquiescence will be
a loss of sovereignty and the ability to run deficits of any real size for any
appreciable length of time for the countries of Europe. Will the peripheral
countries go along? Heck, forget them; will Finland go along? This situation has
been coming along since the foundation of the eurozone. The early founders
acknowledged that a tighter fiscal union would eventually be necessary if the
euro experiment were to survive. And eventually is now. As in this month. Time
is running out if they want to forestall a credit crisis that would be worse
than 2008.
.
The world is watching, as what happens in
Europe will affect us all, in every part of the globe. It could easily tip the
US into recession, and it will only be worse for the emerging markets. For
Europe, the Endgame is now. We can only hope they come up with a plan that
avoids disorderly defaults and a crisis far graver than 2008. They have no good
choices, only difficult ones and disastrous ones. Let us hope they choose
wisely.
.
(And for my fellow Americans, note that we
will face the same consequences if we do not get our own house in order, and
very soon. This is more than an academic observation.)
..It is time to hit the send button so the translator in Hong Kong can get started. In theory, no more really late nights on Friday for me. But this letter has been more than long enough. Have a great week.
.
Your wondering how we Muddle Through
analyst,
.
John
Mauldin
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