Wednesday, September 9, 2009

A Consumer Economy at a Standstill; Rob Parenteau Looks at Where the Labor Market May Be Heading

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The Daily Reckoning
Wednesday, September 9, 2009

  • The US economy is still stuck on the runway...
  • Personal spending is dropping further than most expected...
  • America is no longer the world's most competitive economy...
  • Rob Parenteau looks at where the labor market may be heading...

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    A Consumer Economy at a Standstill
    by Bill Bonner
    London, England

    This recovery is wonderful in every way, except the important ones. It is like a shiny new airplane. It has glossy aluminum wings. It has plush seats in the first class section. Trim stewardesses serve drinks. Movies are available on demand in all sections.

    A majority of those polled by Bloomberg think things are great; 61% said they thought they economy had taken off and was flying high. Stocks are up. Commodities are up. And here's another Bloomberg headline: "Global investors give Federal Reserve Chairman Ben S. Bernanke top marks..."

    The recovery has won the approval of economists and the public. It has almost everything going for it. It just won't fly!

    Comes news this morning that the US economy is still on the runway. This report from the AP explains why:

    "Consumers slashed their borrowing in July by the largest amount on record as job losses and uncertainty about the economic recovery prompted Americans to rein in their debt.

    "Economists expect consumers will continue to spend less, save more and trim debt to get household finances decimated by the recession into better shape. Such behavior, though, is a recipe for a lethargic revival, because consumer spending accounts for 70 percent of economic activity.

    "The Federal Reserve reported Tuesday that consumers in July ratcheted back their credit by a larger-than-anticipated $21.6 billion from June, the most on records dating to 1943. Economists had expected credit to drop by $4 billion."

    Hey, not bad...economists were only off by 430%. Consumers are paying down debt more than four times faster than they thought. Partly because they want to. And partly because they have to. They don't want to borrow...and banks don't want to lend to them anyway. Consumer credit is falling at a 10% annual rate, based on July figures. Credit card debt is going down at an 8% rate.

    When they pay down a dollar's worth of debt that is one dollar less in the consumer economy. But it's also a dollar that is not borrowed. Where the consumer spent all his income two years ago...and borrowed more so that he could increase his consumption even, he doesn't borrow...and he doesn't spend all his income either. Now, the money that used to pour into consumer spending leaks out.

    As we reported yesterday, personal spending is dropping...the figures were down in four of the last six quarters - something that has never happened before, since they began keeping records in 1947. And the level of consumer spending is down 33% from a year ago - with discretionary spending now down to a level it hasn't seen in 50 years.

    Of course, that's just what we've been saying. The great credit expansion began in 1945. It ended in 2007. Credit will contract for many years. One study, also reported here, suggested that consumers would spend 14% less - even after the economy was back on its feet. We estimate that the total level of debt must go down below 200% of GDP. If that's correct, we need to pay down about $25 trillion of debt. That won't be easy and it won't be quick.

    And it will mean high levels of joblessness for a long time. Already, two out of five working-age Californians are unemployed. The other three are working the shortest workweeks in history. No wonder; with spending dropping, sales are falling. So businesses don't need so many people to make, ship, sell and service their products. Then, of course, when they lay off workers to cut expenses, the unemployed workers have to cut spending!

    How is it possible for a consumer economy to grow when consumers are spending less money? Of course, it's not. This is not a genuine's an imposter. A fraud. A recovery impersonator.

    [And as we've all figured out by now, the government is just going to keep throwing money at the economic problems, in the form of 'bailouts'. Despite what you may think, this money isn't just for the banks or the auto industry...due to a legal 'loophole', you can start collecting 'bailout income checks' - totaling up to $17,500 in this year alone. Get your first check now.]

    More news from The 5 Min. Forecast:

    "The great deleveraging has entered a new chapter. We Americans shed $21.6 billion worth of personal debt in July, excluding mortgages, the Fed quietly announced yesterday. That's the largest monthly deleveraging (measured in dollars) in American history.

    "Factor in the last 12 months or so, and the trend is clear: Not only are Americans getting rid of debt, but they are doing so at an accelerating rate.

    Consumer Credit Contraction

    "In other terms, July's decline marked a 10.3% annualized rate of debt dumping, the biggest since 1975.

    "We're proud of the Average Joe... Like any addiction, weaning off easy money isn't easy. We've had to do it ourselves, personally and professionally, and it's not exactly fun.

    "But we suspect this is lousy news for banks and retailers. As we've forecasted numerous times in these pages, most creditors are currently drumming up plans for the recovery - not bracing for a long slog of continued credit deleveraging and default. Here's one example: Wall Street expected a consumer credit contraction of $4 billion in July. Off by more than a factor of five, it's safe to say the men behind the curtain are just a bit out of touch.

    "And we hasten to add, July's record delveraging included a healthy chunk of the cash for clunkers program. You know... That 'stimulus' where the government gave you $4,500 to get rid of your working car in exchange for a new car and $15,000 of debt.

    "How much further could this credit contraction go? Heh, here's the above chart, zoomed out a couple decades:

    Outstanding Consumer Credit

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    And back to Bill, with more thoughts:

    While the private sector is paying down debt, the public sector is adding debt at a ferocious pace - about $150 billion per month. Public spending isn't the same as private spending. It is usually spending for things that people wouldn't buy if they had a choice.

    And it comes with a whole new risk attached - the risk that the feds will inflate their way out of debt rather than pay it off.

    Government spending does not bring a durable, real prosperity. (If it did...think how easy it would be to make people rich; governments love to spend money!) It may look like a recovery. It may have shiny wings and spiffy-looking stewardesses. But it won't fly.

    [Don't let the out-of-control government spending drag you down. Set up a barrier between them and your assets - with your own personal bailout. Everything you need to get started can be found here.]

    The World Economic Forum has taken the United States down from the number one position. America is no longer the world's 'most competitive' economy. That title goes to Switzerland.

    Meanwhile, the US banking system is rated #109 in the world - just below Tanzania.

    "More than one in four US banks announced an unprofitable quarter," Strategic Short Report's Dan Amoss tells us.

    US banks became leveraged casinos during the bubble years. They've still got a lot of leverage...and are still trying to relive those glory days when players lined up to spin the wheel...and free drinks flowed by Niagara Falls.

    Dan will certainly find the best way to play the downfall of US banks - after all, he did call the collapse of Lehman six months early - leading his readers to as much as a $200,000 profit. Look for regular updates on the banking industry from Dan in these pages...

    [In the meantime, check out Dan's latest report. In it, he details his new short idea: one of the hundreds of smaller US financial institutions that will burn through capital like a hot knife through butter. It will have a hard time "earning its way out" of its rising credit losses over the next few years. Find out how to play it by clicking here.]

    "Keeping up with children is a full-time job," said Elizabeth last night. "There is always at least one of them who needs help. Sometimes more than one.

    "Sometimes I wonder if we shouldn't devote ourselves more fully to helping them. That's our main project, isn't it? It's the thing that is most important, isn't it?

    "So...shouldn't we go to where they are...and give them them get their careers and families established? I mean, we're in Europe. Our children are mostly in the US. Shouldn't we go back so we would be available to help them? Maybe we should rent a house in Los Angeles and stay there until Maria's acting career is on a more solid footing, for example. At least she'd have somewhere to go for Thanksgiving...

    "The prevailing view in America is that children leave the nest when they are 18 or 21...and then, they're on their own. But that's not the view here in Europe. In Paris, I know lots of parents who stick with their children all their lives. They spend their vacations together. The parents buy an apartment for the children. They direct their careers...and pass judgment on marriage prospects. Not that the children always listen, but one generation is not left to its own devices. That's why inheritance is such a touchy issue in France. People aren't expected to make it on their own...they're expected to get as much support from the family as possible...

    "Sometimes I think we should take the same attitude. And we do to some extent. Still, I'm not sure the children would appreciate our help. I'm not even sure our help would really be much use. Sometimes they just need to make their own mistakes...

    "Besides, we have our own projects...our own lives. I just don't know what is best..."

    Until tomorrow,

    Bill Bonner
    The Daily Reckoning

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    The Daily Reckoning PRESENTS: The US unemployment rate is up to 9.7% - a level unseen since the recession of 1982. It's estimated that currently there is one job opening for every six people looking for work. Below, Rob Parenteau digs a bit deeper to get a read on where the labor market conditions may be heading. Read on...

    Unlabor Day
    by Rob Parenteau
    San Francisco, California

    As the summer draws to a close, the unemployment rate has stepped up 0.3%, to 9.7%, a level last seen coming out of the horrendous double- dip recession of 1980-2. Yes, private payrolls shed less than 200,000 jobs in August, which is a vast improvement over the nearly 750,000 jobs shed in the opening month of the year. But as summer draws to a close, look around and realize nearly one in 10 of your neighbors is chewing on their fingernails and trying to hustle up a new gig. Perhaps we should rename the recent holiday Unlabor Day, in honor of those sweating out one of the toughest job markets of the post-World War II period.

    From a mainstream economic perspective, it should be renamed Leisure Day, as unemployment is interpreted as an individual choice of leisure over paid labor effort. Of course, only a tenured professor could be expected to come up with such a conclusion. As it stands, it is currently estimated there is one job opening for every six people looking for work.

    Since employment is a lagging indicator of economic activity, we learned over the years to dig deeper than the headline figure to get a read on where labor market conditions may be going. One of the more useful, but often ignored, parts of the employment report tells us about the percent of private industries that are net offering jobs. Even when payrolls are shrinking in total, some industries are still net hiring - and, indeed, this is part of how markets facilitate the reallocation of productive resources during a recession, which, as the Austrian approach reminds us, is crucial to long term-growth prospects.

    This measure is called a diffusion index, and we prefer to look at the average in this series over the past three months to avoid too many miscues. As it stands, the breadth of private industries net hiring, though still at a lower level than the last recession, has consistently climbed from the March lows. The pace of broadening is even a bit stronger than what we observed in the last exit from a recession, which, as you may recall, was followed by a jobless recovery. If the slower pace of layoffs is all a sugar high from extreme policy measures, or if a double dip is about to open up before investor eyes, this is one of the places it should show up first. So far, this diffusion index is more consistent with an unemployment rate that peaks near year-end around 10% and begins to show some improvement in Q1 2010. We would also note while survey results still report perceptions of a very difficult job market, these measures have stabilized in recent months.

    Industrial Hiring Practices

    When firms start shedding labor more aggressively than their production activity is contracting, labor productivity (output produced per hour of work) tends to reaccelerate as the pressure on the remaining work force intensifies. In fact, productivity growth has begun to rebound, and we believe it has a good shot at pushing through 4% year-over-year growth by year-end, from the current 2% pace in the nonfarm sector. At the same time, businesses struggling to stay alive have pressured labor compensation growth. Hourly compensation (wages and benefits) growth has been on a disinflation (that is, decelerating inflation) path through the entire recession. We suspect it will be flirting with deflation near year-end, which is something we have not seen since Q4 in 1949.

    If we put these two developments together - labor compensation growth approaching deflation, while labor productivity growth reaccelerates - we get deflation in unit labor costs. Companies that can hold the line on pricing while unit labor costs are falling will tend to experience rising profit margins, and rising profit margins are generally a signal to expand production. Improving cost conditions are one benefit of recessions, and if final demand can stabilize or improve from sources other than the household sector - say, fiscal policy or an improvement in the trade balance or the onset of some replacement capital spending - then this can be a route back to economic recovery. We will have more to say about this in the next monthly letter, but for the moment, it does look like firms are successfully compressing cost conditions.

    Compressing Unit Labor Costs

    This matters because with the release of Q3 S&P 500 earnings in October, we suspect strong operating leverage will become apparent to equity investors. Earnings improvement through Q2 has been all cost cutting related in a flat or falling revenue environment for most companies. If Q3 begins to show top-line revenue improvement, as we suspect it will, then earnings will be fed by both revenue and profit margin gains. After the seasonal September jitters, the exposure of the operating leverage available to firms that have cut to the bone could very well capture the imagination of investors, leading to the next leg in the advance of US equity indexes since early March.

    According to supply managers in the manufacturing sector, goods sector production has been on the rise since June, and new orders are through the roof. By way of reference, the new orders index was scraping a new historical low back in December, rivaled only by the 1980 lows following Fed credit controls. Never before in the six decades of Institute for Supply Management (ISM) records have new orders surged so dramatically in any eight-month span. Never before has the ISM new order and production indexes recorded these levels without marking an escape from recession. No doubt the "cash for clunkers" sugar high has something to do with this, but we doubt it explains away all of the dramatic reversal in supply manager perceptions, as the export indicator in this report has also improved remarkably since the December 2008 lows.
    "As summer slips away into the flaming leaf show of fall, we conclude the labor market is still a mess, but we can find some broadening of hiring activity even though total payrolls are still contracting."

    These ISM results are usually good for a three-four month lead time on government reports for industrial production, shipments and new orders. We can anticipate the rebound depicted above will now reverberate in the monthly reports from here to year-end, at a minimum. In particular, the ISM production index has provided a reasonably good guide to year- over-year momentum in manufacturing production.

    The sharpest monthly contractions in industrial production began in September of last year as the credit markets went into cardiac arrest, and all parts of the economy went into a cash grab/cash conservation mode so that prior cash commitments could be met. This included dramatically reducing production and liquidating existing inventory stocks. In other words, the comparisons against year ago are about to get ridiculously easy, and a healthy 5% year-over-year manufacturing production growth rate is certainly within reach by year-end 2009.

    Production Rebound

    As summer slips away into the flaming leaf show of fall, we conclude the labor market is still a mess, but we can find some broadening of hiring activity even though total payrolls are still contracting. That means the necessary reallocation of productive resources, which is part of the function of recessions, is under way. More importantly, unit labor costs are falling as the pace of layoffs has overshot the contraction in output, and labor productivity is improving as a consequence, which is a second growth encouraging outcome of recessions.

    The question remains what lies ahead after the massive quantitative easing operations of the Federal Reserve have lapsed and the bulk of the fiscal stimulus is behind us. In the very near term, we can surely expect auto sales to wilt following the end of the cash for clunkers program, but we remain impressed by what supply managers in the most cyclical part of the economy, namely manufacturing, have to say about new orders, production and export conditions. Policymakers panicked and adopted a "whatever it takes" stance, one that has proven to be the most radical outside of major wartime conditions. Looks like something took - and not surprisingly, gold is taking out the $1,000 per ounce mark at the same time.


    Rob Parenteau
    for The Daily Reckoning

    P.S. Though we have a long road ahead of us, there are ways you can protect yourself and your assets from the second leg of this economic downturn. In fact, in my latest report, I detail not only these 'super shields', but also at least five ways for you to see potentially money- doubling and even money-tripling gains over the next few months ahead. Get this report here.

    Editor's Note: Rob Parenteau edits The Richeb├Ącher Letter, founded by the late Dr. Kurt Richeb├Ącher. Each issue provides an examination of the world's currency and credit markets. Previously, he spent 24 years as Chief US Economist and Investment Strategist for RCM Capital Management, an asset management firm. Rob holds a CFA and was appointed a Research Associate at The Levy Economics Institute in 2006. His papers have been presented at the Political Economy Research Institute, the Seventh and Eighth Annual Post Keynesian International Workshop, and the Eastern Economic Association.

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