Ride My See Saw

Yesterday's employment data is the latest story in the up and down emotional ride on Wall Street. Optimists (blind optimists I say) become practically giddy when data indicates that the pace of economic contraction is slowing. Yet when data, such as yesterday's Non-farm Payrolls report indicates that the employment situation has worsened, those with rose colored glasses point out that NFP is a lagging indicator. Fair enough, but we have had this "lagging indicator" at troubling levels for a year. When do the Pollyannas concede that the economy is still in decline?

Other data gives us a clue as to the true state of employment. One is average weekly hours. Yesterday's report indicated that average hours worked in the U.S. fell to 33 hours, the worst in four decades. This indicates that not only are many Americans unemployed, but many are underemployed. Many workers who desire full-time employment are working part-time jobs to survive. Labor underutilization (combined unemployment and underemployment) stands at approximately 16.5%. There can be no economic recovery if there is not an employment recovery. Jobless recoveries are not true recoveries.

Many economists are calling for economic recovery to began in the second half of 2009, but is that what they are really saying? In reports I have read by economists at most major firms, the pace of recovery is expected to be under 2.00%. That is not all that strong. Also, signs of recovery in the second half 0f 2009 may only be a dead-cat bounce of the bottom. In other words, it may only be a correction of an downside overshoot as the economy worsened. Even a dead cat will bounce if it is dropped from a high enough place. The more dramatic the fall, the more significant the bounce, but as with a dead cat, the economy will settle back down to reflect the economic conditions being experienced by consumers.

Why then do many strategists and financial media types keep forecasting a robust recovery, at some point? For one, they have agendas, but it is mostly due to their being creatures of habit. During the past 25 years whenever the economy would stall, the Fed would simply lower rates making leverage less expensive. Wall Street would use "innovation" to make leverage available to an ever-wider group of people. This created an accelerant-driven economy. The problem is that such stimulus is finite. One cannot cut rates forever. It all ends at 0.00%, where the Fed Funds rate is now.

It is the lack of leverage which will curb economic growth. The key here is not to figure out how to increase leverage again (this is how we it into this mess), but prices and salaries will have to moderate. That's right, we need modest inflation or (dare I say it) deflation. Put away your smelling salts, I am not suggesting that the U.S. engage in a purposeful deflationary policy, but let's be realistic.

Let's consider home prices. The price of homes in many areas of the country far out-paced inflation is most other sectors. Home prices need to be permitted to continue to fall to prices at which prospective home buyers can afford and obtain mortgages. This is capitalism. Will some consumers feel less wealthy and pare spending? Yes. Will they be unable to go on home equity fueled spending binges as they have during he past two decades? Absolutely, but any time you stimulate the economy by using leverage, you are moving future sales forward. Just like a person taking stimulants to avoid sleep. Staying active longer only means a longer, deeper sleep later on. U.S. consumers will have to learn to live within their means.

I think consumers can do this, but businesses such as home some builders and some auto manufacturers cannot survive in a productivity drive economy. Home builders who can profitably sell $250,000 homes will survive. Those who need to sell large quantities of $500,000 McMansions will not. Auto manufacturers who can sell $25,000 vehicles profitably will survive. Those which need to sell $45,000 SUVs for profit will fail. This also means that overhead (wages and benefits) in these industries must also fall. Good luck with the current administration.

Also beware of Keynesian policies. Money spent on government job projects (roads, etc.) are almost never efficient and will only have minimal benefits for the economy. Making energy more expensive will not spur the creation of green energy. It will just send more manufacturing offshore where it can be done more cheaply.

What is my prediction for the economy? I think that when the economy expands, it will settle in at growth rates between 1.00% and 2.00%. Wages will rise slowly. Home prices will fall further before settling in and rising with an inflation rate similar to that of growth. Chrysler, GM and Ford will either fail or shed the UAW. Success and the UAW are incompatible.