Tags: recession

More Americans Will Stay Jobless Than You Think

Monday, 04 May 2009 12:06 PM Current | Bio | Archive

Warren Buffett said, on Saturday: "The recent drop in consumer spending and the resulting pressure on retailing, manufacturing, and services industries could last quite a long time. … I think our retail businesses will not do well for some time as U.S. consumers save more. … I would not look for any quick rebound in retail, manufacturing, and services businesses."

Everybody will agree that Buffett is well placed to gauge the health of the economy, since his holding company, Berkshire Hathaway, owns 67 non-insurance operating companies, and many of these businesses are in economically sensitive industries such as retailing, manufacturing and real estate.

It seems to me that Buffett didn't buy at face value the first quarter GDP report that showed misleadingly positive news about U.S. consumer's health.

Nevertheless, markets seem to have overlooked the more recent March numbers on personal income, which were more pessimistic about consumers than the Q1 GDP report seemed to suggest.

In March, consumer spending turned negative again, with a 0.2 percent decrease after gaining 0.4 percent in February. March spending was below the market projection of no change. It showed consumers having less income to work with and a pullback in outlays at the end of the first quarter.

Investors should take notice that this indicates possible erosion of the consumer sector in the second quarter GDP results.

All that said, the continuous climb in unemployment in the United States and globally is expected to unleash a powerful and lasting disinflationary impulse.

Data on labor compensation are already starting to show the leading edge of this effect. Friday's U.S. Employment Cost Index (ECI) report delivered a downside surprise, with overall compensation slowing dramatically to just 2.1 percent year-on-year ending in March 2009, down from the 3.3 percent increase for the year ended March 2008.

In private industry, benefit costs increased a mere 1.6 percent, much less than the increase for state and local government, which was 3.4 percent for the 12-month period ended March 2009.

In developed countries, too, we see personal income growth slowing in the U.K. and Japan, with bonuses and overtime getting hit harder than core pay. By comparison, hourly earnings do not appear to have been much affected yet in Canada or Germany. A look back at the previous recession shows that hourly earnings eventually responded forcefully to the run-up in unemployment.

Investors should take into account that this suggests that there is much more of a downshift in personal income to come across the developed economies.

The increases in U.S. and global unemployment have clearly begun to dampen pay. The downshift in personal income is expected to deepen and broaden in coming quarters. Take care, as this will translate into a sharp slowing in core inflation.

Hundreds of thousands of jobs are now vanishing forever in industries such as auto manufacturing and financial services. Edmund Phelps, the 2006 Nobel Prize winner, states that fallout from this Great Recession will imply a "markedly higher" natural rate of unemployment: "It was 5.5 percent, maybe it will be 6.5 percent, maybe 7 percent."

The current administration and the Fed are counting on the jobless rate to fall to a medium-term equilibrium of about 5 percent as the economy recovers. I don't think those expectations will be met.

A significant rise in the natural unemployment rate will drive up the annual budget deficit, which already tops $1 trillion for the first time this year, in part because of lower tax revenues and higher spending. Everybody, too, will have to reconsider what they call the "natural" rate of unemployment, which is the level that neither accelerates nor decelerates inflation and what normally should provide a state of equilibrium that is often described as "full" employment. This will also force the Fed to make a hard choice:

Accept an economy with more Americans permanently out of work, or try to boost employment at the risk of heating up inflation.

For now, we can only guess at their final choice.

In the meantime, layoffs that are now taking place are similar to those in the 1981 and 1982 recessions when unemployment peaked at 10.8 percent and 2.8 million jobs disappeared, leaving industries such as durable-goods manufacturing, permanently smaller.

Some 14 percent of durable-goods positions vanished in that slump and the sector never regained the employment level of June 1981.

As Lawrence Mishel, president of the Economic Policy Institute in Washington, recently stated: "People tend to think that when you come out of a recession you get the labor market you had when you entered it. … This time you may get something quite different."

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Warren Buffett said, on Saturday: "The recent drop in consumer spending and the resulting pressure on retailing, manufacturing, and services industries could last quite a long time. … I think our retail businesses will not do well for some time as U.S. consumers save more....
Monday, 04 May 2009 12:06 PM
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