But What The Hell Do I Know...

images from lakekatherine.org & New York City Bowery bread line

Happy 4th of July! This Independence Day weekend was greeted with plunging markets, "green shoots" shriveling and a sharp drop in consumer confidence thanks to the release of the June employment numbers from the Bureau of Labor Statistics.

Chances are, you've seen the headline statistics as well as the chatter about how they're worse than "predictions". It never ceases to amaze me how the politicians and pundits put weight in economics predictions when they are almost always wrong. Read The Black Swan, people. Forecasting is a suckers game and history proves it time and again.

Anyway, here's the headline June numbers (via Bloomberg):

• Total employment loss: 467,000 (up from 322,000 in May)
• Unemployment rate (U-3): 9.5% (up from 9.4% and the worst since 1983)

The only areas of the economy that didn't get hit were the health and education sectors, which are enormously subsidized by the government (hell, education is nearly monopolized by Uncle Sam). These are the numbers everyone is talking about, but like all statistics, the real value in the data lies below the surface.

The "Real" Unemployment rate

There is another unemployment metric which is less quoted in the media, perhaps because the numbers are much higher. This broader number is called the U-6 seriesand in June it rose to 16.5%.

You read that right, 16.5%. That's a number comparable to 1931.

Mike Shedlock, who dug deep into the number atMish's Global Economic Trend analysisagrees:

I consider these job losses to be depression level totals. Admittedly conditions are not as bad as the great depression, but this is certainly no ordinary recession by any economic measure including lending, housing, bank failures, jobs, the stock market, commodity prices, treasury yields etc...

Regardless of whether you think these are depression level statistics, unemployment is high and rising. Moreover, the "adverse scenario" in the Fed's stress test was unemployment at 10.3% at the end of 2010.

This analysis is upsetting, as is the U-6 number.But what is this number and how does it relate to the historical record? U-6 is a broader definition of employment that tries to catch a wider net on both the unemployed AND the "underemployed". The BLS report defines it like this:

Total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all marginally attached workers.

That's a dense description. Luckily, the report provides a little help with their terminology:

NOTE: Marginally attached workers are persons who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the recent past. Discouraged workers, a subset of the marginally attached, have given a job-market related reason for not looking currently for a job. Persons employed part time for economic reasons are those who want and are available for full-time work but have had to settle for a part-time schedule.

Many bloggers and critics of the broadly cited unemployment numbers like to point to this higher U-6 as a more "real" measure of the level of employment in the country, especially when considering our current bust in relation to the Great Depression. It's clearly in the interest of the government to have it's media boosters focus on the lower of the two numbers. And since the government's statistics (like all aggregate measurements) are loaded with assumptions and statistical errors, a healthy dose of skepticism should be brought to all of these numbers.

How "Real" is U-6?

There is appealing logic to this criticism of the seemingly willful ignorance of U-6 by politicians and media pundits. If people that want or need full-time work can only find a part-time job, that seems like important information about the health of the economy. But what makes U-6 more "real" than the broadly used U-3 number? While geeking out in the comments at NPR's excellent Planet Money Blog, I was directed by a helpful commenter to an article by Harvard economist Jeff Frankel about the value and application of unemployment stats.

Critics of the official statistics like to point out that the unemployment rate does not capture discouraged workers who have dropped out of the labor force because they couldn’t find a job. True. But the government isn’t trying to make the unemployment number look smaller. Rather, it is just too difficult to decide who is a “discouraged worker,” as opposed to simply being out of the labor force. So the BLS always defines only those who have looked for a job recently as being in the measured labor force. This still allows us to compare changes inunemployment over time, which is the purpose of the unemployment rate. (The agency does compute a measure that attempts to include discouraged workers and part-time workers — theU-6series – but I don’t think it is right to call this the “realunemploymentrate.”)

Frankel's point about using the numbers to compare changes over time instead of judging them on their own is interesting and, I think, valid. In fact, I'd go one step further and say that ALL macroeconomic measurements of this kind, including and especially GDP and the balance of trade, have almost no inherent value outside of demonstrating trends.

Personally, I'd rather not know these numbers at all. Policy makers have and will always abuse them in pursuit of their ideological, election-driven agenda, and the time delays between getting the data and policy actions usually renders them irrelevant (and inflationary).

Wages: Not so Sticky

The most interesting thing of note in the numbers, in my opinion as well as Frankels', is the information about the amount of hours worked (though for different reasons).

For this reason, the third indicator is my personal favorite for gauging the business cycle in real time: the rate of change of total hours worked in the economy. Total hours worked is equal to the total number of workers employed,multiplied bythe length of the workweek for the average worker. The length of the workweek tends to respond at turning points faster than does the number of jobs. When demand is slowing, firms tend to cut back on overtime, and then switch to part-time workers or in some cases cut workers back to partial workweeks, before they lay them off. The phenomenon is called “labor hoarding.” Conversely, when demand begins to rise, firms tend to increase the workweek, before they hire new workers.

The workweek reached a historically short level in June: 33.0 hours. Not a good sign. As one consequence, total hours worked fell 0.8% that month, continuing the same rapid deterioration we have seen since last September, the month when Lehman Brothers failed and the recession worsened sharply.

Frankels sees hours worked as important because he believes it provides a more accurate picture of the economic outlook, and that may be true. But I see it as something different: falling wages. As Planet Money reports:

You could also look at what's happening to wages, which areflat, flat, flat.Ian Shepherdson of High-Frequency Economics writes, "[O]minously, hourly earnings were unchanged for the second time in three months." He predicts, "Wages will soon befalling outright, a classic deflation signal."

Though I'm not sure Mr. Shepherdson is doing so here, I believe that it is wrong to conflate the price of labor with hourly "wage rates" and this has huge implications for policy, in ways that aren't obvious. Worker income and labor costs aren't "flat, flat, flat". It's dropping.

You see, the heart of the economics behind "stimulus" is the idea, first proposed by John Maynard Keynes in the 1930s, that prices and wages are "sticky" downward: they rise but don't fall. The "classical economists" believe(d) that when demand for labor fell, causing a period of surplus labor (unemployment), nominal wages would fall until the labor market moved back towards equilibrium (full employment). And since wages represent the majority of the cost of goods, prices would ultimately fall along with them, leading ultimately back to full employment at comparable REAL wages (wages in terms of purchasing power, not nominal dollar values). After the correction of the recession, you might be making less in dollars, but paying fewer dollars for your goods.

One of the ways in which Keynesian economists point to the "stickiness" of wages is by looking at hourly wage rates. Look! Wages are "flat, flat, flat" even as the economy craters! But hourly rates aren't the true cost of labor, weekly income is. And income for workers means looking at wages multiplied by hours worked. Furloughs and reduced overtime are, in fact, cuts in total labor costs and worker incomes. This should be obvious to anyone facing cutbacks in their hours and seeing their income decline, but has been a fact that seems to escape the followers of Keynes.

Keynesians believe that this stickiness acts as a price control that can lead to permanent, or at least unnecessarily extended periods of unemployment. But prices have been dropping like stones, as have weekly incomes for hourly worker, bonuses, incomes for freelances and a host of other real incomes across the economy. Even if there was a time when union contracts and job immobility made wages more "sticky", there's little "stickiness" to be found today.

I'm not saying that prices and wages aren't delayed to react to supply and demand. I'm saying that they react faster than government policy can.

Picking up the "slack"

Without "stickiness", the entire premise of "stimulus" falls apart. Stimulus through deficit spending is meant to close the "gap" between total demand for goods (low) and capacity in the economy to supply goods (higher) by re-employing workers and these "slack resources" so that their incomes can flow through the economy and "multiply" as it gets spent and re-spent. Hence the administration's talk of "multipliers" during the stimulus debate.

Basically, Keynesians look at a recession and say "we've got all these great resources going unused! Let's have the government use them for us!". Brad DeLong, an stridently partisan keynesian and one of the loudest defenders of the Obama stimulus recently said as much in a debate with free-market economist Michele Boldrin. DeLong professed "government's money is just as good as anyone else's". Indeed, Brad. Perhaps because IT IS ANYONE ELSES.

The great mistake of Keynes and his followers is that they look at the economy in the same way these unemployment numbers do: from 30,000 feet. All means of production are simply "resources" or "productive capacity" that is apparently costlessly interchangeable. In reality, that's not the case. Factories, equipment and worker's skills have specific uses and require time to retool and retrain. An auto factory can't easily be retooled to make windmills or train cars, which is why the Obama administration argued that liquidation of Chrysler and GM would have fetched pennies on the dollar for their assets. And if these "slack resources" are only worth pennies on the dollar, how could it be a good use of scarce resources to maintain them?

Stimulus & Inflationary Depression

Stimulus is, in fact, the idea of a perpetual motion machine where you magically get more out than you put in, thereby producing enough economic benefit to offset the costs of the debt. Paul Krugman, in his recent book "The Return of Depression Economics", actually professed that stimulus during depression was the equivolent of "getting a free lunch", a reference to Milton Friedman's classic (and true) quote that "there's no such thing as a free lunch". This idea is perhaps the very core of economics in a world of scarcity.

Krugman is perhaps the most orthodox keynesian and indeed, Keynes was so confident in this effect that he didn't care if the money is spent productively, so long as the workers turned around and spent it again so that it "multiplies". This classic line from his "General Theory" says it all:

When involuntary unemployment exists, the marginal disutility of labour is necessarily less than the utility of the marginal product. Indeed it may be much less. For a man who has been long unemployed some measure of labour, instead of involving disutility, may have a positive utility. If this is accepted, the above reasoning shows how “wasteful” loan expendituremay nevertheless enrich the community on balance. Pyramid-building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the classical economics stands in the way of anything better.

Paul Krugman has referred to this insane passage with admiration and approval on multiple occasions. I've already gone through the dreadful fallacies of "war as stimulus", but this bizarre idea demands repeating because it is the very heart and soul of the Bush and Obama stimulus plans.

In reality, stimulus is simply borrowing from future potential spending in the form of future taxes to service the new debt and from current private-sector investment, who are crowded out of the market of available funds by the government's bond sales, future dampening recovery. And since people can and do rationally expect their taxes to rise in the face of huge debt, stimulus has little effect on real spending. We're seeing that now as Americans are finally paying down debt and saving their money. Too bad their government is "debt spending for them" anyway (right, professor DeLong?).

My worst fear is that, as unemployment continues to rise, a second "stimulus" plan will be passed, piling on even more debt. This is just what Dr. Krugman ordered, who believes the current $787 billion the administration has borrowed from China should have been closer to $2 trillion. Meanwhile, the current federal debt explosion is already threatening to collapse the value of our currency as international debtors come to fear default by the US government. Talk of replacing the dollar as the world reserve currency is picking up speed among our government's creditors. If that happens as a result of government debt and Federal Reserve monetary expansion to support it, we very well could be looking at an inflationary depression in the coming years.

The only thing that government stimulus stimulates... is more government...

...but what the hell do I know?