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The Dismal Science Really Is

1 7/2/2010

Some Really Dismal Numbers

Unemployment Went Down?

Earnings Take a Hit

Money Supply ConcernsA Central Bankers Nightmare

Why Don't You Reform Yourselves?

By John Mauldin

Theres a reason economics is called the dismal science, and weeks like this justgive it further meaning. In economics, there is what you see and what you dont. Thisweek we are going to examine the headline data we all see and then take a look for whatmost observers do not see. Then well try to think about what it all really means. Withemployment, housing, and the ISM numbers, there is a lot to cover. And this letter will

print out longer than usual, as there are a lot of charts. Warning: remove sharp objectsfrom the vicinity and pour yourself your favorite adult beverage. This does not make forfun reading.

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Altegris, ARP, or one of my other international partners; and if your clients need lowerminimums, then you should work with CMG. And if you have any feedback orcomments, feel free to write me. Now, on to the letter.

Some Really Dismal Numbers

The unemployment numbers this morning were just bad, even though the spindoctors were out in force. Of course we knew that because of census workers being laidoff the number would be negative, and it was, down 125,000. But the bright spot wewere told about was that private payrolls came in at 83,000 new jobs. Lets look at what

you did not see or hear.

First, last months dismal (theres that word again) private job-creation numberwas revised down from 41,000 to 33,000. So in two months, total private job creation is116,000 jobs. We need 125,000 jobsper month just to keep up with population growth.

But it is worse than that. The headline number we look at is from theEstablishment Survey. That means they call up existing businesses they know about andask them how many people are working for them, etc. One of the first things I do whenthe employment numbers come out is look at the birth/death assessment on the BLS(Bureau of Labor Statistics) web site.

For new readers, the birth/death assessment has nothing to do with people dying,but rather is the BLSs attempt to estimate the number of new businesses that have been

created or have died within the last month, and they use these numbers to adjust theemployment total. They use historical, seasonal numbers to create a model from whichthey make these estimates. There is nothing conspiratorial about the numbersthey haveto make an attempt at such an estimate, otherwise the employment number would bebadly off. But the birth/death number can skew the totals a lot more than is typicallyrealized.

Take the last two months. Using the birth/death model, the BLS assumes that362,000 jobs were created somewhere. That is three times the number of jobs in theheadlines we read. Those extra jobs were added into the total because that is what themodel told them to do. And over a complete business and employment cycle, thosenumbers willaverage out to be pretty close to right. But as I said, they can also bemisleading in the short term. Lets look closer at some of the details.

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The B/D adjustments say that we added 65,000 construction jobs in the last twomonths, over half the total number of jobs created. Really? US single-family homes setan all-time low sales number this week. Mortgage applications are way down. Home

construction is off. Commercial real estate construction is down. Where are thoseconstruction jobs?

158,000 new jobs have supposedly been created in the hospitality and leisureindustry in the last two months. And that is consistent with what normally happens insummer time. Typically, these are lower-paying jobs. (I worked a few myself while incollege.) In the actual numbers, as surveyed, they estimated only 33,000 new jobs inL&H, so the B/D adjustment accounted for nearly all the positive number.

But what happens is that most of those L&H jobs go away in the fall, so then theB/D adjustment goes negative. Further, I am not sure we can assume a typical cycle here,

to base the B/D number on.

(One more thing to complicate all this. The headline number we see is seasonallyadjusted, but the B/D assessment isnt. And we just wont go there. Thats way too muchinside baseball sort of trivia.)

But look at this chart from my favorite data maven, Greg Weldon(www.weldononline.com). It shows that the number of people planning vacations is waydown, dropping by over 35% in the last three years, for the second lowest number ever.Ever.
http://www.weldononline.com/http://www.weldononline.com/http://www.weldononline.com/http://www.weldononline.com/

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That is not consistent with a typical hospitality and leisure job-growth pattern. Ihave three kids working in that field, and the talk is not of robust job creation or lots ofovertime. (By the way, my Tulsa readers should go to Los Cabos for some good Mexican

food and leave my daughters Abigail and Amanda some really big tips! And make surethey get your name and address.)

Unemployment Went Down?

We were told that the unemployment number dropped from 9.7% to 9.5%. Thatsa good thing, right? Well, no, not really. The number dropped because the number ofpeople counted as being in the labor force dropped. If you havent looked for work forfour weeks, you are not counted as unemployed. If you add those who were taken off therolls back in, the unemployment number would have risen to 9.9%. In the past twomonths nearly one million people have dropped out of the labor market.

If you counted all the people who would take a job if they could find one asunemployed, the unemployment number would be closer to 11%. As an aside, if I haveany real beef with the BLS over how they create their data, it is this last point. If youwould take a job if you could get one, you should be counted as unemployed. Period.

The Household Survey was rather dismal. (This is where they call households andask about their employment situation.) The survey showed a loss of 301,000 jobs, or363,000 jobs if you adjust it to match the Establishment Survey. Not pretty.

Maybe a better way to look at unemployment is to look at the percentage of the

total population that has a job. That number has been rising off and on for almost 50years as more and more women have moved into the labor force. But notice the largedrop over the last yearalmost 5% of working people in the US have lost their jobs.

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The initial unemployment claims 4-week moving average stubbornly refuses to godown any further. It has essentially gone sideways for over 6 months.

If you go back and look at the data from the last 45 years, the current level istypical of recessions.

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Earnings Take a Hit

No, not business earnings, which seem to be holding up, but personal earnings.Average hourly earnings dropped 0.1% in June, something that David Rosenberg notes isa 1-in-50 event. The trend is downward, with annual growth of less than 1.7%. Averagehours worked were also slightly down.

My friend and Maine fishing buddy Bill Dunkelberg, chief economist at the

National Federation of Independent Businesses, has produced his monthly survey, andthere was not much to cheer about from a future employment perspective. Over the next 3months, 8 percent of the businesses surveyed plan to reduce employment (up 1 point),and 10 percent plan to create new jobs (down 4 points), yielding a seasonally adjusted net1 percent of owners planning to create new jobs, unchanged from May and only thesecond positive reading in 20 monthsbut barely so.

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From Dunks email: Since January, 2008, the seasonally adjusted averagechange in employment per firm has been negative in every month, with a seasonallyadjusted loss of 0.3 workers per firm reported in June for the prior three month period.Most firms did not change employment, 5% (down 3 points from May) increased averageemployment by 3.4 employees, but 15% (down 5 points) reduced their workforces by anaverage of 3.3. Job creation still hasnt crossed the 0 line in the small business sector.

Government (including health care and education) and manufacturing (a large firm

activity) has been providing what few jobs are created, weak given the magnitude ofemployment loss during the recession. And now the elimination of temporary Censusjobs will make the picture look more bleak, although more accurate. A few more privatesector jobs is not enough, we need 225,000 every month for 3 years to re-employ 8million workers who lost their jobs and another 125,000 a month to keep up withpopulation growth.

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A few more data points from this week, and then lets look at some of theimplications. The numbers from the Conference Board survey were weak. The total ofpeople planning to buy a major appliance is at an almost 16-year low. Car sales were lowlast month, and the survey says they may go lower, as plans to buy a car are down from6% to 3.7%. In fact, in almost all categories plans to buy were down. Which makes sense,as 17% of people say their incomes are decreasing.

New home inventory is back up to 8.5 months of supply. As noted above, single-family sales hit an all-time low, as anyone who wanted to buy a home did so in order toget the government incentive. Just as with Cash for Clunkers, all we did was bring buying

forward; we did not create actual new buyers, at least not in any significant numbers.

Money Supply Concerns

After the explosion in the money supply by the Fed in the depths of the GreatRecession, growth in the money supply has gone flat. We recently looked at the fact thatM-3 (the broadest measure of money supply) has turned negative for the first time inmany decades. Look at the adjusted monetary base, below.

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And now lets look at MZM, or Money of Zero Maturity. MZM is a measure of

the liquid money supply within an economy. MZM represents all money in M2, less thetime deposits, plus all money market funds. MZM has become one of the preferredmeasures of money supply because it better represents money readily available forspending and consumption. This measurement derives its name from its mixture of all theliquid and zero-maturity money found within the three M's (Investopedia). Notice thatit too has gone flat, for over a year now.

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These charts suggest that deflation is in the wind.

A Central Bankers Nightmare

Lets recap. Unemployment is high and is in reality going h igher if you countthose who would take a job if they could get one. Incomes are weak. Plans to purchasediscretionary items are falling. Housing is likely in for a further drop in prices. The stockmarket is not exactly booming. Treasury yields are falling, not from a credit crisis or aflight to quality, but because of economic conditions (deflation). Money supply is flat orfalling. Prices are under pressure. The list goes on, and all factors are indicative ofdeflation.

As noted last week, the data suggests we could see weak growth in the last half ofthe year. Over two-thirds of the past quarters 2.7% growth was from inventoryrebuilding, which surveys seem to show is abating as inventories begin to stabilize.

I was on Larry Kudlows show (links below) last Tuesday, and he gave me sometime to air my views. My main concern, as readers know, is that we may have a weakeconomy in the latter half of the year and then introduce a large tax increase, which my

reading of the economic studies on tax increases suggests will throw us into recession.Recessions are by definition deflationary. (Not to mention what another one would do tounemployment and the stock market!) With inflation at less than 1%, could we see thecentral bankers nightmare of outright deflation? We very well could. I think that is whatthe bond market is saying.

How would the Fed react? For an answer, we need to go back to Ben Bernankesfamous helicopter speech of November 2002, entitled Deflation: Making Sure It

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Doesn't Happen Here. (By the way, I have always been convinced that his remark aboutprinting presses and helicopters was an attempt at economist humor, which is why wedont get many offers from comedy clubs.)

I did a fuller assessment of that speech in my weekly letter at

http://www.2000wave.com/article.asp?id=mwo112802. But I want to pull out a fewquotes from the speech. You can read the speech itself at:http://www.federalreserve.gov/BoardDocs/speeches/2002/20021121/default.htm

Lets sum up the helicopter section: You can create inflation by printing a lot of

money. But that is not the interesting part of the speech. Quoting from my letter:

Let's look at what Bernanke really said. First, he begins by telling us that he

believes the likelihood of deflation is remote. But, since it did happen in Japan, andseems to be the cause of the current Japanese problems, we cannot dismiss the possibilityoutright. Therefore, we need to see what policies can be brought to bear upon the

problem.

He then goes on to say that the most important thing is to prevent deflation

before it happens. He says that a central bank should allow for some cushion and shouldnot target zero inflation, and speculates that this is over 1%. Typically, central bankstarget inflation of 1-3%, although this means that in normal times inflation is more likelyto rise above the acceptable target than fall below zero in poor times.

Central banks can usually influence this by raising and lowering interest rates.

But what if the Fed Funds rate falls to zero? Not to worry, there are still policy levers thatcan be pulled. Quoting Bernanke:

So what then might the Fed do if its target interest rate, the overnight federalfunds rate, fell to zero? One relatively straightforward extension of current procedureswould be to try to stimulate spending by lowering rates further out along the Treasuryterm structurethat is, rates on government bonds of longer maturities....

A more direct method, which I personally prefer, would be for the Fed to beginannouncing explicit ceilings for yields on longer-maturity Treasury debt (say, bondsmaturing within the next two years). The Fed could enforce these interest-rate ceilings bycommitting to make unlimited purchases of securities up to two years from maturity atprices consistent with the targeted yields. If this program were successful, not only would

yields on medium-term Treasury securities fall, but (because of links operating throughexpectations of future interest rates) yields on longer-term public and private debt (suchas mortgages) would likely fall as well.

Lower rates over the maturity spectrum of public and private securities shouldstrengthen aggregate demand in the usual ways and thus help to end deflation. Of course,if operating in relatively short-dated Treasury debt proved insufficient, the Fed could also
http://www.2000wave.com/article.asp?id=mwo112802http://www.2000wave.com/article.asp?id=mwo112802http://www.federalreserve.gov/BoardDocs/speeches/2002/20021121/default.htmhttp://www.federalreserve.gov/BoardDocs/speeches/2002/20021121/default.htmhttp://www.federalreserve.gov/BoardDocs/speeches/2002/20021121/default.htmhttp://www.2000wave.com/article.asp?id=mwo112802

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attempt to cap yields of Treasury securities at still longer maturities, say three to sixyears.

He then proceeds to outline what could be done if the economy falls into outright

deflation and uses the examples, and others, cited above. It seems clear to me from the

context that he is making an academic list of potential policies the Fed could pursue ifoutright deflation became a reality. He was not suggesting they be used, nor do I believehe thinks we will ever get to the place where they would be contemplated. He was simplypointing out the Fed can fight deflation if it wants to.

(And now, in 2010, that question might become more than academic.)

With the above as background, we can begin to look at what I believe is the trueimport of the speech. Read these sentences, noting my bold-faced words:

... a central bank, either alone or in cooperation with other parts of the

government, retains considerable power to expand aggregate demand and economicactivity even when its accustomed policy rate is at zero.

The basic prescription for preventing deflation is therefore straightforward, atleast in principle: Use monetary and fiscal policy as needed to support aggregatespending.... (As Keynesian as you can get.)

Again: ... some observers have concluded that when the central bank's policy ratefalls to zeroits practical minimummonetary policy loses its ability to furtherstimulate aggregate demand and the economy.

To stimulate aggregate spending when short-term interest rates havereached zero, the Fed must expand the scale of its asset purchases or, possibly,expand the menu of assets that it buys.

Now let us go to his conclusion:

Sustained deflation can be highly destructive to a modern economy and shouldbe strongly resisted. Fortunately, for the foreseeable future, the chances of a seriousdeflation in the United States appear remote indeed, in large part because of oureconomy's underlying strengths but also because of the determination of the FederalReserve and other U.S. policymakers to act preemptively against deflationary pressures.

Moreover, as I have discussed today, a variety of policy responses are available shoulddeflation appear to be taking hold. Because some of these alternative policy tools arerelatively less familiar, they may raise practical problems of implementation and ofcalibration of their likely economic effects. For this reason, as I have emphasized,prevention of deflation is preferable to cure. Nevertheless, I hope to have persuadedyou that the Federal Reserve and other economic policymakers would be far fromhelpless in the face of deflation, even should the federal funds rate hit its zero bound.

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And there you have it. All the data pointing to a slowing economy? It puts uscloser to deflation. It is not the headline data per se we need to think about. We need tostart thinking about what the Fed will do if we have a double-dip recession and start tofall into deflation. Will they move out the yield curve, as he suggested? Buy more andvaried assets like mortgages and corporate debt? What will that do to markets and

investments?

Note that last bolded line: For this reason, as I have emphasized, prevention

of deflation is preferable to cure. If he is true to his words, that means he may act inadvance of the next recession if the data continues to come in weak and deflation starts toactually become a threat. That is the thing we dont see in all the economic data thepotential for new Fed action. Lets hope that, like the deflation scare in 2002, it doesnt

come about. Stay tuned.

"Why don't you reform yourselves? That task would be sufficient enough."Frdric Bastiat `

It is time to hit the send button. The letter is overly long already. Ill finish withthis thought. This financial reform bill should be thrown out and they should start over.So much has been tagged onto this bill that has nothing to do with reform but is all aboutpolitical agendas. It is also far too vague. Essentially, they create all these newcommittees or empower the bureaucracies that missed it last time to come up with theactual details of regulation. For all intents and purposes, a small number of unelectedindividuals will be given almost total control to write new rules overseeing a huge part ofour economy. No matter how well-intentioned, this is not something that should be donein closed rooms.

We need major reform, of course. And when are we going to get to Freddie andFannie, which are totally ignored but will cost the taxpayer the most? Local CongressmanJeb Hensarling has it right. He estimates there are about 3 unintended consequences onevery page of that 1,200-page bill.

Oh, the Kudlow links:http://www.cnbc.com/id/15840232/?video=1533514810&play=1 http://www.cnbc.com/id/15840232/?video=1533518497&play=1

I am aggressively working on my new book, The End Game. I hope it is going toa good one, given the hours I am putting in.

Have a great week.

Your wishing he was back in Tuscany analyst,

John Mauldin
http://www.goodreads.com/author/quotes/89275.Fr_d_ric_Bastiathttp://www.goodreads.com/author/quotes/89275.Fr_d_ric_Bastiathttp://www.goodreads.com/author/quotes/89275.Fr_d_ric_Bastiathttp://www.cnbc.com/id/15840232/?video=1533514810&play=1http://www.cnbc.com/id/15840232/?video=1533514810&play=1http://www.cnbc.com/id/15840232/?video=1533518497&play=1http://www.cnbc.com/id/15840232/?video=1533518497&play=1http://www.cnbc.com/id/15840232/?video=1533518497&play=1http://www.cnbc.com/id/15840232/?video=1533514810&play=1http://www.goodreads.com/author/quotes/89275.Fr_d_ric_Bastiat

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