Myth of Higher Employment Risks Triggering a Social and Economic Catastrophe
Many investors might be wondering why the markets have tilted toward what can only be described as “correction” mode. The big-name business pundits keep telling us that employment is growing. They boast that the economy is performing better than at any time since the financial crisis of 2008.
Yet, judging from the wavering of the Dow Jones index since the record highs of January, investors are at best skeptical and, at worst flippant, about the optimistic buzz about the economy.
One problem is that economics, far from being a science, is an art, while the economy often depends on psychology. Optimism favors economic growth and vice-versa. Thus, understanding the economy is much like understanding whether the chicken came before the egg. Until recently, often all it took for a recession to begin was for a few key experts, bankers, and politicians to pronounce the dreaded word in public.
Investors Are Quick to Pull Out of the Market
Investors respond by pulling out of stocks, and the higher interest rates that follow ensure that indicators such as interest in employment give way to fear of unemployment.
Recessions were often engineered to control prices and inflation. Meanwhile, accustomed to the high employment standards and all-around growth of the post-World War II period, governments and banks feared inflation far more than they did unemployment. (Source: “Is the U.S. at Full Employment? Should They Put the Brakes on Job Growth to Avoid Inflation Down the Road?,” CounterPunch, April 5, 2018.)
The concern about inflation has not diminished, even if everyone has pondered over unemployment (and employment) statistics and prospects.
Nevertheless, because of the rising interest rates that central banks in Europe, Japan, and, of course, the United States (the Federal Reserve in this case) have adopted, inflation has resumed its place as the highest priority to address.
Any improvement in the employment statistics gives impetus to Federal Reserve Chair Jerome Powell to lift rates.
The Richard Nixon years and his engineered recession produced stagflation. Stagflation occurs when an economy endures high inflation at the same time as high unemployment and stagnant demand. In many ways, the “Great Recession” that followed the 2008 financial crisis has produced similar effects to stagflation.
While wages and job numbers decayed, accounting for the low inflation, prices for goods—we were told—dropped. That wasn’t true for homes or automobiles, or even food and gas. The commodity boom of 2008–2011 pushed prices far higher than statistics for inflation allowed.
Core inflation, by definition, does not consider these essential costs. Nor does it consider the insane costs of medicines and healthcare in the United States, for example.
This is just one half of the present inflation insanity equation. In addition, engineering recessions to control prices has worked with lackluster results. The Nixon team that engineered the recession of his second term in the 1970s did not/could not account for the Yom Kippur War in the Middle East and OPEC’s reaction to it.
The lesson to take from that episode is that encouraging recessions by raising interest rates to control wage and employment increases backfires and causes tremendous social damage. The idea that high employment causes inflation and that only unemployment can cap it has become something of a mantra or a religion.
The U.S. economy now risks resuming the “bad trip” that Nixon’s advisors recommended with their inflation cures. The Federal Reserve and the banking establishment have not reacted well to the seemingly favorable—or so we’re told—statistics about jobs and wage growth.
The stock markets have reacted even more ominously. Instead of celebrating the alleged “4.1% unemployment rate,” the markets have dropped.
They have also suddenly rediscovered macro-level risks. International threats and intensifying trade disputes can send the Dow Jones index down, even though, between December 2017 and January 2018, nothing could stop all boats from rising on an overwhelming tide of optimism on Wall Street.
The Two Problems of the “Recovery” Message
Simply, investors believe that the Federal Reserve will try to slow down the much talked about “economic recovery” because more Americans are employed.
There are two main problems. First, as noted above, there’s nothing certain about engineered recessions as being able to control inflation. But, more significantly, the supposedly favorable indicators aren’t all that favorable. The 4.1% unemployment rate has not caused salaries to increase. One reason is that the high number of cheap imports has reduced the impact of the wage/employment relationship.
That’s the minor reason.
The bigger issue is that, even as we have been told that unemployment has fallen to just slightly higher than four percent, the real unemployment figures are much higher than that statistic suggests.
Indeed, the bigger reason is that real unemployment is much higher than 4.1%. There are millions of potential workers who have stopped looking for jobs altogether. As noted, psychology plays a major role in economic performance. It does so starting at the optimism needed for an individual to look for a job, let alone find one.
There is a lingering labor surplus, not a labor shortage. The jobs—or what passes for them—are largely at the minimum-wage level. That’s why so many Americans have stopped looking.
Apart from the economy, the effects on stocks have been unfavorable. It has made them vulnerable to unfolding crises. Any excuse is good enough now to trigger negative sentiment. The risk is that, sooner or later, one of these factors will reveal that “the king has no clothes.” That is, the economy has not improved as we have been told.
One of the most evident factors is the U.S.-China trade war. The prospects of a trade war—which could eventually affect the largest U.S. exporter of all by value, Boeing Co (NYSE:BA)—have suddenly become a valid excuse for stocks to fall. President Donald Trump had threatened this since the days of his election campaign. Yet, investors are suddenly discovering that the president has protectionist plans.
The problem is that the duties and counter-tariffs between the U.S. and China, whether they affect $50.0 billion or $100.0 billion worth of goods are not the problem. They are masking the fact that the United States can’t cope with the end of its addiction to cheap credit.
“Easy Money Anonymous”
The Federal Reserve has guaranteed easy money. Investors in turn, many of whom have failed to learn the lessons from the 2008 financial crisis, have indulged. They have over-leveraged their financial strategies, borrowing to bet on stocks—perhaps not even the safe long-term ones, but the “pump and dump” type.
This fear is what amplifies the market reactions. The algorithms of electronic trading on the markets add their own special accent.
Now, just imagine that the ongoing correction—showing little signs of relenting—that started in February has worsened. In a period of so-called economic expansion, what’s going to happen when the next recession happens? That next recession could be around the corner. One more rate hike could be the proverbial straw on the camel’s back.
What this suggests is that, sooner or later, the negative sentiment will cause a major stock market crash. It will have a domino effect. A market crash will reveal that the so-called healthy economy of 2019 is smoke and mirrors. It will exacerbate all the real unemployment figures and we could end up in a situation where we might regret 2008–2009.