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ECONOMY: Unemployment Headed for 9 Percent

Prof. Peter Morici - 2/6/2009

Today, the Labor Department will report employment data for January. In December, the economy lost 524,000 jobs, and the consensus forecast is for another 535,000 jobs lost in January. My forecast is for a 520,000 loss.

Unemployment should reach 7.4 or 7.5 percent and is headed for 9 percent before the end of 2009.

From December 2007 through December 2008, the economy lost 2.6 million jobs. Construction and manufacturing shed 632,000 and 791,000 jobs, respectively, as the credit market meltdown and growing trade deficit wrecked havoc on residential construction and manufacturing. In recent months, layoffs spread to commercial construction, finance, retail sales, and other sectors.

The banking and housing crisis and the trade deficit are central culprits dragging the economy into recession and causing steep job losses. The proposed stimulus package, consisting of expansion of government programs, some infrastructure projects and personal and business tax cuts will give the economy a needed temporary lift the latter half of 2009 and into 2010 and 2011. However, the package moving through Congress is too weighed down with special interest spending and tax breaks sought by lobbyists to replace any more than half of the jobs that will be lost by mid-2009. A smaller package, but with more infrastructure spending, would be much more effective.

To get the economy on a sustainable growth path, the new Obama Administration must fix the banks and find ways to reduce oil imports and the trade deficit with China and other Asian export powers. Otherwise, the private sector will struggle to find capital to expand; and as GDP recovers, the trade deficits on oil and consumer goods from Asia will balloon. Credit shortages and an increasing trade deficit will slow down the economy and cause renewed job losses as the effects of stimulus spending and tax rebates expire. Then the economy will require successively larger stimulus packages, and borrowing from China and other foreign governments, or it will slip back into recession.

Regarding banking and the trade deficit, the Obama economic team, including Treasury Secretary Timothy Geithner and Director of the National Economic Policy Council Lawrence Summers, so far has offered little indication recognizing the need for a fundamental change from Bush Administration policies for addressing the banking crisis and trade deficit that caused the downward spiral in GDP, employment and national moral.

The caps on executive compensation announced this week are far too limited. Bank executives and compensation specialists are crying foul but they created the crisis and now won’t accept responsibility and reasonable pay for the work they do.

Timothy Geithner, as President of the New York Federal Reserve, was one of the principal architects of the Bush Administration’s bank bailout policy, which pledged some $8 trillion in equity, loans and guarantees to resolve a crisis caused by about $2 trillion in mortgage-backed securities without unlocking credit markets. Geithner was a principal player, for example, in the recent $300 billion dollar bailout of Citigroup.

The trade deficit, which at the peak of the economic expansion exceeded 5 percent of GDP, is a huge drain on demand for U.S. goods and services. Imports exceeding exports by 5 percent requires Americans to consume 105 percent of what they produce to keep the economy going. Essentially, Chinese, Saudi royals and other foreign sovereigns and private investors have been buying the bonds that permit Americans to borrow to consume more than they produce.

Foreign lenders bought Treasury securities and collateralized debt obligations that fueled the housing bubble, reckless lending against home equity and foolish household borrowing. That house of cards has collapsed, and without a sizeable reduction in the trade deficit, a sustainable growth path for U.S. GDP is not possible.

Oil imports and trade with China account for 90 plus percent of the trade deficit. Policies that conserve oil, boost domestic energy production, and redress the trade deficit with China are urgently needed. While needed, projects to boost alternative energy sources will hardly quickly help oil imports, and the diplomacy, favored by both Bush and Obama, have failed to persuade China to stop subsidizing its exports, undervaluing its currency and manipulating the rules of free trade. Chinese mercantilism is rocking Midwestern manufacturing, while both the Bush and Obama Administrations have behaved as if this is a grand chess match for global diplomats with no urgency.

These problems require quick, radical and unconventional solutions--solutions that will upset the thinking of free market economists. Unfortunately, Geithner and Summers are not known for out of the box thinking. High Priests of the Temple of Conventional Wisdom, they are not likely to view anything beyond higher mileage standards for cars and subsidies for alternative energy sources as acceptable energy policy. They are likely to dismiss direct action to redress Chinese mercantilism as protectionism.

An infrastructure-focused stimulus package, rather than more tax rebates and more government bureaucrats, can provide some quality private sector jobs quickly and limit the depth of the recession. However, the Japanese experience in the 1990s and the U.S. Great Depression indicate that unless structural problems are addressed repeated jolts of stimulus will be required with no end in sight.

To stop the destruction of good paying jobs, Obama should push through an infrastructure-focused stimulus package to soften the impact of the recession and stem jobs losses, and at the same time, fashion policies to fix the banks and unlock credit markets, reduce oil dependence, and fix trade with China.

In Friday’s jobs report the key variables to watch are:

Jobs Creation. January 9, the Labor Department reported the economy lost 524,000 payroll jobs in December, and 1.3 million jobs in the fourth quarter overall. My forecast is for a 520,000 loss in December.

The economy continued to expand during the first half of 2008, but productivity rose faster than demand for goods and services, thanks to the devastating impacts of higher gas prices on consumer buying power and automobile purchases, subsidized Chinese imports on employment in U.S. manufacturing, and the banking and housing crises on construction activity.

GDP fell at 0.5 and 3.8 percent annual rates, respectively, during the third and fourth quarters of 2008, and economic activity will continue to slow through the third quarter of 2009. Job losses in the range of 500,000 appear likely for the next several months. We will not see the worst of things until at least the end of the second or third quarters of 2009.

Unemployment. In December, the unemployment rate, as computed by the Labor Department, was 7.2 percent, and is expected to rise to 7.4 or 7.5 percent for December.

Since President Bush took office, more adults have chosen not to seek employment owing to worsening labor market conditions. If labor force participation today were at the same level as when President Bush took the helm, the unemployment rate would be about 9.4 percent. The difference is discouraged workers that have quit looking for work that the Labor Department does not count when computing the unemployment rate. Add workers in part time positions that cannot find full time employment and the hidden unemployment rate is about 14.5 percent.

Business vs. Government Payrolls. In December, government employment expanded by 7,000, even as overall payroll jobs contracted 524,000. This indicates the private business economy shed 531,000 jobs. Municipal and county governments added 3,000 jobs.

Construction. In December construction lost 101,000 jobs, and manufacturing lost 149,000 jobs.

Residential construction shed nearly 18,000 jobs, while 83,000 jobs were lost in nonresidential buildings, roads and other infrastructure projects. Notably, since residential construction employment peaked in September 2006, that sector has lost 231,000 jobs, while the balance of the construction industry lost 576,000 jobs.

Those losses indicate the housing recession, credit crisis, high oil prices, and China trade deficit are infecting the long-term growth prospects of the entire U.S. economy. American businesses are simply not hiring or building for the future in the United States, and this bodes poorly for GDP growth in the second half of 2009 and beyond.

Productive assets not put in place over the next twelve months will not be available to produce goods and services after the recession ends. The U.S. economy will be on a permanently lower growth path thanks to mismanagement of the credit crisis, energy policy and trade with China and other Asian developing countries pursuing mercantilism strategies.

Retailing. Retail trade has shed 548,000 jobs since November 2007, and lost 67,000 jobs in December and 100,000 jobs in November.

Finance and Insurance. During the economic expansion finance and insurance, along with technology sectors offered some of the best new job opportunities, outside of health care and technology-related activities. Since April, finance and insurance shed 89,000 jobs, and 9,000 in December alone.

It’s not just the U.S. credit crisis. U.S. financial services are facing tougher competition in booming markets, like the Persian Gulf, where the U.S. credit meltdown has tarnished the image of U.S. service providers like Citigroup. Increasingly U.S. investment banking firms cannot demand premium high prices for their services, as sophisticated buyers prefer local, more reasonably-priced and less-tarnished competitors.

Manufacturing. Over the last 105 months manufacturing has lost 4.3 million jobs. The dollar remains overvalued against the Chinese yuan and other Asian currencies, and the large trade deficit with China and other Asian exporters is a key factor pushing down U.S. manufacturing employment.

To keep the value of the yuan low against the dollar policy, the Chinese government intervenes in currency markets, selling yuan for dollars and other western currencies at a discount from a market determined price. The yuan is at least 40 percent undervalued, and provides a like amount subsidy on Chinese exports into the United States and on Chinese products competing with U.S. exports in China and other markets around the world.

Many U.S. manufacturers find it easier to locate production in China and other Asia locations than add jobs in the United States to produce goods. U.S. made goods must scale considerable trade barriers and compete against subsidies provided by undervalued currencies in China, India and elsewhere in Asia and regulated fuel prices.

Were the trade deficit cut in half, manufacturing would recoup at least 2 million of the 4.3 million jobs lost since 2000. U.S. GDP growth would be in the range of 3.5 to 4.0 percent a year instead of 2.5 to 3 percent expected as the economy resumes growth the latter half of 2009. Real wages would rise briskly.

At his confirmation hearing Treasury Secretary Geithner acknowledged China is manipulating its currency and promised to work toward a realignment of currency values. But since then, Vice President Bidden backed off this position, much as did Democratic Senator Charles Schumer from his bill to take action against currency manipulation during the Bush presidency.

President Obama must get behind a policy to reverse the trade imbalance with China, or preside over the wholesale destruction of many more U.S. manufacturing jobs. These losses have little to do with free trade based on comparative advantage. Instead, they derive primarily from currency practices that make Chinese products artificially cheap in U.S. and other markets and Chinese restrictions on imports. These Chinese policies deprive Americans of jobs in industries where they are truly internationally competitive.

In the end, without assertive steps to fix trade with China, as well as fix the banks and curtail oil imports, the Bush years will seem like a walk through the park compared to job and real income losses Americans will suffer during the Obama years.