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The employment report points to long-term stagflation [ClearOnMoney]
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The employment report points to long-term stagflation

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Commentary

The employment report points to long-term stagflation

2 Sep 2011 by Jim Fickett.

Long term trends, as well as current leading indicators, suggest that employment will not recover pre-recession conditions any time soon. So record corporate profits are unlikely to continue, and the depressed mood in the stock market is entirely justified. Movements in the bond market, however, make sense only for the short term; we are much more likely headed for long-term stagflation than deflation.

Ignore the fact that the number of jobs failed to increase at all from July to August. The month-to-month change is so noisy that it is only useful to traders who want to know which way the crowd is going to jump. Besides, something both more important and more depressing is going on.

Over the last 30 years, it is taking longer and longer to recover from recessions and each time the recovery is weaker. First look at the graph below, showing the percent change in jobs through and following each of the last four recessions. The diagonal dashed line shows the growth in population, so jobs need to get back up to that line before pre-recession conditions are regained. In the 1981 recession that recovery was accomplished in about 3 years. In the 1990 recession it took 4 years. In the 2001 recession, we never made it back to pre-recession employment levels before the next recession hit. And this time there is so far to go it looks very likely the same will happen again.

You can see the same phenomenon in the following graph of the year-over-year change in the number of jobs, where the diagonal dashed line now serves to highlight this unhappy trend.

Adding weight to this depressing long-term trend, two well-known leading indicators for the year-over-year change in jobs suggest that, in this recovery, the rate at which jobs are added may never get much higher than the rate at which the population is growing.

What is going on? That will be argued by experts for a long time, but I can at least offer an explanation that makes the trend unsurprising. Stimulus has both benefits and costs. The benefit side is often expounded: somehow a jolt is needed to pop the public mindset out of excessive caution. But there is a cost as well, which is no mystery, but is discussed less often – stimulus tends to push people in the wrong long-term direction. Bankers are encouraged in risky behavior, investors are encouraged to watch the Fed rather than invest in productive enterprise, savers are discouraged, debt builds up, ordinary people are pushed towards jobs related to current bubbles rather than what is most productive long-term, Congress concentrates on a quick fix rather than fixing fundamental problems like sub-standard education and fiscal balance. All this is not to say there is no case for stimulus, and a stimulus right now might well be called for. But stimulus can easily be overused, and a steady diet of stimulus at the slightest sign of trouble, as we've seen in this country for a long time, is bad for long-term prospects.

So where does that leave us? Some say recession, and that may well be, though the evidence is still not at all clear. What is clear is that the employment data strongly suggest a VERY slow, and perhaps never really complete, recovery. To an extent, this supports the Japanification view that is currently popular.

But with a very big difference. Though the US may face substandard growth for a long time, we have, very much unlike Japan, a government and a central bank that both lean strongly towards inflation. So it is much more likely that we are headed, in the longer run, for stagflation than deflation. Yes, I realize worrying about inflation is very unfashionable just now, and to an extent I agree. Inflation does not seem very likely in the short run. But for those taking a longer-term view, who buy assets for years or decades rather than weeks or months, preparing for possible high inflation should remain a very high priority.

The stock market reacted correctly to today's news, even if on the basis of one ephemeral number. Low growth means record profits are unlikely to continue and stocks are clearly overvalued.

The reaction in the bond market, however, will, I think, be proven wrong. Low growth will not mean low yields, in the longer run. Though the Fed and Congress may or may not be able to create jobs, they can certainly create more stimulus and, in the long term, inflation. The 10-year yield went back down to 2% today. Given that Congress has not demonstrated any real progress on long-term overspending, that Bernanke is absolutely determined to prevent deflation (and has shown himself willing to use unprecedented measures), and that the economics community is quite supportive of creating higher inflation in order to speed deleveraging, how rational is it to lock in 2% return for 10 years?