More on why jobless claims aren’t yet signalling double dip
Jobless claims have been quite elevated of late, averaging around 450-480,000 for the past few months. While these are worrying figures, they do not in and of themselves point to recession. In my last post I used a chart of the year-on-year change in initial jobless claims to point out that every recession in the last 40 years has been preceded by a sharp rise in jobless claims. And a sharp rise (+50,000) in initial claims has always meant recession.
Right now, 4-week average initial jobless claims are still almost –90,000 lower than they were at this time last year. This doesn’t look like the kind of employment data that has presaged recession in the past 40 years.
A reader asked:
If the economy continues to shed 420K to 490K jobs a month, won’t this steady "drip-drip-drip" loss of jobs accomplish the same thing – aka, a recession [or at least something that feels like one if not "technically" a recession] – as a big spike down of 600K or more lost jobs? The "drip-drip-drip" loss of jobs scenario will take longer, but the effect will be the same. Won’t it?
My short answer is no. Here is a longer answer.
First, we have to keep in mind that we are working from a lower base now. Last year, when talking about recovery I said:
Before the Great Depression in 1929, the U.S. had nominal GDP of $103.6 billion. By 1933, this had dropped to $56.4 billion due to deflation and a decrease in production. Over the next four year, GDP growth soared. It was 17.0% in 1934,11.1% in 1935, 14.3% in 1936 and 9.7% in 1937. That’s some serious growth, right? Well, GDP was only $91.9 billion in 1937, a full 11.3% lower than it had been 8 years earlier. In fact, it wasn’t until 1941 that we attained the nominal production output of 1929.
What this should illustrate is that working from a lower base makes an increase in GDP comparatively easier than when working from a higher base. Yes, it was a powerful recovery, but it did not get the United States back to the same productive level for many years. In that sense, recovery does not mean recovery immediately.
Recoveries by definition start from a point of diminished output because recessions are periods of diminishing output. So output in the initial period of any recovery is always lower. That’s how the math works – and also why I continue to stress that this is a technical recovery.
But, the important part to remember is how the business cycle works and how the recency effect creates self-reinforcing declines or recoveries in output.
Increases in income lead to increases in retail sales which lead to increases in output and inventories which lead to more jobs and thus a further increase in income. This is a virtuous circle that defines the upward path of a business cycle. The same is true in reverse as the business cycle tops out. Decreases in income lead to decreases in retail sales which lead to decreases in output and inventories which lead to fewer jobs and thus a further decrease in income. The self-reinforcing nature of the swings in the cycle owes much to the calculation of businessregarding anticipated future demand in creating goods and services and staffing up or down.
In terms of the demand for goods and services, personal consumption expenditures make up some 70% of GDP (see chart below). When more people earn more money, collectively we have more disposable income. We can therefore spend more on goods and services. (Many may even leverage up or eat into savings and buy more than they earn, causing retail sales to increase by more than disposable income.) This causes retail sales, and thus GDP, to increase. So, by-and-large, GDP is dependent on jobs. So the labour market is crucial.
In terms of the labour market, think of demand for labour. Let’s say you are a business person who owns 15 print shops. Now, if business is so good that you can’t keep up with demand, you hire new people, probably temps at first and then full-time. If this continues for a while, you continue to add staff in anticipation of future business.
Here’s the thing though: eventually businesses miscalculate and extrapolate growth that doesn’t come to pass. Maybe the government raises taxes, maybe income growth slows. In any event, mid-cycle there is always a slump when industry recalculates. Initially, this recalculation doesn’t mean huge layoffs for your print shops because laying off workers needlessly when demand is still increasing is a killer for future business. However, the larger the miscalculation, the larger the recalculation.
We saw these kinds of larger recalculations mid-cycle in 1976-1977 in 1985 and again in 1995-1996.In each case jobless claims rose precipitously and many worried the economy would fall back into recession. However, businesses were able to recalibrate enough that the damage was limited and the cycles continued their upward path.
But, business cycles end when the miscalculations are largest. In the post-war era, usually it was the Fed raising interest rates which has set off the slump that leads to recession. The anticipated future business, inventory and staffing overhang are so large that they result in a huge and sustained upswing in jobless claims. Households can only maintain their desired spending level for so long in such an environment. Eventually, the collective cut back in retail sales and deleveraging is so large that it induces a further retrenchment in staffing and output and the cycle goes into reverse.
In sum, there is a tipping point in every business cycle that sends the economy into recession. In the past, it has been preceded by higher Fed Funds rates and higher jobless claims. The jobs picture is key in the chain of events which leads to recession as it takes a large increase in job losses to trigger the change in spending patterns that induces the leg down.
So, I don’t see a 450,000 jobless claims number as recessionary in isolation. I think we need to see an uptick in claims for the jobs picture to be the critical piece in inducing recession – something that I could see happening in 2011 (50-60% odds I say).
This cycle will probably be different though. Right now consumers are continuing to reduce their debt loads even though nominal GDP has turned up. This is true deleveraging as Household debt to GDP is declining. See Comstock Partners’ The Significance of Consumer Deleveraging. Could this induce a double dip without our seeing jobless claims tick up too? I doubt it because I see jobs as the critical factor. But I will be watching the numbers.