Mondays with Dr. Joe:
August 25th, 2008
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Slow Economic Growth Teases Us; High Inflation Bludgeons Us
GDP and Print
Don't Be Misled by the Decline in Commodities
Unemployment is Rising... Or Is It?
Latest Industry Forecasts
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Slow Economic Growth Teases Us; High Inflation Bludgeons Us
Lately we can't even trust the most basic of macro economic indicators, GDP. Inflation has been so strong that inflation adjustment of GDP seems out of whack, causing the measurement of our real output to be called into question. Remember, GDP uses an index that changes weights based on how consumption of goods changes. That means if prices of goods rise to a point of decreasing demand for those goods, the Personal Consumption Expenditure (PCE) inflation adjustment places less weight on goods with declining demand in the calculation of real GDP. If the goods rise excessively in price, like oil has done, crowding out consumption of other goods, that creates other problems. There's something positive to be said about the fixed market basket of the Consumer Price Index which does not outsmart itself in this way. If inflation is mild, all of the methods for inflation adjustment work fairly well. It's not mild now, so they can create problems.
GDP and Print
If you believe the latest GDP report, economic activity is increasing. Real GDP for the second quarter was increased to +3.3%, and is much stronger than the first quarter's +0.9%. On a current dollar basis, which is not adjusted for inflation, GDP was up +4.6%. Since most businesses do not inflation adjust their financials, current dollar GDP is what should be used. But practical experience tells us that real and current dollar GDP for this last quarter are much too close. This quarter's inflation adjustment does not meet the data “sniff test.” Look for another revision to GDP, but this period's data may not be reliable until they make one of their multiyear revisions a year or two from now. It's one of those cases where getting the data right then does not help us now.
The Institute for Supply Management Manufacturing and Non-manufacturing reports have been far better at painting a picture of economic activity (or lack thereof). They have both been in the “no growth” range for a few months, and continued that in last week's readings.
For most economic data, I prefer to look at rates of change on an annual basis, comparing a given period to the same period the previous year. I also use moving totals, so I always have annualized numbers. This eliminates many monthly or quarterly fluctuations that might unnecessarily confuse the analysis. The chart below looks at print and CPI-adjusted printing shipments.
If GDP (the yellow line) and Print (the red line) have the same growth rate, then the difference between them (the blue line, GDP minus Print) would be 0%; it only gets there once, thirteen years ago. The difference is often greater than GDP growth rates, indicating that print shipments decreased while GDP grew. The average difference is +3.4 percentage points. For the entire range since 1994, GDP on a year/year basis has never been negative. Print has been negative in 34 of the 58 quarters, almost 60% of the time.
Readers of this column are not surprised by this, of course, but there are still owners, executives, and managers who insist on their belief that print demand follows GDP. This means that they constantly misdiagnose what is really happening, attributing changes in demand to economic factors and not to other influences. These other influences have been powerful, to say the least. If our industry had followed GDP growth for the last 15 years, we would be about $175 billion in size; this year we may consider $97 billion as a small victory.
So here's the comparison for the last year: your business has to be growing by +4.2% compared to current dollar GDP. But I don't think that's enough. Compared to the Consumer Price Index, your business has to be up by +5.6% over the last year.
Here's a tougher comparison: for the last three months, CPI has grown at an annualized rate of +9.6%. Face it: unless your business has grown by a 10% annual rate these last few months, you've just been keeping your head above water.
Don't Be Misled by the Decline in Commodities
Even though oil prices are retreating, don't forget that even at $100, where it is likely to settle for a while, it's still 25% more than it was last year at this time when it was just starting to test $80. We have yet to see the news stories with local TV reporters finding poor elderly widows explaining how they must decide between food, medications, and heat. These reports will just be starting around Election time. None of these reports will include comments about how Fed policy, underwriting subprime failures, and tax rebates all expanded the money supply and created the higher prices because there was no increase in new goods or services to absorb the extra money.
Nearly all commodities prices have retreated in the past couple of months, but compared to last year, they are still high. Many users of commodities had to purchase them at prices higher than they are today to use them in production. While the GDP report was boosted by exports, many of those exports require imported materials that are not available elsewhere, and those imports cost more because of the weak dollar.
So much of this is “what have you done for me today” thinking. Value chains and inventory shipments of raw goods are planned and purchased months in advance. In some cases, products based on $147 oil are just starting to be used. Southwest Airlines, for example, hedged its oil prices for years, and its price is $50-$55 a barrel. This means that higher current oil prices are not fully reflected in its prices yet. Southwest's fares will be pressured to rise as those hedging strategies run their course. For other companies, oil prices might be going down now, but much of the oil that is being used today was purchased at significantly higher prices. Don’t look for cost issues that confound managers to go away anytime soon. Any expectation that the daily price of oil on the commodities exchanges being down will be reflected in equal declines in the prices of goods and services is misplaced.
Unemployment is Rising... Or Is It?
If GDP is rising, why is unemployment growing? First, the easy part. Friday's report sent the unemployment report to 6.1%. The household survey was down by -325,000 while +250,000 more people joined the workforce, netting +575,000 more people looking for work than last month. The rule of thumb says that full employment is between 4-6%, but actually it's between 4-6.4%, or at least that's what the academics think now (when I left college the first time, they were starting to insist it was 6-8%; oh those economists, always changing the rules to fit their scenarios). For all practical purposes, we're out of the full employment comfort zone.
There are three key things going on that are pushing up unemployment. First, the extension of unemployment benefits to the unemployed lengthens the amount of time the unemployed stay that way. Academic research, as a rule of thumb, indicates that one-third of the unemployed find jobs quickly, one-third wait until their benefits expire, and the other third are a bit pickier and take their time. This unfortunately means that workers are not deployed to other businesses or retrained as soon as they could be. This is one reason many jobs still go unfilled even when unemployment rises.
Second, productivity is rising faster than GDP. That is, anytime businesses can produce more with less, their need for workers declines. When GDP is greater than productivity, employment rises. A reason for the productivity improvement is the inflation of materials and resources used in production. Those price increases cause businesses to strip out as much cost as possible and to look for greater efficiencies where they can. Productivity gains are preventing the economy from falling into deep recession, but this trend may not last much longer.
Third, there has been a flood of job-seekers into the workforce. Normally, the U.S. population rises at an average rate of 0.96% per year. The increase in the workforce (those working plus those looking for work) has been 1.29%. To explain what happened, and how the unemployment calculation works, here's an example using a typical American family.
The main breadwinner of the family, Homer, is starting to worry about his job. (The unemployment rate in Homer's house is 0%). His mortgage rate has increased, and the cost of getting to and from work is increasing. His loyal wife, Marge, decides to look for a part time job. (Marge is now added to the workforce, so the unemployment rate in Homer's house is now 50%). Marge finds a job (the household unemployment rate is now back to 0%). Bart, their son, decides that he wants to buy an iPod and an Xbox. Homer and Marge explain that running a house is expensive, and he needs to get a part-time job. Reluctantly, Bart starts looking (the household unemployment rate is now 33% because two people have jobs, and one is seeking a job). He finds one (unemployment is now 0%). Lisa sees this scenario unfolding and realizes that her only chance to escape the house is to buy a car, and the only way to do it is to save money on her own. She looks for a job (the household unemployment rate is 25%) and she finds one (the rate is back to 0%). Homer's house now has four workers when it had only one, and the population of the house did not change. Bart earns enough money for the iPod and Xbox, so he quits his job (boy, was his boss relieved) and does not want another one (the unemployment rate stays at 0%, even though the home has one less worker).
When times get tough, people look for jobs. When one breadwinner's job is threatened, another person in the household starts looking for work. Because of this, it is common that during recessions unemployment will get worse because the workforce increases more rapidly than the economy can accommodate the new additions. Also, when an economy starts to improve, the workforce can actually contract, decreasing the unemployment rate while the number of employed people may stay the same.
The fact that the unemployment rate is up this much is normal under the current conditions, unfortunately. Higher inflation, however, may push more people to seek work and more businesses to aggressively pursue productivity measures, raising the rate even more. The number of employed today is actually higher than it was in October 2006. The sky is not falling, but some of those fasteners holding it in place seem to have broken loose.
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