Trouble Ahead: Employment, Inflation, And The Fed

This article originally appeared in the Daily Capitalist.

Yesterday the Bureau of Labor Statistics told us that unemployment was still stubbornly high. While it has improved year-over-year, a 9.0% unemployment rate is still high and does not signal an economy in recovery. And that has political and policy implications for the U.S. 

Also, the Fed's FOMC (Fed Open Market Committee) minutes were released Wednesday and Fed Chairman Ben Bernanke held a press conference as part of the Fed's new openness and desire to clearly communicate policy. They made no policy changes but Bernanke expressed concern about the slow recovery and high unemployment and said "We're prepared to do more and we have the tools to do more."

Unemployment, Fed policy, and the coming worldwide economic recession will do more to influence the future of our economy than anything else.


There was slight improvement in the unemployment rate, but overall, it remains very high at 9.0% of the civilian working population, which is 13,897,000 unemployed people in America. If you look at the wider unemployment measure, known as U-6 unemployment (part-time and marginally attached—see definitions in the chart below), then the rate is 16.2%, or 25 million people. That percentage has stuck at the 16-17% level for about two years.

Here is some interesting detail on employment:

Total nonfarm payroll employment continued to trend up in October (+80,000). Over the past 12 months, payroll employment has increased by an average of 125,000 per month. In October, private- sector employment increased by 104,000 [needs to be 250,000 for 5 years to go back to pre-2008 levels]. Government employment continued to contract in October.


Employment in professional and business services continued to trend up in October (+32,000) and has grown by 562,000 over the past 12 months. Within the industry, there have been modest job gains in recent months in temporary help services and in management and technical consulting services.


Employment in leisure and hospitality edged up over the month (+22,000). Since a recent low point in January 2010, the industry has added 344,000 jobs.


Health care employment continued to expand in October 2011 (+12,000), following a gain of 45,000 in September. Offices of physicians added 8,000 jobs in October. Over the past 12 months, health care has added 313,000 jobs.


In October, mining employment continued to increase (+6,000); oil and gas extraction accounted for half of the increase. Since a recent low point in October 2009, mining employment has risen by 152,000.


Manufacturing employment changed little in October 2011 (+5,000) and has remained flat for 3 months. In October, a job gain in transportation equipment (+10,000) was partly offset by small losses in other manufacturing industries.

These numbers are the reason why President Obama and the Republican candidates are talking "jobs, jobs, jobs."

The Fed

The lede in for the article about the FOMC statement was:

Federal Reserve Chairman Ben Bernanke opened the door to a new round of central-bank purchases of mortgage-backed securities after releasing dismal projections for economic growth and unemployment through 2014, but he declined to commit firmly to such a move. 

"It is certainly something we would consider if conditions were appropriate," Mr. Bernanke said in response to a question at a news conference following a two-day meeting of Fed officials. ... "We're prepared to do more and we have the tools to do more."

To paraphrase the FOMC statement: they noted that unemployment was still high, but they expected modest higher growth in the future, but there are significant downside risks. You can ignore most of what they say about the future because they have been consistently wrong about the future course of the economy.

Here are the only important things from their statement:

[R]ecent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated.


[T]here are significant downside risks to the economic outlook, including strains in global financial markets.


The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee's dual mandate as the effects of past energy and other commodity price increases dissipate further. ... To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to continue its program to extend the average maturity of its holdings of securities as announced in September.

They are worried about unemployment but they are not worried about "inflation." In fact the statement says that price inflation isn't high enough. There was one dissenting vote from the C0mmittee's statement and that was Charles Evans, president of the Chicago Fed, a well known inflationist, who thought the Fed should go further to stimulate growth.

The Fed is watching and waiting for the economy to improve and the Q3 GDP bump up to 2.5% gave them some hope. If they see economic activity and employment worsen or at least stagnate, they will "do more."

I saw an interest piece in the Financial Times by Scott Minerd, chief investment officer at Guggenheim Partners, in which he believes the Fed is relying on a Phillips Curve analysis to determine whether or not more monetary stimulus via quantitative easing should be unleashed. That got me to thinking that he may be right.

The Phillips Curve is econometric analysis of prices, inflation, and employment in which it was/is believed that mild price inflation causes economic recovery because rising wages make people think they are richer than they are so they spend and thus new jobs are created. It was debunked for the most part after the 1970s when it was discovered that you could have inflation, stagnant economic growth, and high unemployment at the same time. But its supporters still say it only works in the short-term because inflation is "unexpected" and people are fooled into spending.  At the point when prices outstrip people's inflation expectations, inflation is "expected", and the wealth effect wears off. Mr. Minerd believes short-term price inflation is a good thing and we'll see QE3 and perhaps QE4 and QE5.

I don't accept the Phillips Curve because I don't believe that it is "inflation expectations" that causes inflation. It is an illusion of post hoc ergo propter hoc thinking (because A happened and then B happened, A caused B). You find this all the time in empirical analysis. In fact inflation occurs first and then you have "expectations." It's like saying demand creates supply ignoring the fact that you can't demand something without having first produced something (goods, labor). How else do you pay for the things you demand?

Inflation, as we have written many times, is an increase in the supply of and demand for money. It's a monetary phenomenon. When you increase the amount of dollars by fiat, it is, in effect, counterfeit wealth, which is to say that these new dollars aren't wealth (they are just pieces of paper). Inflation causes many harmful economic effects, one of which is that ultimately all prices tend to rise. But the most harmful effect of inflation is that it causes us to consume capital. The destruction of capital is the force that causes the economy to decline. So by printing money you can get price inflation and economic stagnation ("stagflation").

What all this has to do with the Fed is that they believe that short-term price inflation will cause economic growth à la the Phillips Curve theory. That will encourage them to increase the money supply because they believe that "inflation" is low and even if they exceed the Fed's price inflation target (2%±) that will be OK in the short-term because it will spur economic recovery. Thus another round or two of QE.

We have been forecasting that the Fed would implement QE3 most likely in QE2 2012. We believe that the Fed will be under political pressure from the Obama Administration to make this happen. The pressure will be due to continued high unemployment. Additional pressure will come from a declining world economy that is paying the consequences of prior monetary stimulus, monetary inflation, and high indebtedness, in much the same way that occurred in the U.S. in 2008-2009. This will cause U.S. exports to shrink affecting the bottom lines of not only the multinationals but also smaller exporters. Exports have been the main driver of the economy post Crash. This will put further pressure on employment as a result of a weakening manufacturing and industrial sector.

Will the Fed respond? In his press conference on Wednesday, Bernanke said:

 "Politics is politics," but the Fed's job is to "do the best we can" and pursue its mandates. "We're going to make our decisions based on what's good for the economy. We're not going to take any politics into account."

If you believe that the Fed is isolated from political influence you would be wrong. They have always catered to the needs of the existing Administration. The recently released diaries of Arthur Burns (Fed chief under Nixon) detailed his willingness to please the president. I believe Bernanke and the FOMC will respond to the demands of Representatives. Senators, and the Administration to "do something." Seeing that they have almost no other alternative, and with price inflation perceived as being low, with a weakening economy and growing unemployment the Fed will do what it does best: "print" money via QE3.

The result of that will be a temporary boon for the financial markets, more price inflation, and more capital will be consumed, further depressing the economy. The implications of that are money flowing into Treasurys, increasing gold prices, and possibly more social unrest.