1. Employment Forecast 2010 By Dan Perry I. Introduction Unemployment guides economic production in a variety of different forms. It has a major impact on the flow of credit, both from the supply and demand side of the equation. It has a major effect on delinquency rates and defaults. It affects consumer confidence and thus has major implications on asset markets, trade, consumption, and political policy. More than anything, however, unemployment is a problem permeating every household’s standard of life and expectations of prosperity. Throughout this recession, we’ve seen unprecedented speed in job losses and have now reached a double digit employment rate. These dismal statistics are exasperated by trends showing decreases in wages and hours, conversions to part time status, and hiring shifts favoring temporary or contractor employment. While mass layoffs seem to have reached a pinnacle, there are virtually no signs of life in hiring statistics or even intentions to make full time hires. Despite seemingly obvious evidence to the contrary, most mainstream economists are predicting unemployment to peak in 2010 and begin a massive recovery. While this scenario is entirely possible, it ignores many important factors and demands investigation into alternative scenarios. One thing most economists and policymakers can agree upon is this recession has been more severe than any since the Great Depression. Such a serious situation requires a serious consideration of all possibilities, which is what this forecast seeks to explore. This presentation will closely examine the current U.S. employment picture as a starting point and then utilize historical data, current trends, and future predictions to estimate unemployment over the next decade. Many assumptions will be based purely in quantitative reasoning but others will take a common sense perspective of where the economy is going. My analysis has generally been more pessimistic than the consensus over the last two years but has ended up much closer to reality. Nonetheless, I will present three different scenarios to allow readers to draw their own conclusions. II. Current Data Unemployment has recently reached 10% after the steepest and quickest ascent since WW2. This is the highest level since hitting 10.8% in 1982. Unemployment Rate: U6 underemployment is a much more representative picture of the national employment situation. U6 measures the rate of unemployment but adds part time workers who want full time work and those giving up on a job search but wanting employment. This is a much more representative figure for the economy. The current U6 rate is 17.3%. Underemployment Rate: Initial jobless claims appear to be stabilizing but are still above average. The reductions in mass layoffs have been the primary reason for this trend. Initial Claims: Continuing claims, however, have stayed at a tremendously high level and possibly represent jobs that may never return. According to the most recent BLS press release, 4 of 10 unemployed workers were jobless for 27 weeks or longer. While firings appear to be improving, there is little incentive to hire. Continuing Claims: The United States isn’t the only country with a deteriorating employment picture. Most major economies are in significant contraction, and the sovereign debt issues in smaller countries like Greece, Latvia, and Iceland are threatening to weigh on international finances even more. Unemployment Rate By Country: III. Scenario 1 As previously alluded to, most economists are predicting a tremendously rosy employment picture over the next 5-10 years. The most common assumption examines all recessions since WW2 and the V or U shapes shown in the chart below. In all instances, jobs recovered back to their pre-recession levels at a relatively quick pace. As this chart exhibits, every recession since 1945 have had a V shaped job recovery. Since the current recession’s magnitude was much higher, it would probably take another 24+ months to realize the same pattern. At the same time, history seems to indicate this type of recovery is extremely probable. Since initial claims are leveling, continuing claims are slowly on the decline, and GDP has turned positive, it appears now is the time for the unemployment rate to begin leveling and soon declining. Additional evidence can be found with an apparent bottom in several leading indicators: GDP: Consumer Sentiment: Manufacturing New Orders: The stock and commodity markets have been on an upward trajectory for months, while the bond market has developed the steepest yield curve we’ve seen. While economic results still have a long way to go, most measures seem to indicate a bottom and thus should see unemployment declining in short order. As it pertains to the unemployment rate, demographic trends will ensure significantly less growth in the labor pool than normal. The following charts illustrate the impact of Baby Boomer retirement: Many economists cite these trends in their unemployment forecasts. Scenario 1 takes an average of these forecasts and extends the data to 2020. This represents the best case scenario, although not one I find particularly likely. Below is a visual representation of this scenario: Scenario 1: Scenario 1 makes several key assumptions: The recovery will be U shaped with unemployment topping in late 2010 and reaching full job recovery by around 2013. There will be no additional recessions in the period 2010-2018 causing the downward unemployment rate curve to fluctuate. The US economy is capable of achieving full employment (below 5%) and should see this rate sometime near 2016. In past eight-year periods, the US economy has realized similar quarterly percentage job increases. While there is historical precedent for such growth, I believe this is an extremely optimistic scenario and would place its odds at about 5%. Nonetheless, it is the forecast primarily utilized by the federal government, Federal Reserve, and the consensus among top economists. The next two scenarios will present evidence questioning these assumptions. IV. Scenario 2 This scenario will begin examining some of the conflicting evidence that a U shaped recovery is in the works. While most economic measures seem to imply a bottom, the last few months of data can better be described as “less bad” rather than “good”. In addition, there are many factors going completely ignored by proponents of Scenario 1. The most critical economic measure in this economy is the flow of credit. Just as this unprecedented global boom was fueled by a major growth in credit, its recovery is contingent upon a return to these conditions. The following chart illustrates the growth and decline of credit: The growth in consumer credit was simply unsustainable from 1992-2008. The trend line represents substantial growth but at a reasonable rate consistent with income growth. At the current run rate of 4.5% annual credit contraction, it will take almost a full decade to reach the sustainable trend line. This will undoubtedly impact employment, as many businesses rely on revolving credit to fund expansion and everyday operations. In addition, a peak level of consumer credit implies a peak level of consumption and earnings. Businesses are unlikely to hire, knowing their top line is in a structural rate of decline. Another major factor worth considering is how employment will increase. We’ve already seen evidence that the U6 unemployment rate has rapidly increased, signaling many workers are being shifted to part time work. Part Time Workers For Economic Reasons (Thousands): When employment does eventually pick up, temporary workers should lead the charge. In most recessions, cautious employers stick with temporary workers but in today’s recession, I’d expect this to last longer than usual. Employers are simply too uncertain about health care, energy policy, organized labor power, and concerns about maintaining profitability to commit to full time workers. Temporary Workers Monthly Change: Prior to hiring new workers, employers will boost the hours and productivity of their existing workforce. This number has been at severely low levels for years due to technological innovation and efficiency. I’d expect these statistics to remain low but any employment recovery will first see improvement in work week. This chart shows recent trends: Average Work Week: Finally, we have seen a dramatic drop in the labor participation rate. With prospects so dim, many potential workers have simply given up searching for jobs. If the employment picture improves, this should move back toward historical averages as the following chart displays: Labor Participation Rate: As qualitative assumptions are made for Scenario 2, it is useful to observe trends on an industry by industry basis. After all, the construction and health care sectors, for example, have exhibited completely different trends both recently and over the past few decades. In order to develop a solid grasp of the employment picture, we will examine each industry’s recent and past statistics and make qualitative assumptions based on macroeconomic events to determine their employment outlook going forward. This industry level forecast takes the current employment level in each sector and compares the current recession’s average annual job performance to the most recent booms between the 2003-2007 and 1990-2007 periods. The work force has increased by an average of 1.65% since 1970. With a major percentage of the work force entering retirement age, we will assume the growth declines by half this rate over the next 8 years. Taking the projections within each industry from the above table, we get the following unemployment curve: Scenario 2 (Based on Industry Projections): Many economists point to a quicker recovery but are hard pressed to specify exactly where the jobs will come from. Looking at these industries, there is very little evidence or qualitative analysis toward greater job growth. In addition, the graph assumes there will be an absence of recessions through 2018. With an economy solely on government support and problems littered throughout the economy’s structure, this is highly unlikely. In reality, the road will be much bumpier and is considered in the final representation of Scenario 2: Scenario 2 (Final): Scenario 2 makes several key assumptions: The recovery will mostly be L shaped and closely follow Japan in the 1990s Many of the jobs lost, especially in manufacturing, construction, and retail/wholesale will never come back. While it is possible to see major advances in technologies like alternative energy, biotechnology, or green technology, many sources of jobs in the 1990-2007 timeframe have been structurally eliminated. The economy will slip in and out of recession throughout the next decade. Unemployment will peak above 11% in 2011 and then follow a slow, bumpy path downward. This scenario assumes no major external events causing further pressure on jobs. Examples of this will be explored in Scenario 3. This scenario purposely excludes highly technical, quantitative models to eliminate excessive bias in historical results, linear patterns, and commonly held assumption. Because this recession is unlike any of its predecessors, it requires starting from scratch and making qualitative assumptions based on statistics and trends. Based on this evidence, Scenario 2 is my base scenario and thus my expectation for how things will ultimately turn out. I’d put the odds of this scenario or a close deviation at 65%. V. Scenario 3 Scenario 3 uses the same underlying methods and assumptions as Scenario 2 but considers a more stressful and adverse impact. As previously noted, Scenario 2 considers an L shaped recovery where the economy slides in and out of recession over the next decade. Scenario 3 guarantees a double dip recession but one of greater magnitude, similar to the early 1930s. This is a valid comparison, as both today and 1930 share the common characteristic of following a major credit crash, where economists were optimistic about a quick recovery despite an economy of severe fundamental flaws. Various trends point toward a similar pattern of events (although probably less severe): Government stimulus cannot last forever. A large majority of the economic progress has been on the backs of taxpayer funded economic programs. Cash For Clunkers, the first time homebuyer credit, the economic stimulus, 0% interest rates, a litany of Federal Reserve lending programs, favorable accounting rule changes, and a multitude of bailouts have been the only source of life for this economy. While these efforts can persist for some time, the government cannot indefinitely maintain this level of support. A severely constrained fiscal situation. The most populous and economically vital states are approaching budget crisis including California, Illinois, New York, Arizona, Florida, and New Jersey. Meanwhile, the federal government is already projected for record budget deficits, even under favorable economic forecasts similar to Scenario 1. This is already on top of a national debt fast approaching current GDP and without an end in sight: Our country is rapidly approaching a fiscal crisis where the dollar’s reserve currency status is being called into question and budget projections may outpace ability to raise new debt. A currency or funding crisis would cause unemployment to skyrocket. Sovereign debt problems have debunked the decoupling theory that international economies would be able to recover in the absence of a US led rally. Iceland, Greece, Latvia, Venezuela, Mexico, Argentina, Spain, and Ireland have already revealed immense fiscal pressures and a real possibility for sovereign default down the line. Japan, United Kingdom, and Russia haven’t had major events but face dismal prospects for their own financial situations. China has seen tremendous growth resume but appears to be in the midst of its own credit bubble from an unprecedented government stimulus and lending initiative. A major sovereign episode may originate from anywhere, but it is highly likely there will be several events with the capability of putting tremendous pressure on the US economy. Because deficit and debt problems are inevitable, a rise in taxes will be forthcoming in the not too distant future. In an already difficult spending environment, many households will be severely impacted by tax hikes. Interest rates are at historic lows but have done little to spur the economy. When interest rates are inevitably forced upward, the probability of a second credit pinch is likely. Assuming the economy recovers as rapidly as many economists predict, inflation will be a major concern capable of sending the economy back into recession. No matter which scenario plays out, it is difficult to envision a situation without higher interest rates and/or higher inflation producing terrible difficulty. Bank excess reserves are at all time highs because there is an expectation of future losses and a new brand of conservative underwriting standards at lending institutions. This chart illustrates just how substantial these levels currently are: Excess Bank Reserves: While many believe this signals the threat of future inflation, this is simply not the case. The following chart proves banks are not allocating enough reserves for loan losses. It gives the ratio of total assets for banks allocating enough for non performing loans to the total assets of banks not allocating enough allowances. The excess reserves may be at tremendously high levels but are actually too low for what is needed: Allowance For Loan & Lease Loss Ratio: The US economy cannot expand without a return to 2006 credit conditions. Banks have displayed a reluctance to undertake anything but the safest loans, while most households are in their own deleveraging process. Both the supply and demand for new credit has deteriorated, guaranteeing declining or at best stagnant growth levels. Trade wars have been accelerating in recent months, with most governments under intense public pressure to adopt more protectionist policies. Such policies are universal and foreshadow a less favorable trading environment. There is always a possibility of an oil shock, resource shortage, war, terrorist attack, etc. While these events are entirely unpredictable, these risks should be considered. Government policy has been increasing the level of uncertainty from a hiring perspective. Public backlash against large corporations, the threats of increased taxes due to health care or energy policies, and runaway government spending have created a cautious hiring environment. The aforementioned economic conditions have different probabilities of occurring and varying degrees of consequence, while some are only loosely correlated with employment statistics. Nonetheless, it is highly likely many of these trends and possibilities will come to fruition and this should be considered in any economic forecast. Scenario 1 does not account for any of these developments, and thus is only 5% likely to occur. Scenario 2 considers these events taking place over the next decade but only having a loose impact on the unemployment rate. Scenario 3 assumes these events are highly likely and will have a profound impact on the unemployment rate. Timing and magnitude are difficult to assess, and hence Scenario 3’s shape may look different in reality. With this in mind, the following is a graphical representation of Scenario 3: Scenario 3: Scenario 3 makes the following assumptions: 2010 will continue the appearance of a recovery and benefit from census and stimulus hiring. The events listed above will all have major impacts but will be most adversely impacted by a global sovereign debt crisis and the realization of a credit fueled deflation similar to the Great Depression. V. Conclusion Forecasting unemployment requires an examination of many different factors and thus there is no precise, quantitative method of accurate prediction. While these three scenarios cover all bases, the purpose of this presentation was to explain which factors will cause which outcomes and the probability of each occurring. Scenario 2 was my base unemployment scenario and my best effort at predicting the next eight years. There is a remote chance everything will go smoothly during this time and Scenario 1 can occur. There is historical precedent for such recoveries and seems to be consensus among most economic authorities. While pretty dismal, Scenario 3 has a real likelihood of occurring because there are too many structural flaws with the economy not to expect additional crises and economic hardship through 2018. It would be very surprising if none of these variables came to fruition, although it may not cause the level of adversity in this prediction. My best guess would put us somewhere between Scenario 2 and 3. The three scenarios are provided in a side by side comparison below: ** All information was taken from publicly available government sources. Employment data is sourced from the Bureau of Labor Statistics, while all additional information is from the Federal Reserve. **