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David Rosenberg (Fred Lum)
David Rosenberg (Fred Lum)

David Rosenberg

Deflationary undertow threatens U.S. recovery Add to ...

David Rosenberg is chief economist and strategist for Gluskin Sheff + Associates Inc. and a guest columnist for Report on Business

Here we are fully 28 months past the point of the onset of the Great Recession and ostensibly nine months after bottom in real GDP, and it seems safe to say that the U.S. economy is out of job-shedding mode. The steady downdraft in jobless claims and layoff announcements would attest to that view.

Then again, after a record 8.4 million decline in payrolls from the cycle peak, which brings employment down to levels prevailing a decade ago in a run of job destruction not seen since the 1930s, inertia alone would have ensured that a bottom has been reached - after all, the level of payrolls was not going to decline forever. But, while it may be encouraging to see employment, especially in the business sector, finally begin to rise after such a lengthy and precipitous decline, the U.S. labour market still remains in the grips of a serious deflationary undertow.

Indeed, the most disturbing aspect of the March jobs report was the 0.1-per-cent decline in average hourly earnings - to see a contraction in wages in any given month is practically a 1-in-100 event; the last time that happened was in April 2003, a time when Alan Greenspan and Ben Bernanke were busy building a firebreak around deflation.

The year-on-year trend in wage growth has been sliced to 2.1 per cent from 2.5 per cent three months ago when employment hit rock bottom, not to mention the 3.5-per-cent pace a year ago. As long as excess supply dominates in the jobs market, expect the downward trend in wages to persist.

So despite the positive headlines on payrolls, don't think for a second that the Fed is not aware of, or insensitive to, the deflationary pressures that continue to build in the labour market. Against this backdrop, any premature tightening by the central bank or a sustained backup in bond yields is simply out of the question.

In a nutshell, as one chapter of the labour market downturn is closed (employment contraction), another one starts (wage deflation). The most recent employment data, on the surface, may well have met the challenge served up by the consensus of economists, but it fell well short of addressing the massive amount of excess slack that still exists in the labour market.

Not only did the headline unemployment rate not budge at 9.7 per cent, but the broader U6 measure - those who have stopped looking for work or who can't find full-time jobs - rose for the second month in a row, to 16.9 per cent (the highest it ever reached in the previous recession and jobless recovery in 2003 was 10.4 per cent, just to show what we are up against). So, as long as we have this much spare capacity in the labour market - with nearly one in every six unemployed Americans vying for every job opening - deflationary pressures can be expected to build.

Finally, the ranks of the unemployed who have been looking for work for at least six months soared 414,000 in March, or nearly 7 per cent, to 6.5 million. This is a double from 3.2 million this time last year when equity investors believed the world was coming to an end. Of course, the world did not end for the equity investor who was bailed out by massive government incursion, but the world for the long-term unemployed has tragically become even darker (the gap between Wall Street and Main Street has scarcely been as wide as it is today).

Long-term unemployment as a share of the total jobless pool now stands at a record 44 per cent versus 26 per cent the last time the official unemployment rate was as high as it is today, back in the early 1980s. There are three main reasons for this. The first has to do with the lack of mobility in a distressed national real estate market. The second reflects the permanent job loss that permeated this recession because the jobs in bubble sectors, such as construction and finance, are simply not going to be coming back any time soon. Thirdly, large states such as California, Florida, Illinois and New York, in the past, could always be relied upon to be significant drivers of employment opportunities, but they are just too cash-strapped today to play any role at all.

There are many factors related to the tragedy of rising long-term unemployment that lead us to the conclusion that deflation will prove inevitable. The longer it takes to find a job - the average duration of unemployment just hit a fresh record of 31.2 weeks from 29.7 in February - the more likely it is that these people will be rehired at a lower wage than they were receiving before they were let go from their previous job.

It would be a disservice to overreach in terms of what this means to economic growth, inflation, equity prices and interest rates over the next year and yet we are sure that many pundits will be uncorking the champagne bottles because of the headline job figure and the back revisions. But if one is willing to look at the forest rather than the trees, it becomes clear that we still have an enormous supply-demand mismatch in the U.S. labour market, which is at odds with current valuation levels in the equity market and yield levels in the bond market.

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