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Laboring

By

Not sure what I'm gonna do if employment doesn't pick up soon

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Much ink has been spilled in the effort to describe the forces at work in the US labor market. Politicians, economists, investment strategists: all have been trolling for reasons why the US economy is 8.8mm jobs short of a "normal" cyclical recovery. Given the attention this topic will receive thanks to this Friday's March employment numbers, we thought we'd frame the reasons as we see them and add yet another twist to the debate.

The commonly accepted reasons for such low employment gains this past year have been varied: outsourcing of manufacturing jobs to China, white collar service jobs being exported to India, booming productivity, and lastly a workforce that has not kept pace with the skills demanded by the global economy. Each of these, surely, plays some role, but as we've tried to make clear, they are not principal causes. After all, manufacturing employment in the US has been declining every year since 1970. Yes, 1970. Shipping our manufacturing jobs overseas is clearly nothing new. And if you believe Forrester Research, white collar services jobs exported to India will amount to no more than several hundred thousand per year for the next handful of years. In an economy with 137 million workers, this hardly counts as a causa proxima for lack of employment growth. Productivity of course has increased, markedly, but there is no statistical relationship that would suggest this level of productivity should be keeping a lid on employment to this degree. In past cyclical rebounds, strong productivity growth was accompanied by far larger employment gains.

We have written several times that we believe a major factor in the employment picture is the heavy hand of intervention. Both the Fed and the administration have created substantial monetary and fiscal disincentives to CEOs and entrepreneurs to hire employees. Excessively cheap capital, along with a capex tax credit, have joined forces to make capital far less expensive than labor on a relative basis. We have used the example that, for an average CEO, it's simply cheaper to buy a Dell server and a Cisco router than it is to hire an additional person. The Fed funds rate at 1% and that capex tax credit have seen to that.

This income statement arbitrage is entirely in keeping with basic economic principles: if CEOs and entrepreneurs can increase sales and profits more by adding capital to their business than by adding labor to it, they will do so. They will do so until the arbitrage between the two goes away: that is, until the cost of capital increases or the cost of labor decreases. And since the Fed is adamantly "patient" in keeping capital costs artificially low, we can safely assume that the above arbitrage between labor and capital will continue to take place. In other words, employment gains will continue to be stagnant at best.

But there are other inputs into the income statement of the average businesses than simply labor and capital: raw materials are an important part of the income statement for a host of businesses. (Please indulge our oversimplification insofar as services businesses are concerned: no they don't have "raw" material costs per se but increases in raw materials throughout an economy eventually trickle down to services businesses in the form of increased "higher order" input costs.)

The rise in commodity prices (as reflected in the CRB index or in the prices of copper, silver, etc. and in dollar terms) of late has been hard to miss. There are a host of possible reasons for such a run-up in prices: the falling dollar, demand from China, etc. Another possible explanation that gets little print is liquidity: since the demand for money from the "real" economy is slack, the massive liquidity that the Fed has engineered in the last 3 years has found its way into all asset classes via speculation: stocks, bonds (especially high yield bonds), real estate, and, yes, commodities. Evidence for this view can be found in the unusual correlation that has existed between and among all asset classes since the Fed started their reflation campaign: commodities, bonds, stocks, real estate. Each has had fantastic runs over the last 18-24 months, and each has attracted a tremendous amount of speculation (if the CoT data is to be believed).

The point is that the Fed's reflation efforts have not only altered the relationship between capital and labor (in favor of capital) and thus created the unintended consequence of lower employment, but their reflation efforts have also resulted in higher raw material prices (commodities).

So what's the effect of higher raw material costs on businesses? In an environment where businesses cannot raise prices on end products, an increase in raw material costs has the effect of squeezing the intermediary costs on the income statement. In other words: inflationary forces on the input side and deflationary forces on the output side have the effect of squeezing the next largest cost on the income statement: labor.

Adding insult to injury, not only has the Fed's excessive credit creation caused labor to suffer at the hands of capital, but that same credit creation has caused an increase in raw material costs that has placed still more disincentive on employing labor. If this combination of factors doesn't represent a "perfect storm" for employment, I'm not sure what does. And to think that this is the result when the Fed is trying to help the economy. What's that old saying? "With friends like these..."

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