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Bears Overly Pessimistic About Unemployment


The outcome is uncertain, but some factors are irrelevant predictors of growth.

Many readers ask me how it's possible for the economy to recover if unemployment is so high. Indeed, many are fond of pointing out that the "real" unemployment rate is higher than the 9.7% reported today.

The truth of the matter is that when projecting growth, it really matters very little what the absolute rate of unemployment is -- whether it be 9.7% or the 16.8% U-6 alternative figure provided by the BLS, or the even higher figures publicized by Shadowstats.

What matters is the change at the margin. Growth is all about change.

Let's assume that the unemployment rate is 10% and that it remains at that level for a full year -- i.e. the unemployment rate remains unchanged. Let's assume that the average number of hours worked doesn't change. Let's also assume that there's no net change in the number of long-term unemployed. What would one project for the growth rate of private consumption over the next 12 months?

One would expect nominal consumption growth of at least 4.0%. Why?

First, 1.0% growth is generated simply from the 1.0% growth labor force, which means that in order to keep the unemployment rate constant, there needs to be employment growth of 1%. All things equal, employment growth of 1% will mean nominal gross national income growth of 1.0%.

Second, even in the midst of the current brutal recession, average hourly earnings have grown by 2.6% per annum. All things being equal, income growth of 2.6% will imply consumption growth of the same magnitude.

Third, productivity is growing at a 6.0%-plus clip, which implies earnings growth for companies. Even the most bearish Wall Street analysts are forecasting very dramatic earnings growth in 2010. Companies will either spend or invest most of that money, providing a substantial boost to net private expenditures.

Fourth, a stable employment situation will cause households to reduce precautionary savings somewhat as the fear of job losses subside. This will necessarily boost consumption.

Thus, in a scenario of a stable labor market -- i.e. employment conditions are neither improving nor worsening -- it's difficult to see how consumption will increase by much less than 4.0%. A lower projection would require one to assume that consumers are going to become even more stingy and frugal than they are right now. That doesn't seem likely. To the contrary, it seems more likely that on the aggregate, consumers will relax a bit on some of their more draconian savings measures.

Today's Employment Report

So what does today's employment report portend for future consumption growth?

Across the board, either on a month-over-month (MoM) or on a three-month rolling basis, whether you look at the overall non-farm payrolls numbers, the part-time work numbers, the discouraged-workers numbers, and all of the rest of it, it's clear that the rate at which the employment situation is worsening has continued to slow. And it must be recognized that the situation is currently considerably better than most bears were expecting at the beginning of this year when forecasts of 500,000 job losses through the end of 2009 were common
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