The Economic Outlook: No Confidence Vote

Today, the Labor Department reported the economy lost 63,000 payroll jobs in February, after losing 22,000 jobs in January.

Governments added 38,000 jobs and private sector employment contracted 101,000. Businesses have become too pessimistic about the outlook for the economy and the capacity of the Bush Administration and Federal Reserve to manage it, to be adding new employees or replacing those that leave.

The Labor Department reported a slight decrease in the unemployment rate to 4.8 percent. However, this statistic was greatly affected by the fact that so many adults have become discouraged and have stopped looking for work. Factoring in the decline in the number of adults participating in the labor force, the unemployment rate is closer to 6.8 percent.

These poor jobs data are the strongest evidence yet that the economic expansion has ended. The economy has slipped into a recession of uncertain depth and duration.

Weak retail sales and slow automobile sales indicate that high gasoline prices and the subprime crisis have slowed down consumers. Along with weakness in housing and nonresidential construction, weak retail and automobile sales are causing businesses to trim second quarter production, investments in new capacity, and hiring plans.

Exports are lifting sales and employment in durable goods and materials industries that support those industries, but overall a weaker dollar against the euro and other currencies and the resulting increase in exports are not enough to lift industrial production and employment from recession levels.

Contribution of Federal Reserve Policy

Rising prices for food, energy, metals, and other materials are pushing up inflation, but the Federal Reserve can do little to curb rising prices. The ethanol program is pushing up food prices, and robust growth in China and elsewhere in Asia are pushing up energy and raw material prices. The Fed could only marginally affect these pressures by constraining U.S. growth.

The Federal Reserve’s aggressive interest rates cuts will have a limited effect on GDP and employment growth, and the stimulus package is likely to be too little and arrive too late to head off a recession. The stimulus package at $152 billion is only about half as large as the losses taken by the major New York banks and their customers on subprime securities. Its value will be to lessen the pain imposed by whatever slowdown or recession the economy endures, not to head it off entirely.

The Federal Reserve is in crisis, because its mix of policies addresses an old style recession, one premised on inadequate demand but solid financial institutions. This recession has its origins in questionable banking practices and a breakdown of investor trust in the integrity of Wall Street’s most venerable banks and investment houses.

Federal Reserve regulators, apparently lacking appreciation for the gravity of these problems, have focused mostly on urging banks to raise new capital without effective parallel efforts to reform bank business models and practices. Often, new capital has been provided by sovereign wealth funds or private equity firms, which lack sophistication in the intricacies of commercial and mortgage banking and demand few changes in bank management policies. The result is sophisticated buyers of fixed income securities, such as insurance companies, remain unwilling to accept loan-backed securities from the banks. The market for mortgage backed securities issued by commercial banks has evaporated.

The Federal Reserve and Treasury need to prod the private banks to reform lending practices, and to encourage bond rating agencies to return to investor financed ratings. Unfortunately, Henry Paulson and Ben Bernanke have been shy to do this. That is why the stock market has not been much moved by recent interest rate cuts, the dollar is so weak against the euro and gold prices continue to rise. The economy is sailing through dangerous, unchartered waters, and the helmsmen, seem confused and unsteady, adding to pessimism about the outlook for GDP growth and jobs. The weak dollar and high price for gold are a financial market vote of no confidence for them.

Further Federal Reserve interest rate cuts are certain but these will do little to improve the growth prospects for the economy or the job market for ordinary workers.

Weak Wage Growth and Unemployment

Construction, manufacturing, finance, and retail trade displayed weakness, reflecting a contracting economy.