How Long Can The US Economy Defy Economic Gravity?
Some readers (judging by their tone, I think they are Democrats) took issue with my view that there was still steam in the US economy and that the subprime fiasco would not sink it (It's not the housing market that threatens the US economy). I also pointed out more than once that readers should not be surprised if the Fed cuts rates. Well, the jury has passed its verdict: real gross domestic product came in at an annual rate of 3.9 per cent for the third quarter. This was on top of the 3.8 per cent growth rate for the second quarter. Taken at face value one would have to say that the US economy is accelerating.
Let's take a look at a few more stats. The construction industries reported a cut in payrolls in October by about 5,000. No surprises there considering the current state of the housing market. For manufacturing the job situation was a little murky. Although it reported a cut in jobs of 21,000 new orders continued to grow with the ISM (Institute of Supply Management) Employment Index showing employment strengthening at 52.0.
Overall the ISM report indicates that manufacturing is continuing to expand. A couple of points here. It didn't take a genius to argue, as I did, that the depreciating dollar should give US manufacturing a fillip, which now appears to be the case. The other point -- and I think it's an important one at this stage -- is that producer prices appear to be pretty stable. This suggests that manufacturing is not running into an production constraints, meaning that it is not experiencing shortages of materials or fixed capital.
When it comes to jobs the pattern of employment is very important. Throughout 1999 and 2000 I stressed that despite the low employment rate rising unemployment in manufacturing -- combined with falling output -- indicated that a recession had arrived. The rising demand for labour in the lower stages of production, even as manufacturing contracted, confused economic commentators. This gave us the myth of the "dual economy".
Unfortunately the economics profession has forgotten the vital insight of the older economists that "the demand for commodities [consumption goods] is not the demand for labour". Now according to Automatic Data Processing's private employment survey October would have produced about 130,000 or so jobs. In fact, the actual figure was a stunning 166,000 private jobs. Naturally, this has the optimists jumping up and down while the Democrats curse their bad luck. (According to Dem lore Republicans are incompetent as well as evil).
Not so fast, however. These figures require closer examination because they neatly illustrate my point about the dangers of employment aggregates. Virtually all of these jobs came from the lower stages of production: the leisure and hospitality industries created 56,000 positions, education and health care industries created 43,000 and professional and business services 65,000. The aggregate conceals the fact that the number employed in manufacturing has dropped by 210,000. I have to admit that the boom-bust pattern seems to be repeating itself. (Always remember: history never repeats itself -- it's just that people keep on making the same mistakes).
But we must exercise prudence, particularly about manufacturing jobs. If manufacturing is expanding how could it "lose" 210,000 jobs from October 2006 to October 2007? (Bureau of Labor Statistics News Table B-1). Well, this amounts to a 1.5 per cent drop and could be explained by retirement and churning. It is when job losses follow a fall in output that we should take it as a warning sign of economic troubles ahead*.
Now the Fed's 0.25 cut has got inflation hawks worried while supply-siders continue to party. I sympathise with the hawks. It's the CPI that trips up the monetarists and supply-siders. One reader insisted that the supply-siders must be right "because during the past 5 years the CPI moved in the opposite direction to the funds rate". True but irrelevant. The US has -- like Australia -- been running extraordinarily high current account deficits. This is called "exporting your inflation". In return both countries received oodles of consumer goodies that the commentariat managed to misinterpret as "importing deflation".
What matters is not just the supply of money but the demand for money. For example, increasing productivity raises the demand for money and so tends to raise its purchasing power. This is what happened in Britain during most of the nineteenth century. (The US economy: Greenspan and Bernanke have a lot to answer for)
Finally, there are still those -- meaning just about every economics commentator -- who still see the economy as being driven by consumer demand. In their view the subprime crisis should have sapped demand and sent the economy into recession. That this did not happen only means that the inevitable has been delayed. For the gazillionth time -- business spending is what drives the economy. This fact was known long before Keynes swept everything before him.
In 1934 it was estimated that "...income produced or net product is roughly only about one-third of gross income". (Sumner Slichter, Towards Stability, New York: Henry Holt & Co., 1934, p. 7, cited in C. A. Phillips, T. F. McManus and R. W. Nelson, Banking and the Business Cycle, Macmillan Company, 1937, p. 71). The Bureau of Economic Analysis now calculates what it calls gross output. The figure includes spending on intermediate goods which puts consumer spending at about 50 per cent of the aggregate. (This is still too high in my opinion).
*Since 1998 US manufacturing has lost about 6 million jobs. I know that many economists take a rather sanguine view of this situation, comparing it to the decline of agriculture as a proportion of GDP. I think they are may be making a grave mistake.