Is Yellen Being Misled By Employment Statistics?

Yesterday, Chairwoman Janet Yellen presented the Federal Reserve's Semiannual Monetary Policy Report to the Congressional Committee on Banking, Housing, and Urban Affairs. While the financial markets were closely focused on clues as to the future direction of monetary policy and rate hikes (see "Analyzing Impact Of Fed Rate Hikes), I wanted to address her comments regarding the current employment situation and outlook.

"In the labor market, gains in total nonfarm payroll employment averaged about 230,000 per month over the first half of this year, a somewhat stronger pace than in 2013 and enough to bring the total increase in jobs during the economic recovery thus far to more than 9 million. The unemployment rate has fallen nearly 1-1/2 percentage points over the past year and stood at 6.1 percent in June, down about 4 percentage points from its peak. Broader measures of labor utilization have also registered notable improvements over the past year."

While it is an accurate statement that the U-3 unemployment rate, as reported by the BLS, has dropped to 6.1% as of the latest report there is much controversy surrounding the validity of that statement.  (For more on this read: What Is The Real Unemployment Rate?")

However, when it comes to creating economic growth it is only full-time employment that matters. Full-time employment fosters higher income levels, promotes household formations and increased consumption. In an economy that is roughly 70% driven by consumption, the "quality" of employment is much more important than the "quantity."

Therefore, the first chart below shows the ratio of those that "usually work full time" as compared to the working age population (16-54 years of age.)

 

 (Note: While the latest report from the BLS showed an increase of 288,000 jobs in June, the full-time employment to population DECREASED by 0.5% due to the loss of 580,000 full-time jobs.)

What is missed by most of the economic reporters and analysts is that while jobs are created from one month to the next, the working age population is also growing.  Since the official end of the recession in June of 2009, as shown in the chart below, employment has grown by a cumulative total of 7.8 million while the working age population (individuals between the ages of 16-54) has grown by over 12.3 million.

While employment has indeed returned to levels seen just before the financial crisis, there is clearly an issue between the Fed's view of full employment versus the "real" economy. The next chart shows the ratio of total employment versus the working age population back to 1977.  There are two important points to note: 1) the ratio has been declining since 1999 as productivity gains, and outsourcing, has reduced the need for domestic employment, and; 2) the last time the ratio was at 56% was in April of 2009.

This data suggests that the "real" economy is far from achieving actual full-employment levels that absorbs the excess "slack" in the labor force, increases wages and leads to organic economic growth. The risk that the Federal Reserve runs by potentially increasing interest rates too soon is that higher borrowing costs will likely fracture an already fragile employment market as businesses currently only as necessary to keep up with incremental demand created by population growth.

"Baby Boomers" Are All Retiring?

Ms. Yellen did try to argue against the extremely low levels of labor force participation by stating:

"Labor force participation appears weaker than one would expect based on the aging of the population and the level of unemployment."

There have been numerous discussions about the number of "baby boomers" that are retiring in droves each day which is upending the labor force participation ratio.  As shown in the chart of employment-to-working-age-population above, the decline that begin in 1999 is hard to justify by a "retiring" group of individuals for a couple of reasons:

1. Given recent studies that suggest the roughly 50% of Americans have less than $2000 in the bank, there is little evidence to support that a massive number of people are actually retiring, and;
2. After two major bear markets that destroyed a large chunk of the retirement savings plans of individuals there are many that have returned back to, or continue in, the labor force to supplement retirement welfare.

As I addressed recently in "Don't Blame Baby Boomers For Not Retiring,"

"Let's start with the retirement of the boomer generation.  Recent statistics show that the average American is woefully unprepared for retirement. On average, 40% of American families are NOT saving for retirement, and of those who are, it is primarily about one year's worth of income.  Furthermore, important to this particular conversation, one-fourth of those at retirement age postponed retirement with only 18% being confident of having enough saved for retirement."

"With 24% of "baby boomers" postponing retirement, due to an inability to retire, it is not surprising that the employment level of individuals OVER the age of 65, as a percent of the working age population 16 and over, has risen sharply in recent years."

 

What seems to be missed by the majority of employment analysis, in my opinion, is whether the economic viability for the average American has improved? The fact the social benefits as a percentage of real disposable incomes has risen to an all-time record certainly suggests that it has not.

The actual state of employment in the U.S. is likely far weaker than the economic statistics currently suggest. If this is indeed the case, it creates a potential for policy mistakes that could have negative consequences to both the economy and the financial markets.

While the Fed is "committed to policies that promote maximum employment" there is little evidence that the trillions of dollars injected into the domestic economy have had any real effect on improving employment beyond what would have been expected due to population growth. While the Fed has inflated asset prices to the satisfaction of Wall Street, it has done little to improve the economic prosperity for a bulk of the middle class.

Janet Yellen was correct when she suggested the "fiscal" policy was dragging on economic growth. Fiscal policies provide the capability for business increase production, raise wages, and boost employment. However, what businesses want is fewer regulations, which increase costs and reduce efficiencies, while government officials keep piling on more.

As I stated in yesterday's missive:

"Most importantly, the number of times that Federal Reserve has hiked interest rates without a negative economic or market impact has been exactly ZERO."

This time is likely to be no different.