Whatever Happened to the “D” Words?

October 20, 2014.   Having just published a book predicting a federal debt default in 2021 (and describing what can be done to prevent it), I am beginning to feel rather lonely. Everyone seems to have forgotten how close the country came to financial Armageddon six years ago. The “occupy” movement petered out. The “tea party” fervor peaked and is heading toward irrelevance. And concerns about the fiscal dangers to American governments have gone from front page news to deadening silence. Even in the midst of hard-fought election campaigns, you have to listen really hard to hear any of the “d” words—deficit, debt, or default. Part of that is the normal news cycle—issues like ISIS terrorists, the Ukraine, and Ebola have understandably dominated recent news. But it is also that a sense of complacency has emerged as the financial crisis and Great Recession have diminished in the rearview mirror.
Five years of sluggish economic growth and a smattering of austerity measures have reduced the federal deficit and improved the fiscal condition of most states. Even the perennial fiscally challenged state of California has managed to balance its budget (more or less). The federal deficit has fallen to under $500 billion in FY 2014 (October 1, 2013 to September 30, 2014), from a stimulus-induced high of just over $1.4 trillion in FY 2009. Both of these minor miracles have been accomplished with the help of a surging stock market and some smoke and mirrors. In the case of the federal government, some austerity in the form of tax increases and expense tightening have helped reduce the deficit. But the bulk of the “savings” have come from the extraordinary fiscal and monetary interventions in the economy. And the most significant area of actual expense reduction is the result of the military withdrawals abroad.
The federal government now essentially owns and controls the mortgage business in America, through its takeover of Fannie Mae and Freddie Mac. In FY 2014 the government received an estimated $70 billion from these two GSEs (Government Sponsored Enterprises). That source of offsetting receipts is expected to largely disappear in the future, and will become a negative outflow from the Treasury when Fannie and Freddie incur losses. The GSEs are no longer allowed to build capital reserves against future losses, which will now be absorbed in their entirety by the taxpayers during the next downturn. Meanwhile the Federal Reserve currently owns $2.5 trillion of the federal debt and $1.7 trillion of mortgage-backed securities. After expenses, the Fed returns the interest earned on this debt to the U.S. Treasury, to the tune of $100 billion in FY 2014. This source of revenue will also decline, as the Fed has been winding down bond purchases (quantitative easing) and will eventually begin to liquidate its positions.
The bottom line is that about $170 billion of current federal receipts are direct short-term effects of extraordinary fiscal and monetary interventions. Many billions more have been collected by the federal government (and state governments) from banks and other businesses since the recession. The four largest banks alone are reported to have paid approximately $100 billion in fines and penalties during recent years. Tax receipts have also been helped by the Fed-induced increase in asset values, particularly the artificially fueled rise of the stock market. The resulting capital gains, dividends, and bonus distributions make for a very convenient (and fleeting) source of high rate taxable income. On top of all these one-time financial benefits, the U.S. government is paying interest on the ever-growing debt at historically low rates, which will eventually (possibly soon) begin to increase.
How much further will Washington be willing and able to control spending? Some of the belt-tightening has already been reversed; and the military savings are likely to disappear in response to a very unstable world situation. At the same time, we are just now beginning to see the tidal wave of baby boomer retirements. That means millions and millions more long-lived retirees collecting Social Security and Medicare for more and more years. And then there is the cost of another recession—the last one doubled the federal public debt in four years as a result of lower tax receipts, stimulus spending, and increased benefit payments. No one likes to use the “r” word either, but the average time between recessions has historically been about six years—which is right around the corner. When the next recession does arrive, the government and the economy are ill-prepared to deal with it and to find a way to climb back out again.
According to my calculations, the real federal deficit (the difference between continuing revenues and expenses) remains at $750 to $800 billion. That is better than immediately post-recession but still in the danger zone. And the deficit is almost certain to start to increase again, even before the next recession and without the expected interest rate increases. When either or both of those events are factored in, the numbers get downright scary. The federal debt is $12.8 trillion at the end of September, 2014, not including the $5 trillion the government owes itself. That is the most the federal debt has been, as a percentage of the economy, since the one-time massive borrowing for World War II. And that does not include the trillions of dollars in state and local debts or the several trillion dollars of unfunded public pension liabilities. Unfortunately the numbers speak for themselves—we are nowhere close to being out of the woods.

Does the Unemployment Rate Matter Anymore?

The first Friday of every month at 8:30 AM (EST) is a very important time for those of us who follow news about the economy. That is when the U.S. Bureau of Labor Statistics (BLS) releases its monthly report entitled “The Employment Situation.” The headline figures of new jobs created and the unemployment rate are featured in all the major news outlets. The investment community analyzes the details of the BLS report, which includes twenty-five tables of statistics. The stock market reacts almost immediately in pre-market trading and throughout the trading day after the bell rings an hour later. Politicians on both sides of the political spectrum (unfortunately we only have the two) receive new talking points from their advisors to buttress their political arguments one way or the other. To paraphrase the old real estate adage, there are only three critical issues in American politics—jobs, jobs, and jobs.

The number of net new jobs (i.e., the change in total nonfarm payroll employment) is based on a monthly survey of approximately 144,000 businesses and government agencies (called the establishment survey). Although seasonally adjusted, increases in total employment are variable month to month and may not be indicative of the overall trend. The unemployment rate is the figure that stays in our collective memory, and it is more important for two reasons. First, the percentage of prospective workers who are unable to find a job reflects the human toll of an underperforming economy. Second, the percentage of unemployed is the prime measure of how far the economy is from its maximum level of production—and arguably the best indicator of the potential for inflation to rear its ugly head. Unfortunately, the methodology for determining the unemployment rate is seriously flawed, rendering it practically meaningless in today’s economy.

The unemployment rate is derived from a different survey than the establishment survey’s new jobs data. In order to calculate the unemployment rate, the Current Population Survey (CPS) collects information from about 60,000 households every month. Assuming for the moment that the CPS actually collects accurate data depicting the workforce (a dubious assumption), the official unemployment rate is still not reflective of the jobs economy. The two numbers that are used to calculate the rate are completely pliable and unreliable. The “civilian labor force” (the denominator in the all-important unemployment equation) counts only those persons at least sixteen years old who are actively looking for work, as evidenced by a specific set of job search activities undertaken during the previous four weeks. If someone failed to perform any of these activities during the prior month, even if ready, willing, and able to work, that person does not officially count as part of the labor force.

Even in a good economy the “civilian labor force” would be understated because of these criteria. In an economy that has been in a deep recession and slow recovery for five years, the volume of ready, willing, and able workers who have tired of sending out resumes is substantial. This large number of potential workers are not counted in the official labor force and are not considered by the government to be unemployed. Of course they are unemployed, are part of the labor force, and should be counted in the unemployment rate. If they were properly counted, the unemployment rate would be about 12 percent instead of the official 6.3 percent announced in the BLS report for April 2014. The government counted 9.7 million Americans as being unemployed, but the real number of unemployed is closer to 20 million. There are more than twice as many unemployed Americans as the Bureau of Labor Statistics acknowledges.

This huge discrepancy can be validated simply by looking at historical comparisons. There are a definitive number of Americans who are 16 years of age and older and who are not in the military or institutionalized. This “civilian noninstitutional population” is the starting point for employment statistics. Many of them are either unable or unwilling to work due to old age or other circumstances. The remainder of the civilian noninstitutional population, those who are working or would work if jobs were available to them, is the “civilian labor force”. The percentage of the civilian noninstitutional population that are in the labor force is called the participation rate. From the 1960s to the late 1990s the participation rate gradually increased from under 60 percent to 67 percent, as more women joined the labor force and the growing service economy allowed more people to work later in life.

The participation rate remained above 67 percent from 1997 through 2000, and then declined slightly through 2008. Since 2008, the rate has plummeted from 66 percent to 62.8 percent, the lowest level in 37 years. There is no reason for such a dramatic decline in the percentage of people interested in working. In fact, one would expect that a higher portion of the eligible population would want to work when times are tough. The only explanation is that the faulty survey methodology is drastically undercounting the number of “unemployed”. If the percentage of the eligible population who are interested in working (the real participation rate) has remained at 67 percent, which is probably understated, that equates to 20 million unemployed and a 12 percent unemployment rate. That is the real state of the U.S. economy!

Since 2008 the civilian noninstitutional population has grown by 5.8 percent, but the civilian labor force has barely increased by 0.7 percent, according to the BLS. This aberration cannot be explained by anything other than the flawed methodology used to collect and report the data. In reality, the unemployment rate has not dropped from almost 10 percent down to 6.3 percent as government reports contend—it has hardly moved, from 12.7 to 12.1 percent according to the methodology used here. There were slightly over 20 million Americans unemployed during the recession and there are still around 20 million unemployed today. A conspiracy theorist might see a connection between politics and the official reports of improving rates of unemployment. But I am more inclined to chalk it up to good old bureaucratic inertia and incompetence. Despite an obvious need to change the way unemployment is defined, politicians and bureaucrats cling to an old, unreliable, and outdated method that denies the reality of millions of unemployed Americans.