The "Virtual Reality" Recovery - And Beyond

We are told that lost manufacturing jobs are made up in the service sector. OK then, let's look at how many service jobs were created during the last expansion versus the past. Surprise, surprise: such job creation peaked at the lowest level since at least 1940, when BLS started keeping data (chart below, click to enlarge).

Service-Providing Jobs - 12 month percent change (BLS)

The service job situation is not isolated, but part of an overall decline in job-creation trends. Total non-farm job creation has been weak in the last expansion, too - again, the lowest peak since 1940 (chart below).

Total Non-Farm Jobs - 12 month percent change (BLS)

The recovery following the 1990-91 recession was called the "jobless recovery" because of the low rate at which it created new jobs (peaked at +3.5% y-o-y) . What, then, should we call the recovery from the 2001-02 recession, which created jobs at a peak rate of only +2.1% (currently at +1.0%) ? And this was only made possible through the rapid expansion of household debt vs. income and the pumping of asset bubbles.

I think, therefore, that for the US the 2003-07 period should be called the "virtual reality recovery". Unfortunately, the looming recession is already shaping up to be very real.

The US is not alone in this condition: several European countries followed the same path, made possible by record-low Euro interest rates. ECB slashed rates as low as 2% in 2003 and a building boom created jobs and consumer demand that kept Europe growing, albeit very slowly. Club Med and the UK are particularly pointed examples, but so are some of the newer EU members and peripheral economies (e.g. Turkey). Households there borrowed heavily in foreign exchange (e.g. euro, yen and swiss francs) to "take advantage" of low interest rates vs. their own currencies.

In the US, the Fed is bending over backwards to accommodate Bush fils by sharply cutting rates, even in the face of rising inflation (Nov.2007 was 4.3% annualized). Perhaps Bernanke does not want to be accused of damaging the economy - as Greenspan was by Bush pere for keeping rates too high prior to the 1990-91 recession, which cost George Bush a second term ("It's the economy, stupid"... "I've fallen and I can't get up").

But the ECB is not playing along, seeing that average consumer inflation in the eurozone is at 3.1% vs. 2% target. Indeed, several eurozone countries are already experiencing higher rates: Spain 4.1%, Greece 3.9%, Ireland 3.5%. Many non-eurozone EU countries have much higher inflation (e.g. Latvia 13.7%, Bulgaria 11.4%, Estonia 9.3%, Romania 6.8%), but the key point is that every single EU country (except Holland at 1.8%) is now above the 2% ceiling and even inflation-phobic Germany is at 3.3% (all figures annualized November 2007 rates). Unless inflation somehow drops sharply in the next few months, do not expect the ECB to cut rates significantly.

In Asia, China is raising interest rates and bank reserve ratios quickly, imposing price controls for food and fuel and allowing the yuan to appreciate somewhat faster. With 37% of its GDP made up of exports, a concurrent slowdown in the US and EU won't leave its economy unscathed, despite hopes of decoupling. A slowdown from 11% growth to even as much as 5% won't be a "recession" per se, but I think it will definitely feel like one in China. And if the US-EU slowdowns happen faster and last longer than current projections, the Chinese economy itself will enter a bona-fide recession, as unthinkable as this may seem right now.

In conclusion, I believe the "virtual reality" recovery that sustained the Western economies and boosted Asia into an export boom is coming to an end.