Monday, January 14, 2008

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.


  1. Good Post Hell.

    China's savings are a source of untold accumulated national wealth.

    China's burgeoning economy is command controlled by the PTB that pull the central levers. Not saying thay always get it right, but one major difference as far as I can see is that China has a large cushion within which to maneuver should things start getting rough in this global slowdown.

    China subsidises the energy its industries and consumers use. They have direct control over currency their appreciation. Through subsidies and tax breaks, various industries and consumption are stimulated and restrained. Banks are extroadinarily benevolent with export financing. Tax breaks are regularly employed to stimulate certain sectors , such as the agricultural/rural areas.

    Many levers exist for the central Chinese Gov't to deal with slowing worldwide demand in their economy.Of course China will not decouple from these effects but I expect given the momentum of a population base of 1.3 billion who have been speeding into an era of conspicuous consumption, their ability to weather this storm is considerable.

  2. Dear Hellasious

    will the ECB withstand the Dollar/Euro unpaired change rate? Euro is again appreciating at a fast rate and this will again spell problems on the political side. If (when) the FED will drop rates again they will probably go below 4% and below ECB rates and this is an important psychological barrier.

    In a recent interview I have listened to mr. Trichet, asked about the Dollar/Euro exchange rate, answering with the usual nonsense that he believes to the statement from Bernanke, that "a strong dollar is in the best interest of USA".

    Soon Bernanke is going to demonstrate he is not such a good chaperon, and monsieur Trichet will be forced to find some more sophisticated discussion point.

    What do you think about this issue?



  3. Hellasious, have you listened to what GOP candidate Ron Paul is saying ? A strict Constitutionalist he is. That's the type of republican the country needs again. It's such a shame his chances are so low. The brainwashing of the vast majority of people is certainly complete.

  4. Italian,

    The US is deflation-phobic and the EU's main powers are inflation-phobic. The Fed has no compunction whatsoever to slash interest rates to "protect" the US economy, while the ECB is always "behind" the curve.

    This scenario is more or less bullish for the Euro. The current US administration does not wish to see a strong dollar. And it didn't since day one, back in 2001.

  5. gsm,

    Given China's dependence on FDI and exports, i.e. the transnational sector within China while at same time it has subsidized domestic inefficiencies, a more global perspective is required.

    'speeding into an era of conspicuous consumption' assumes away the above, assumes away most of the countryside, while imagining endogenous development based on what? SOEs, peasant farmers, floating population and ??

    It is subject to the contradictions of capitalism; command economy or not, it cannot avoid the cycle.

    For an idea about the mentioned dependencies, read:
    Made in China:From World Sweatshop to a Global Manufacturing Center?
    Yun-Wing Sung Department of Economics Chinese University of Hong Kong Shatin, Hong Kong, SAR, China

  6. It is quite difficult to make sense out the baloney and blather of messers Bernanke and Trichet. Much of their comment does not seen anchored in reality. Presumably the two gentlemen are speaking 'for-the-press', and are being very coy about reality.

    There are very high levels of debt out there. And the amount of this debt is accumulating exponentially, whilst there is a concomitant single-digit rise in wages and salaries. Hence, paying down the debt is going to consume more and more and more - until there is hardly anything left for necessities. There is barely a single mention of this serious mis-match between debt liabilities and disposal income to discharge the debt. Curious.

    Less money in circulation is deflation. That is, the debt payments garnered by the finance houses and banks sits in their vaults because few can/will borrow - even if interbank rates are lowered. Japan seems to be the textbook case of this scenario: So the Japanese finance houses 'lent out' their spare cash to you-know-who!

    Is it feasible that the cash-heavy US, UK and EU finance houses will try something similar with China?, India?, Russia? Or will the severe capital losses by these finance houses mean that they have to hoard the cash to stay solvent?

    On the matter of Inflation. Every time I hear some commentator on the TV or radio, or read a financial comment in the newspaper, the description of Inflation is just plain wrong - and it goes uncorrected. "Inflation is rising prices". Now this is news to me. I thought Inflation, (the economic definition), was an increase in the amount of money (cash and credit lines). Bernanke actually uses the word inflation, when he should use the word, increase; Why is this?

    Prices of many commodities are indeed rising, but this is due almost entirely to 'external' factors - plain ordinary supply-and-demand, and the increased costs of energy and energy-based production methods.

    So, our 'great and good' Central Bankers, (should that B be substituted with a W?), will cure deflation by lowering the Target Rate - and cure inflation by raising the Target Rate? God help us!!

    Brian P

  7. Hello Hellasious -

    m3anon here - I already lost my password!

    I gotta run and was not able to read your post today but I found this interview on the KitcoCasey website and thought you might be interested if you hadn't seen it. It is an interview with Matt Simmons (one of your book pick authors) and they are talking about oil - as well as Ocean currents as the best energy source???

  8. m3anon,

    While I disagree with Simmons peak oil scenario, I very much agree with him in re. ocean currents:

    The total worldwide power in ocean currents has been estimated to be about 5,000 GW,
    with power densities of up to 15 kW/m2. The relatively constant extractable energy density near
    the surface of the Florida Straits Current is about 1 kW/m2 of flow area. It has been estimated
    that capturing just 1/1,000th of the available energy from the Gulf Stream, which has 21,000 times more energy than Niagara Falls in a flow of water that is 50 times the total flow of all the world’s freshwater rivers, would supply Florida with 35% of its electrical needs.

    Countries that are interested in and pursuing the application of ocean current energy technologies
    include the European Union, Japan, and China.

    See: Technology White Paper
    Ocean Current Energy Potential on the U.S. Outer Continental Shelf

  9. Dear Hellasious,

    As a fairly recent reader of your blog (one of the better ones out there, if I may say so), I'm curious why you disagree with Simmons, regarding peak oil. I'm a long term bull on oil (up to 10 years out), and just recently read Twilight in the Desert, which obviously reaffirmed my "thesis". But I'd be very interested in hearing your take on things.



  10. Sorry to confuse you Jan but I am not Hellasious so probably should not have responded but when I hear energy from ocean currents, hard to resist.

    In re. 'peak oil', I have little doubt that will occur someday but believe it impossible to predict. Additionally, I find that most who accept peak oil do so uncritically, never take the time to read the critiques but engage in ad hominems when doing so is suggested. Too many 'peakers' are too uninformed about industry practices, about the modern price regime, etc, so tend to simply believe the 'I am an expert' routine provided, no matter that these predictions have been wrong so often that they cannot be taken seriously, no matter that socio economic and tech changes are dismissed in favor of geologic determinism.

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