The Weak Labor Market Continues...

The economy lost 299,000 jobs in the third quarter, with 159,000 of those losses occurring in September. Hurricanes Gustav and Ike inflated the decline, but there is little reason to believe that this was just a temporary setback. Labor market conditions are deteriorating and will continue to do so. Until recently, we found some comfort in the fact that outside of construction and manufacturing, employment was still rising. That is no longer true.

To make matters worse, government added 79,000 jobs in the third quarter which means that the private sector lost 378,000 jobs in the last three months and almost one million since the start of the year. The crises that hit Wall Street in September started hitting Main Street back in January, a clear case of the chickens coming home to roost.

In the past two (relatively mild) recessions, employment fell about 1.5 percent from peak to bottom. In the more severe recessions of 1980 – 1982 and 1974 – 1975, the employment declines were 2.5 percent. So far, we have seen a decline of only 0.6 percent which means the economy could lose anywhere between 1.3 million and 2.7 million more jobs. Put bluntly, the worst is still to come.

Not only are more people out of work, but the depth of their unemployment is greater. Two million workers have been unemployed for more than six months, a 60 percent increase since last September. The portion of the labor force out of work for six months or more is at its highest level in 25 years.

The rise in long-term employment is also tied to the housing slump. If you cannot sell your house, you cannot move to another part of the country where employment prospects might be brighter.

What's Going On With Interest Rates?

The calamities in the financial markets can be summed up by one simple statistic. On September 17, the yield on three-month Treasury bills fell to 0.03 percent, a rate not seen since the Great Depression. It was a stampede to the safety of government securities. Short-term yields recovered somewhat by the end of the month but are still far below their level of two years ago, when the yield curve was inverted.

It has been called a liquidity crises but liquidity is not really the problem. There is still plenty of money available but lenders have little confidence that debts will be repaid. The spread between Baa-rate corporate bonds and 10-year Treasuries increased to almost four percent. Even the relatively low risk LIBOR market was affected, as rates shot up almost 150 basis points, a troubling development since so many adjustable rate mortgages are tied to this rate. What this really means, however, is that credit markets are still working as they should, with yield spreads reflecting perceived risks of default. Inter-bank loans are considerably more risky than they were just a few weeks ago.

For the foreseeable future, Treasury yields will remain low but that will be of little help to borrowers seeking funds. It is a classic case of “crowding out” in which money flows into government debt and away from private sector investment. And less business investment today means less economic output in the future – a polite way of saying that the US economy is in recession.