Why the US employment picture is much grimmer than it looks

published 6 May 2008

Markets got very excited towards the end of last week.

There was all that loose talk about the credit crunch being over for starters. This was compounded by some better-than-expected US economic data.

Apparently, the US economy grew by 0.6% year-on-year in the first three months of 2008. It's not great, but it's not a recession. Meanwhile, jobs data on Friday showed that there were just 20,000 job losses in April, against expectations for a 65,000 fall.

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So has everything been blown out of proportion? Was the credit crunch really just a storm in a teacup?

It'd be nice to think so. But let's take a closer look at those figures...

Why we shouldn't rely on GDP figures

I don't tend to pay much attention to GDP figures when they come out. And there's a good reason for that. They're not really worth the paper they're printed on.

Both here and in the US, GDP figures are subject to substantial revisions, long after (we're talking years) they have first been published.

So while the estimate of 0.6% growth for the US in the first quarter of this year might look fine just now, as US fund manager John Mauldin puts it, "my bet is that the numbers for GDP will be revised down when the economy is well on the way to recovery That is what happened when we found out a few years later that the last recession started in the third quarter of 2000. The initial numbers were positive."

Another interesting point that Mauldin makes is that the inflation figure used to calculate the GDP figure is very forgiving. The US Government department calculating the GDP figure reckons that inflation was 2.6% during the first quarter. With nominal growth at 3.2%, that gives the real' GDP figure of 0.6%.

But if you take the official headline' measure of inflation, which came in at more than 4.1% during the first quarter, then real' GDP growth would quite clearly be negative.

It's not to say that this is all a massive conspiracy to keep people in the dark about the true state of the economy. But clearly there's an incentive for governments any government to present the most forgiving figures they can. And that's bound to have some effect on how the figures are put together.

US jobs data deserves a closer look too

As for the jobless data, delving into the make-up of these is another eye-opener. You see, the jobs data in the US isn't just a simple measure of the real number of jobs being added to the economy. There's an additional quirk called the birth/death ratio.

What's this? Well the employment survey goes around established businesses. But it can't hope to pick up on all the small businesses in the country and the hiring and firing that they do. So an estimate for the number of jobs small businesses add to the economy is thrown in.

This works fine most of the time. The trouble is, as both Mauldin and regular MoneyWeek contributor James Ferguson point out, that it all falls apart at turning points.

The birth/death ratio is based on historic trends. Right now, a historic growth trend is ending, and turning rapidly into a downturn. However, the birth/death ratio hasn't picked up on that yet.

In fact, this April, the birth/death ratio added more jobs 267,000 to the labour survey, than it did last April (262,000). As Mauldin points out, this included 45,000 jobs in construction, even as the actual survey showed construction job losses of 61,000 at established companies. There were also 8,000 jobs added in the finance sector, and 83,000 in the hospitality sector.

"Without that addition from the birth/death number, total private employment would have dropped by 296,000 when the final revisions are in, we shall see that job losses were well south of 100,000," reckons Mauldin.

Again, the birth/death ratio isn't part of any government conspiracy to keep us all in the dark. It's just a statistical smoothing device that ceases to function properly when the economy reaches a turning point. It's over-estimating the number of jobs being added today as the economy turns down, just as it under-estimated the strength of the job market back in 2003/04 when the economy started to come out of recession.

And none of this is obscure information. Analysts and investors should know all this, so it's odd to see the market responding at all to these figures. But then, as I've said a few times, we're still in glass half-full' mode.

How oil prices could hurt the UK economy

But make no mistake, that won't last. With oil prices breaching $120 a barrel, the Ernst & Young Item Club has warned that it may have to slash its UK growth forecasts for next year. The group suggested that if oil prices remain this high, inflation will remain above 3% for the next three years. And if oil hits "$200 per barrel, as one Opec minister recently predicted, then frankly all bets may be off," said Hetal Mehta of the Item Club.

That $200 a barrel seems extreme. But then, $120 a barrel seemed extreme only six months or so ago. There'll be more on oil prices from my colleague Dominic Frisby tomorrow, but suffice to say, even if prices don't get much higher for the moment, the Bank of England is going to have a very decision to make on interest rates on Thursday.

Turning to the wider markets

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The FTSE 100 climbed 128 points on Friday, to end at 6,215. Upbeat retail sales news from John Lewis helped buoy high street chains such as Next.

Across the Channel yesterday, the Paris CAC-40 dipped 6 points to end the day at 5,063. And in Frankfurt, the DAX-30 gained 9 points to 7,052.

On Wall Street, US stocks took a tumble as Microsoft dropped its $50bn bid for rival Yahoo. The Dow Jones fell 88 points to end at 12,969. The broader S&P 500 closed down 6 points, at 1,407, while the tech-heavy Nasdaq lost 12 points to close at 2,464.

In Asia this morning, Asian stocks were lower as results from financial stocks weighed on markets. Australia's fifth-largest bank, St George Bank, fell as bad debt and funding costs rose. Meanwhile, the Reserve Bank of Australia left interest rates unchanged at 7.25%. Japanese markets were closed for a public holiday.

Crude oil was trading at around $119.77 in New York. Meanwhile Brent spot was trading at $117.69.

Spot gold was trading at around $876 an ounce this morning, while silver was trading at $16.76. Platinum traded around $1,919.

Turning to forex, sterling was trading at 1.9696 against the dollar, and at 1.2738 against the euro. The dollar was last trading at 0.647 against the euro and 104.98 against the Japanese yen.

This morning, Lloyds TSB has written down £387m in US subprime-exposed assets. The group said that excluding the writedown, pre-tax profits rose by more than 10% in the first quarter, while it had "significantly improved" its market share of new mortgage lending.

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Crude oil was trading at around $119.77 in New York. Meanwhile Brent spot was trading at $117.69.

Spot gold was trading at around $876 an ounce this morning, while silver was trading at $16.76. Platinum traded around $1,919.

Turning to forex, sterling was trading at 1.9696 against the dollar, and at 1.2738 against the euro. The dollar was last trading at 0.647 against the euro and 104.98 against the Japanese yen.

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Will the Federal Reserve keep cutting rates?

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.