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The Fed (And Others) Miss The Point


Missing The Point

Sometimes I wonder if the ridiculously-foolish pronouncements out Fed economists are intentional or the product of folks with plenty of brainpower but damn-little real-world experience.

Such is true for this ditty entitled A Mis-Leading Labor Market Indicator.

The employment-population (E/P) ratio frequently is used as an additional labor market measure. The E/P ratio is defined as the number of employed divided by the size of the working-age, noninstitutionalized population.

Yep.  I cite it every month as the only number that matters.  If you’ve read my column you know this already, so it was with much bemusement that I went through the analysis in this paper.

The base claim is that this data does not demonstrate labor-market slack.


(Blue line)

Well, we can have that debate if you’d like, but it’s not the debate to have.  The debate is much-more fundamental with the E/P ratio.

Simply put the E/P ratio is a relative gauge for the sustainability of a given size of government, all-in (Federal, State and Local.)

The reason is this — for each person they are either a net source of revenue for the government or a net sink.

That is, you either are producing something (and thus can pay taxes, hopefully at least as much as you consume in government services) or you are not, and thus inevitably must consume more than you produce.

As this value has fallen the maximum, all-in size of government that can be supported on a forward basis has dropped by about 6% since 2007, and by about 8.5% since 2000.

The problem is that government of all forms has not decreased in size, it has increased.

This is the source of the huge budget deficits during the 2000 and the inexorable ramp that has happened since.

And how has the different been made up?  By borrowing, which leads to a trap that the Japanese find themselves in.

See, today’s low interest-rate environment has dropped the interest on that federal borrowing dramatically, to about 1/3rd of its expected market level.  Unfortunately this is a chimera, because one of two things must inevitably happen.

  • The economy will actually improve and begin growing again.  In this case The Fed will have no choice but to withdraw liquidity rapidly and forcefully to prevent inflation from running away from them.  If they fail to do so then our currency devalues dramatically and imports, upon which we are dependent, become expensive and choke off said economy.  Unfortunately if rates rise the government will end up spending three times what it does now on interest, or to put a number on it, an additional $400+ billion a year, and that assumes we add no more new debt at all, which is course a fantasy. 
  • The economy will not improve.  In this case interest rates will stay low because there is no inflationary threat to worry about.  However, to the extent that the government attempts to provide for the people through more deficit spending irrespective of the programs they deficit spend on, they continue to layer ever-more debt, all of which comes with interest due over time, on top of what we already have.

Now here’s why it matters: The markets expect the good parts of both scenarios to happen at once, which is why the stock market is at all-time highs and people like Susan, who queried me on Fox Business, believe it is wise for corporations to borrow in order to buy back stock and pay dividends.

But that’s an impossibility.  You can get either of the two outcomes but you can’t have part of both.  Either there is going to be no improvement in labor markets and growth, and thus no inflationary threat, or there is going to be improvement in labor markets and growth, and thus an inflationary threat.

The two have never, ever decoupled through history.  No economy has ever had all of extremely low interest rates, high growth, high employment and no explosion of inflationary pressure.

That’s the bet being made in equity markets right now, and it’s a guaranteed loser.  Either you’re not going to get improvement in the labor market and economy, in which case sales cannot continue to expand, or you are and rates will rise, making rollover of the existing debt you took on instead of shrinking it down impossible.

Borrowing during a time of low rates for a long period of time to expand capital equipment can make sense, provided you are reasonably able to forecast thateven if the economic environment does not improve you can use that capital equipment expansion to grow both sales and profits.

However, that’s not what companies are doing with their borrowed funds.


Green dashed line, gentlemen.

Net investment has not changed materially; it remains right near 12% and in fact has been between 12-13% of GDP since 2004, having dropped just a little — to around 11% — during the depths of the recession.

Companies are not borrowing to expand property, plant and equipment.

They’re borrowing to give the money away, basically, exactly as is the government, and in both cases they’re doing so on a premise that, on a forward basis, is impossible.

The Market Ticker

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