Smith Faculty Opinion Article	November 2, 2007
By Dr. Peter Morici, Professor of International Business E-MAIL WEB SITE

Economy Adds 166,000 Employees in October, While Ranks of the Self Employed Drop Credit Crisis Grows, Bernankes Credibility Suffers

Today, the Labor Department reported that its survey of employers indicates the economy added 166,000 payroll jobs in October, after posting a 96,000 gain in September.

Conflicting with this positive news, the Labor Department also reported that its household survey, which includes the self-employed, showed employment dropping by 250,000 in October, after rising 463,000 in September. Such wild and inconsistent swings in data, cast a long shadow on the reliability of both surveys.

The grip of the mortgage crisis and housing adjustment are apparent in the important and high paying construction and manufacturing sectors.

Construction shed 5,000 jobs, reflecting continuing weakness in the residential construction.

Manufacturing lost 21,000 jobs, despite the much advertised surge in exports. The troubles of the Big Three automakers and imports of consumer goods from China head the list of causes. The housing crisis drags on the important truck market. Imports from China continue strong, because Beijing has doubled purchases of dollars and other currencies in foreign exchange markets to hold down an increasingly undervalued yuan. Those purchases are now about 16 percent of Chinas GDP and 45 percent of its exports.

Japan, Brazil, Russia, and several other Asian economies follow similar currency strategies, frustrating efforts to undo global trade imbalances, significantly reduce the U.S. trade deficit, and restore some 2 million U.S. manufacturing jobs lost to currency manipulation and trade protectionism over the last seven years.

Consumers are trimming spending. Rising gasoline prices and falling home prices are eroding consumer confidence. Businesses are becoming skeptical about growth prospects in the domestic market, and exports offer the greatest hope generally only for the large multinationals and diversified financial institutions.

The economy will likely grow at 1.5 to 2 percent in the fourth quarter but could easily slip into a recession.

The unemployment rate was steady at 4.7 percent in October, unchanged from September. However, these numbers belie more fundamental weakness in the job market. Many more adults are sitting on the sidelines, neither working nor looking for work, than at the beginning of the decade.

In September another 465,000 adults chose not to participate in the labor force, and since February 2000, that number has increased by more than 10 million. Factoring in these workers raises the effective unemployment rate to about 6.6 percent.

Wages increased a moderate three cents per hour, or 0.2 percent in October. Moderate wage and labor productivity growth should help keep core inflation in check, and this should help abate Federal Reserve concerns about core inflation, as it navigates the fallout from the subprime and housing crises.

Rising energy and commodity prices do threaten to reignite inflation; however, with wages unlikely to set off an inflation spiral, the Federal Reserve should focus on restoring stability to credit markets and the housing industry.

Unfortunately, this weeks Fed statement inferred that it is through cutting interest rates. This only served to further destabilize credit, stock and housing markets, and negate the potential positive effects of its quarter point reduction in the federal funds rate.

Through this statement, Ben Bernanke reversed his recent expressions of concern about the consequences of the housing crisis for the broader economy. This was a dramatic flip flop and serves to seriously undermine his credibility.

The increasing risk of recession will grow and pressure the Federal Reserve to cut interest rates further in December.

The threat of recession does not emanate from some internal clock in the economy, as it did in the 1950s and 1960s. Rather, the risk at this time comes mainly from a structural crisis in credit markets. This was caused by reckless private credit strategies and ill-conceived federal regulations, and could be addressed by prompt and creative Administration and Fed policies. Some would include greater flexibility for Fannie Mae and other federally chartered banks, and Fed purchases of Treasury securities on the long end of the yield curve to pull down long rates.

The Fed could be more creative and do a lot more, but Bernanke's Fed clearly has trouble thinking outside the box.

The Fed's Misstep

The big news this week was not the Federal Reserves decision to cut federal funds rate from 4.75 to 4.5 percent, rather the notable event was the Fed's indication it would not likely cut rates further. The Open Market Committee stated:

The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

Given how steady inflation has been, despite rising oil prices, many market participants interpreted after this action, the upside risks to inflation roughly balance the downside risks to growth to mean this is it, we are done. Although the next sentence gives the Fed an escape hatch, players expect that it will take a lot of bad news for the Fed to cut rates again.

Recessionary pressures continue to build, and the Fed will face stronger pressures to cut rates more in the weeks ahead.

A big problem remains adjustable rate mortgages (ARMs) due for resetting or that have only recently reset. Lower long-term mortgage rates would make it possible to transition more ARMs to fixed rate mortgages, including even some mortgages whose outstanding balances exceed the values of their properties by modest amounts.

Also, the market for commercial paper has not fully recovered, and lowering short-terming borrowing rates would permit a larger margin on short-term loans, offering more affordable financing to businesses while further assuaging creditors about risk.

These are temporary and unusual conditions. The threat of recession does not emanate from some internal clock in the economy, as it did in the 1950s and 1960s. Rather, the risk at this time comes mainly from special conditions in credit markets that could be addressed by more creative Administration and Fed policies. Some would include greater flexibility for Fannie Mae and other federally chartered banks, and Fed purchases of Treasury securities on the long end of the yield curve to pull down long rates.

The Fed made a mistake implying this was the end of the rate cuts. It can always change its mind but such flip flopping damages Bernanke's credibility. The Fed should have just cut rates and said further actions would be determined by conditions.

The Fed could be more creative and do more but Bernanke's Fed clearly has trouble thinking outside the box.

Forecasts

Here are my forecasts for upcoming economic data.

Forecast Previous Period

November 2

Nonfarm Payrolls - Oct 100K 110
Manufacturing Payrolls -7 -18
Unemployment Rate 4.7 4.7
Average Work Week 33.8 33.8
Hourly Earnings 0.3 0.4

Factory Orders - Sept -0.4% -3.3
Durable Goods Orders -1.7 -4.9
Nondurable Goods Orders 1.0 -1.6

Week of November 5

November 5
ISM Services - Oct 55.2 54.8
ISM Prices 66.3 66.1

November 7
Productivity (p) - Q3 3.0% 2.6
Unit Labor Cost 0.8 1.0

Wholesale Inventories - Sept 0.2% 0.1
Wholesale Sales 0.5 0.4

Consumer Credit - Sept $8.0b 12.5

November 8
Initial Jobless Claims 325k 327

November 9
Export Prices - Oct 0.1% 0.3

Import Prices - Oct 0.7% 1.0
Import Prices, ex petroleum 0.2 -0.2
Import Prices, petroleum 2.5 5.4

Trade Balance - Sept -$59.8b -57.7

Mich Cons Sentiment - Nov (p) 79.5 80.9

Week of November 12

November 13
Treasury Budget -$53b 111.6

Pending Homes Sales - Sept 85.5 85.5

November 14
PPI - Oct 0.2% 1.1
Core PPI 0.2 0.1

Retail Sales - Oct 0.3% 0.6
Retail Sales, ex Autos 0.5 0.4
Retail Sales, Autos -0.8 1.2

Business Inventories - Sept 0.3 0.1

November 15
CPI -Oct 0.2% 0.3
Core CPI 0.2 0.2

November 16
Net Foreign Purchases - Sept $80.0b -69.3 (line 19 US Treasury TIC Report)

Industrial Production - Oct 0.1% 0.1
Capacity Utilization 82.1 82.1

November 17
NABE Index 19 18

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.