Smith Faculty Opinion Article	June 1, 2007
By Dr. Peter Morici, Professor of International Business E-MAIL WEB SITE

Economy Adds 157,000 Jobs in May, Personal Income Down But Spending Up; No Change in Fed Interest Rate Policy Likely and
Stocks Will Continue Up

Today, the Labor Department reported the economy added 157,000 payroll jobs in May, up from 80,000 in April. In the first quarter, the economy added 496,000 payroll jobs, or about 165,000 jobs per month, and the economy is not on track to equal that pace in the second quarter.

Wages increased a moderate 6 cents per hour, or 0.3 percent, despite surging energy and food prices. Moderate wage and labor productivity growth should help keep core inflation in check, but rising gasoline prices and pressure from the ethanol program on grain and food prices could yet ignite a wage-price spiral. The Federal Reserve will remain cautious about inflation.

Consistent with moderately growing wages and employment, the Commerce Department reported in April personal income fell $7.1 billion or 0.1 percent, disposable personal income decreased $9.7 billion or 0.1percent, and personal consumption expenditures increased $52.0 billion or 0.5 percent. The decline in personal income and personal disposal income, in part, reflected usual items, such as bonuses and exercise of stock options, that boosted reported wage and salary income by about $50 billion per month in January, February and March; therefore, the decline in both measures of income in April is not alarming. Savings continued negative at 1.3 percent of disposable personal income, as consumers continued to spend, portending an up tick in GDP growth for the second quarter.

The price index for personal consumption expenditures rose 0.3 percent in April and 2.2 percent year over year. However, the personal consumption price index, less food and energy, was up only 0.1 percent in April and 2.0 percent from April 2006.

Somewhat slower employment growth in April and May is consistent with decent productivity growth and a moderately expanding economy. New home construction is likely bottoming out. Continued strength in consumer spending and an up tick in business investment and commercial construction should lift GDP growth to above 2 percent in the second quarter.

This is hardly a stellar performance. Thanks to a dollar overvalued against the Chinese yuan and many other Asian currencies, the economy continues to underperform its potential to grow about 3.5 percent per year. Sub par growth is reflected in the poorer quality and number of jobs created for workers outside the high flying health care, technology and finance sectors.

Nevertheless, with energy and food price inflation threatening to spread through the economy, the Federal Reserve is in no position to lower interest rates. Look for steady interest rates through the June and August meetings of the Open Market Committee.

Unemployment at 4.5 Percent Masks Discouraged Workers
The household survey of employment, which includes the self employed, shows the unemployment rate at 4.5 percent in May, the same as in April. More importantly, the survey indicates another 52,000 adults left the labor force, as the ranks of discouraged workers continue to swell.

Despite the Bush Administrations exhortations, this unemployment rate is hardly low by historical standards. In November 2000, when George W. Bush won the presidency, unemployment was 3.9 percent, and the proportion of adults working or seeking employment was much higher than today. Were the same percentage of adults participating in the workforce today as in 2000, the unemployment rate would be about to 6.2 percent.

Low wages are discouraging many adults, who prefer to draw down assets or rely on incomes of spouses rather than accept substandard employment at poor wages and with few benefits. The unemployment statistics do not reflect this reality, though it is importantly responsible for lackluster GDP growth, terrible U.S. savings performance, Americans borrowing from foreigners at a pace of $50 billion per month, and a U.S. debt to foreigners now topping $6 trillion.

Manufacturing, Construction and the Quality of Jobs
The economy is adding lots of jobs for college graduates, especially those with technical specialties in finance, health care, education, and engineering. However, for high school graduates without specialized skills or training, jobs offering good pay and benefits remain tough to find. For those workers, who compose about half the working population, the quality of jobs continues to spiral downward.

Historically, manufacturing and construction offered workers with only a high school education the best pay, benefits and opportunities for skill attainment and advancement. Troubles in these industries push ordinary workers into retailing, hospitality and other industries where pay often lags.

Construction employment was flat. Housing continues to flag, though prospects appear better for commercial construction. Most of the new job opportunities will be in government infrastructure and commercial projects, where tightening industrial capacity should instigate additional activity.

Durable goods manufacturing remains robust but competition from Asian imports, benefiting from undervalued currencies and other subsidies, limits employment.

In May, manufacturing lost 19,000 jobs, and over the last 85 months, manufacturing has shed more than three million jobs. Were the trade deficit cut in half, manufacturing would recoup about 2 million of those jobs, U.S. growth would exceed 3.5 percent a year, household savings performance would improve, and borrowing from foreigners would decline.

Over the past 15 months, the dollar has weakened against the euro; however, against the important Chinese yuan, Japanese yen and other Asian currencies, the dollar remains too high. The yuan sets the pattern for other Asian currencies, which are critical to reducing the non-oil trade deficit and instigating a recovery in manufacturing employment and technology-intensive services that compete in trade.

The chronic trade deficit shifts workers from higher valued jobs in manufacturing and exportable services into lower valued services that do not compete in trade, such as the restaurant and lodging industries. This lowers U.S. productivity and wages, and slows growth. Overall, it is responsible for the poor job market faced by many workers without a college education or specialized skills.

The recent failure of the Strategic Economic Dialogue with China to obtain meaningful results indicates, unless Washington pursues a new strategy, U.S. manufacturers will continue to compete against massively subsidized Asian products, the economy will continue to limp along at less than its potential, and many workers will continue to face a lousy job market.

Outlook for GDP Growth and Stock Prices
In 2007, GDP will be in the range of 1.8 to 2.3 percent, without tangible steps to reduce the trade deficit or lower interest rates.

Slow growth results not from economic fundamentals but from conscious policy choices at Treasury and Federal Reserve. Treasurys inability to manage the international value of the dollar and its ideological opposition to other steps to reduce the trade deficit slow U.S. employment and productivity growth. This leaves the Federal Reserve beset by only moderate growth and the potential for higher inflation, and disinclined to either raise or lower interest rates. Look for the Federal Reserve to stand on the sidelines until at least September.

Stock prices will continue to outperform the U.S. economy. Many large U.S. companies earn a good deal of their profits abroad. The combination of strong growth in Asia, coupled with moderate growth in the United States, will be good for corporate bottom lines and attract individual investors.

With opportunities to expand U.S. operations limited, many U.S. companies will continue to buy back shares, and private equity funds will continue to buy and reorganize U.S. publicly traded companies. Both trends will continue to boost demand and prices for stocks.

A weaker dollar against the euro makes U.S. equities a particular bargain for European and Japanese investors. Large U.S. multinationals, earning significant profits in Asia are a great investment opportunity for Europeans and Japanese who sit on strong euros, pounds and yen but have few good investment options at home.

Surging corporate profits, moderate growth and steady interest rates at home, and robust demand for equities from corporate buybacks, private equity, and individual and foreign investors should power up U.S. stock prices. The bull market will continue into 2008 and the Dow should breach 14,000 before the end of the year.

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