The COVID Labor Market
The US labor market was in very bad shape in 2020, which was seemingly ignored in the rush to proclaim “economic recovery” after COVID lockdowns. One year on, and another wave of shutdowns and reopenings later, how have things shaken out for American workers? Here’s a before and after perspective.
Where Do Central Banks Need To Focus Their Attention? 2
Compounding matters is that all of these deep seated economic problems combine to adversely affect money velocity.
The falling labor force participation rate means that a growing portion of the American population do not have an income, at least not a formal one, and as a result struggle to obtain bank lending.
Naturally, this poor access to credit, combined with these folks not having an income, negatively impacts both their ability and willingness to spend.
These folks are almost always hoarding whatever amounts of money they have, simply because of how uncertain their economic situations are.
Put another way, if someone does not know when, where, or how they will next obtain a paycheck, they will tend to be a lot more conservative with how they spend their money in order to make sure they can afford to eat and pay the bills.
While this is a dire situation for anyone to be in, their plight isn’t often reflected in aggregate macroeconomic data.
This is simply due to the fact that people who have less or make less, spend less. Which means that when viewed from the perspective of the entire economy, their actions are miniscule to the point of being negligible.
But, should the number of people in this, or similarly tough economic situations grow large enough, then their economic plight can become visible enough to be inferred in some data sets.
A good example of this is money velocity, as you can see from the chart below, M1 velocity peaked just before the Great Financial Crisis in 2008, and has been falling ever since.
M2 velocity, which takes a broader view of what constitutes money in the economy, topped out sometime in the mid 1990’s, and started to accelerate downwards after the Dot Com bubble burst.
In other words, money has been changing hands at a decreasing rate for almost 30 years for M2, and 13 years for M1.
This decreasing rate is what allows us to infer the consequences of falling labor participation and credit availability. Money velocity slows in response to individuals deciding to spend more carefully, and in extreme cases, hoard their cash.
Considering that the labor force participation rate, as shown below, began to accelerate lower in the wake of the ‘08 crisis, and topped out just before the Dot Com bubble, we have cause to suspect that its decline is somehow linked to the decline in money velocity.
However, it is very important not to look at both charts trending the same way, with similar inflection points, and jump to the conclusion that one definitely caused the other.
As we like to point out, correlation does not equal causation, and the truth is that we simply do not know, and will never know with full certainty if one caused the other.
Putting aside the psychological need to attribute cause, what we can say with a fair degree of certainty is that declines in both share a common denominator – income.
Or rather, the lack of income that leads to reduced spending and even outright hoarding.
Considering that both these data sets have declined strongly even as the Fed has pumped trillions of bank reserves into the banking system over the last 13 years, we know that current monetary policy really isn’t solving the problem(s).
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The Other Side Of The Savings Coin 2
The first group will be the ones with the highest degree of pent up demand, simply because they were never in a position of financial difficulty during the pandemic in the first place. For people in this category, pandemic lockdowns were a literal block on their ability to spend, at least with regards to dining in restaurants, going to bars, and living a social life outside of their homes. Naturally, when full reopening occurs, these folks will be out spending with a vengeance.
On the other hand, the second and third groups will not have such high levels of pent up demand. Why? Simply because, in most cases, they still cannot afford to spend much money.
For those in the second group, going back to work alleviates much of their uncertainty and would probably see a spike in initial spending as they celebrate receiving their paychecks and being able to go out again. This spike would represent this category of workers’ pent up demand; not a small amount, but not sustainably large either. Why the emphasis on sustainably?
Because for these folks, not having incomes during the lockdown months meant having to live on, and conserve their savings for an uncertain future. While going back to work is undoubtedly a good turn of events for them, they still need to rebuild their savings. This necessarily means less spending, and hence a lower degree of pent up demand when compared to people in the first group.
Finally, people in the third group will have the least pent up demand of the groups. Like those in the second group, they had to live off their savings and conserve cash. However, they have not returned to work, and are still stuck struggling to secure a stable income. As a result, these folks simply cannot spare the cash to spend on anything beyond what is necessary.
Again, It comes back to having stable employment and a secure income stream. This is the third point of the trinity, and is what determines how much pent up demand an individual or family can have. As can be seen from the examples given above, those with no, or the least secure incomes (people in the second and third group), simply are not in as good a financial position to dip into their savings and spend wildly.
Consequently, savings must be considered together with income (or lack thereof) when discussing the effects of pent up demand during economic recoveries. Not doing so paints the macroeconomic picture with too broad a brush, which can limit our ability to perceive real problems in the post pandemic economy.
What good is a couple of quarters of superlative GDP growth numbers due to pent up demand, if the structural employment problems in the country persist? We are only storing up problems for the future.
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The Other Side Of The Savings Coin 1
Mainstream narratives seem to believe that savings and expenditure are two sides of the same coin. What if this isn’t the case, and instead of it being a two sided affair, it is actually a trinity?
Which begs the question, if it is a trinity, what is the third point of the triad? Simple – income.
This is best observed in the aftermath of a downturn, when the phrase “pent up demand” comes to dominate narratives. Pent up demand really is what it’s name says it is – demand that for some reason or other was forced to stay bottled up being suddenly released.
The reason “pent up demand” is most often heard in the middle of downturns, or during periods of great economic uncertainty, is because consumer spending tends to drop sharply during such times. The conventional economic perspective puts this down to people not being willing to spend because times are uncertain, which is definitely true.
However, the train of thought takes it one step further, and claims that once the source of the uncertainty is removed, spending will bounce back, due to people having saved more money. This bouncing back is pent up demand.
The issue with pent up demand as a concept is not that it doesn’t apply in real life, because it does. The issue is that it paints too broad a picture across the economy, when reality is always much more nuanced. Consider these three general categories of consumers in the context of the current Covid related economic problems.
First, we have the ones who never really struggled financially over the past twelve or so months. This includes the richest people, along with those who cannot be considered rich, but had jobs that allowed them to work from home (or remotely). The key here being the ability to remain employed, with a stable and somewhat secure income stream.
Second, we have the people who lost their jobs but have jobs that they can go back to. This would apply to workers who were furloughed as companies cut production and/or service capacity in order to conserve cash and survive lockdowns. If the company was successful in its efforts, it will be able to scale back its capacity to what it was before lockdowns, of course contingent on a full reopening of the economy. Consequently, the workers in this category lost their incomes, but are lucky enough to have a job to return to.
In our last category, we have people who lost their jobs. Not temporarily as with those who were furloughed in the second category, but permanently. Their old jobs simply do not exist anymore, either because the company that hired them no longer has the resources to support their position and axed it; or because the company itself has gone bust. These workers have lost their incomes and their jobs. An example of this would be employees of businesses that were shut due to the pandemic, but will never reopen because they ran out of cash, and have no means of raising new capital.
To be concluded…
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The Unemployment Rate Illusion: Europe
The labor market in Europe is improving at a rapid pace as their economies open up after their second Covid related shutdown; with the unemployment rate dropping from a pandemic peak of 7.7% to 7.3%. While this seems good on the surface, how do things look underneath?
The unemployment rate rarely tells the whole story, and can sometimes create an illusion that all is well when broader problems are brewing beneath the surface, like in the United States.
Therefore, while improvements in EU employment levels do reflect job gains that are occurring on one level of the economy, we have to look at the labor force participation rate to get a more holistic understanding of what is happening.
On a quarterly basis (the data to calculate the labor force participation rate is only available at a quarterly frequency), we can see that the Europeans are facing the same problem as their American counterparts. Namely, the unemployment rate is coming down, but the labor force participation rate isn’t.
While this can be more clearly seen in American data due to a higher frequency of reporting, the same pattern can be observed in the EU chart above. After a strong initial bounce higher in the labor force participation rate, it levels off and ceases to improve in a meaningful way, even as the unemployment rate continues to trend lower.
The same can be observed in Euro Area data.
As such, Europe is experiencing the same problems as the US, where over the past year, labor market conditions deteriorated to a point where many people simply gave up looking for work. Statistically, this means that they have dropped out of the labor force (in Eurostat’s terminology, they are “Inactive”) and are no longer counted as unemployed – since one has to be looking for a job in order to be counted as being unemployed.
Needless to say, the longer these folks remain out of the labor force, and unable to re-enter due to the lack of a robust enough recovery, the higher the potential for permanent damage.
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A Year From COVID: Pandemic Insurance
If financial markets needed a reminder that we still are in the grip of a global pandemic, they need look no further than use of the Pandemic Emergency Unemployment Compensation (PEUC) scheme.
PEUC data gives us a crucial glimpse into the health of the labor market outside of the usual dimensions marked by the Jobs Report and weekly jobless claims numbers. This is due to the PEUC providing unemployment insurance to people who have lost their jobs and exhausted their unemployment insurance claims.
Unemployed individuals only get 26 weeks of unemployment insurance, with this being accounted for first in initial jobless claims, when an individual first loses their job and applies for unemployment insurance; then in continuing claims. Of course, if they manage to find employment within their 26 week allotment, they will cease to be part of the continuing claims data set.
But, if they reach the end of their 26 weeks without finding a job, they also cease to be part of the continuing claims count. This produces a data set that misrepresents the state of the labor market during times of crisis. It does so by creating the illusion that less people are on continuing claims, and implying a labor market improvement, when in truth people are spending longer periods of time unemployed.
This was exactly what happened in September 2020, when continuing claims began falling even though the US economy was clearly still in its Covid funk. PEUC allowed us to see then, that the fall in continuing claims was not an improvement, but rather a transition of unemployed individuals from one benefit scheme to another.
What is the PEUC data indicating now? Nothing positive, unfortunately.
From the chart, you can see that PEUC continuing claims, that is folks who are still claiming PEUC benefits, are near their highs at slightly more than 5 million. More importantly, the number has hovered in the approximate range of 5 million to 6 million since February of this year. This stands in contrast to the improvements recorded by other labor market data sets, such as the Jobs Report, jobless claims, and JOLTS.
In addition, continuing claims (of the 26 week variety) are not tracking lower with initial claims. This points toward a large number of laid off workers who are still unable to find jobs, even as fewer people are being laid off each week. Since initial claims were over 700,000 per week for a whole year, it will be a while before the last 4 months’ fall in initial claims will bring down the continuing claims number. Barring, of course, a major surge in job creation and economic recovery.
This, when taken together with the lack of recovery in PEUC continuing claims (they have not come down appreciably), and a labor force participation rate that has refused to improve in 2021, strengthens the view that this labor market recovery is still in its early stages. It isn’t yet robust or broad enough to bring back the millions of people still stuck in medium-soon-to-become-long term unemployment.
Furthermore, as long as these trio of indicators remain stubbornly stuck at their current levels, these folks will not be brought back into the fold of employment and hence full participation in the economy.
In other words, the labor market will remain bifurcated, and inequality rife.
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