Recent unemployment reports have begun to show what is likely the last shoe to drop in recession-related job losses in the US. State and local governments have begun to lay off workers as they try to come into compliance with laws that require them to balance their budgets in a time of falling revenues. (As a byproduct, large budget deficits are also highlighting a difficult long-term issue. Like the US car companies of the Seventies until they went into bankruptcy, state and municipal governments have promised employees munificent retirement packages of pension and medical benefits that they cannot possibly afford. Estimates of the shortfall between what the states have promised to pay and what they’ve put aside to cover these expenses range up to several trillion dollars.)
Non-government hiring has begun to perk up, but not by enough to absorb all the new entrants to the workforce. So that does little to aid the plight of those laid off during the economic downturn. And, as we gain more distance from the financial crisis itself, pundits are beginning to realize that the US unemployment problem has more causes than simply that we are suffering the hangover from having several years of way too many people building way too much housing, offices and shopping malls. There are also at least two big secular issues: the destruction of an older, more labor-intensive distribution system by the Internet, and the expanding role in world trade of firms from the developing world with excellent products and a wage scale sharply below that of the developed economies.
Japan had a very similar problem when the money authority raised interest rates in late 1989 in an attempt to deflate a speculative real estate and financial market bubble. Not only did the country have glut of detached houses, apartments office buildings and shopping centers. It was beginning to feel competitive pressure from China. And it was close to completing a massive expansion of its industrial base that upped its companies’ ability to crank out Eighties-era products that were very quickly becoming obsolete.
The Japanese government responded to its crisis in several ways. I denied it had a problem. It covered up bank loan losses for a decade. It encouraged financial institutions to lend to bankrupt “zombie” corporations and enacted legislation that prevented activist investors from unseating incompetent managements. The Diet also launched wave after wave of public works construction projects aimed at keeping its myriad of construction workers employed (what else were these workers equipped to do?), but which created no long-term additions to national wealth and ran up a gigantic government deficit.
All in all, Japan seemed to do everything it could to prevent economic adjustment from happening. Look what that produced–twenty years of economic stagnation.
The US is unlikely to follow the same path. For one thing, we know from Japan’s example where it leads. For another, we have two (arguably quirky and backward-looking, but still espousing different points of view) national political parties in the US not just one. And the national debate is beginning to distinguish clearly between short-term economic band aids that are basically a waste of money and measures that will help the longer-term competitiveness of the US economy. The downside to this, more sensible, approach is that unemployment will remain high for a longer time.
From an investment point of view, two aspects of the current US situation are interesting:
–One is that publicly traded US companies have been posting very strong profit growth in spite of the general economic malaise. It makes sense that this could happen since half of their business is outside the US, much of that in fast-growing emerging markets. Also, publicly traded companies are typically the best of breed. And although the market has a health dose of financial firms, it has almost no exposure to the hardest-hit industries, like construction or autos.
–The other is that domestic investors seem unable to absorb this information, and act as if the S&P should follow the course of the general economy and the unemployment rate. This, despite many examples of stock markets outside the US (the UK or Hong Kong are particularly good instances) where there is a sharp differentiation between the performance of the economy and that of the market. In a perverse way, this is a good thing for stocks, since as investors gradually connect the dots in a new economic world they should be increasingly drawn to equities.