Calculated Risk Sheds Light

Well I just had an interesting discussion with the guy at Calculated Risk - my mind is now completely numb.

Through the magic of the online BLS database query, new light has been shed on the mystical birth/death model adjustment, and we can all go on with our lives, secure in the knowledge that the headline jobs number is not a complete fraud.

Left unresolved however, is the question of what happens after the birth/death adjustment has worked its magic for the current month. If you look at the historical seasonally adjusted and not-seasonally adjusted data for 2004, you get 2.194 million and 2.161 million new jobs, respectively. So that kind of makes sense, the data is consistent between the seasonally adjusted and not-seasonally adjusted, it is just being smoothed - the smoother the better, as they used to say at Fannie Mae.

There is also historical data for the birth/death model adjustments, and for 2004, that total is 836,000.

So what is the relationship between the 2.1 million and 836K numbers?

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Jobs, Jobs, Jobs

It was backslaps and high-fives all the way around this morning on Squawk Box as the non-farm payroll number for April came in at +274,000 - this was heralded as more evidence that the underlying economy is strong and that this recovery is sustainable ... yes, of course.

Not surprisingly, there was a net loss in manufacturing jobs for like the 999th month out of the last 1000, but the good news was that construction and service jobs showed robust increases. They've just added a separate category for Real Estate Agent and, as you might expect, there were healthy gains there (just kidding!).

So, +274,000 new jobs ... Hmmm. As described on the BLS website, this number is arrived at like this:

"This information is collected from payroll records by BLS in cooperation with state agencies. The sample includes about 160,000 businesses and government agencies covering approximately 400,000 individual worksites. The active sample includes about one-third of all nonfarm payroll workers. The sample is drawn from a sampling frame of unemployment insurance tax accounts."

Sounds legit, huh?

Look at the unemployment insurance records, then seasonally adjust, and voilà!

Well, not exactly ...

Let's look at the other adjustment that gets done - the "Cheney adjustment", uhhhh... I mean the "Birth/Death Model Adjustment" is an adjustment to account for jobs that could not be accurately reflected in the unemployment insurance data because they were created by new businesses which had not yet reported to the state agencies. If you look at data for the month of April, you find a staggering +257,000. So, can you just subtract the adjustment from the headline number to determine what the unemployment insurance survey indicated? As described on the FAQ, the answer is (obviously) No!

Q: Can I subtract the birth/death adjustment from the seasonally adjusted over-the-month change to determine what it is adding to employment?

A: No. Birth/death factors are a component of the not seasonally adjusted estimate and therefore are not directly comparable to the seasonally adjusted monthly changes. Instead, the birth/death factor should be assessed in the context of its effect on the not seasonally adjusted estimate.

Q: Can BLS provide an estimate of the contribution of the birth/death adjustment to the seasonally adjusted monthly payroll change? Can BLS independently seasonally adjust the net birth/death component?

A: There is not an estimate of the seasonally adjusted contribution of the birth/death model. The sample collected on a monthly basis, the imputation of business births using deaths, and the net birth/death model are all necessary components for obtaining an accurate estimate. The components are not seasonally adjusted separately because they do not have particular economic meaning in and of themselves.

Yes, it's much more complicated than that - and good luck locating the not seasonally adjusted data - you'll have to just trust the BLS to do the right thing. And oh, by the way, don't forget this note on the main Birth/Death Model page:

"The most significant potential drawback to this or any model-based approach is that time series modeling assumes a predictable continuation of historical patterns and relationships and therefore is likely to have some difficulty producing reliable estimates at economic turning points or during periods when there are sudden changes in trend."

So, this means that, if we are at a turning point right now, for example, as some other indicators seem to be pointing toward, due to the Birth/Death Model adjustment, the reported jobs numbers may not reflect that turning point until the yearly revision is performed in January 2006.

Hmmm...

Now, that's what I call intelligent design!

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A Different Explanation

Although David Greenlaw at Morgan Stanley provides a different explanation for yesterday's policy statement omission, this blog isn't buying it - we are sure it was a Freudian slip (see A Fly on the Wall below).

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A Fly on the Wall

You know, we heard the policy statement today and we'll get to read the meeting minutes in about six weeks, but wouldn't it have been fun to be a fly on the wall at today's Fed Policy Meeting?

Those able to read body language surely could have learned something by watching the assembled board members. Was anyone squirming in their chair, or shaking their head, or did anyone raise their eyebrows as others spoke?

How about more overt non-verbal communication? Did anyone, at any point, giggle or knock on wood? How about the hang-loose/hook 'em horns thumb/pinky wiggle/wave which when steadied and applied to one side of the head means "Al, call me"? Did anyone do a Vulcan salute or ... how about the dreaded loose fist (all fingers forming a cylindrical shape) which is then shaken up and down at the wrist? The Brits have a word for this ... now, what is that?

And what of the late correction to the policy statement where they initially left out the line "Longer-term inflation expectations remain well contained"? Was there some off-the-record discussion about this being perceived as a Freudian slip? That their subconscious minds were telling them to tell the world that they are now so far behind the inflation curve that their only recourse will be to again revise the inflation calculations to ensure that inflation stays under control?

Let's see, Donald Kohn was there. Do you think any of the other board members coughed strangely when he spoke? His most recent speech about imbalances in the economy had this gem:

The current imbalances will ultimately give way to more sustainable configurations of income and spending. But that leaves open the question of the nature of that adjustment. Ideally, the transition would be made without disturbing the relatively tranquil macroeconomic environment that we now enjoy. But the size and persistence of the current imbalances pose a risk that the transition may prove more disruptive.

Do you think Al was muttering Flexible! Flexible Markets! I've got eight months to go, you idiot!

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The Energizer Bunny

On the eve of another Fed Policy meeting, it's always good to check in with Stephen Roach, chief economist at Morgan Stanley. In many ways, when it comes to criticizing the Greenspan Fed, Stephen Roach is like the Energizer bunny - he just keeps going and going and going.

It's nice to see that a big financial services firm allows their head economist to speak out about problems and imbalances that he observes - it seems the job of most economists (especially at big Wall Street firms and business new shows) is to always predict blue skies and clear sailing while at the same time attempting to explain what just happened in a way that calms investors ... to keep the game going even if there are fundamental flaws in the system.

Roach's latest commentary, Trapped, starts out with a jab at the "soft patch crowd" - a reference to Greenspan's remarks about a year ago when there was a precipitous decline in share values concurrent with the first big run up in oil prices into the $40+ range. He then goes on to note the eerie resemblance between US patterns and those in Japan in the 1990's, as our "post-bubble shakeout" churns on, and wonders if we may suffer the same ultimate fate:

"I fully realize the indelicate nature of this question. Everyone -- from investors and recovering dotcomers to policymakers and politicians -- seems united in their conviction to dismiss this possibility as nothing short of blasphemy. Federal Reserve Chairman Alan Greenspan summed up the consensus view on this critical issue over two years ago, when he famously declared that '…our strategy of addressing the bubble's consequences rather than the bubble itself has been successful'."

"The risk, in my view, remains that the Chairman may have been premature in taking this victory lap."

You just don't hear this kind of commentary on CNBC or in SmartMoney Magazine - "investors" may lose faith.

Now, if you really want a good scare, go to last Friday's commentary Asia's Only Hope. We all know that the rest of the world is lacking in internal demand - that they rely on the crazed US consumer to continue to spend, spend, spend even though this spending is now much more a function of increased asset prices and increased debt, rather than increased wages.

More than ever, Asian economies are vulnerable to downturns if and when the American consumer starts to retrench - we all know this is inevitable. What is happening with jobs and real estate prices and consumer debt in this country is a system that is fundamentally flawed and sure to revert to historical norms (unless of course it really is different this time) ... it's just a matter of the timing. But, the shocker here is what do the Asians think about the inevitable retrenching?

"Little wonder Asians now have a new edge in their voices when they ask me about the fate of the American consumer."

"Needles to say, my message has not been received with open arms as I travel through this region. Most Asians react with sheer disbelief when I even dare to mention the possible demise of the American consumer. Never mind the juxtaposition between excess US consumption and subpar wage income generation: Consumer outlays have surged to a record 71% of GDP since 2002 versus a 67% norm over the 1975 to 2000 period, while real private sector wage and salary disbursements are up only 5% in the first 39 months of this recovery versus a 15% average increase in the five previous cycles. Nor do Asians want to hear about the excesses of the household debt cycle -- in terms of the record stock of indebtedness as a share of GDP as well as debt service payments that are near historical highs in an historically low interest rate climate. Believe it or not, one client out here was so angry with me he actually tore my chart of the vanishing personal saving rate into tiny little pieces. Asians want to believe that the income-short, saving-short, overly indebted, asset-dependent American consumer will never stop spending."

Uh oh - this may end badly.

Asian business leaders and policymakers may be in as much denial as their US counterparts.

Roach has been consistent, and consistent for a long time in his criticism of the Greenspan Fed. If you peruse the Morgan Stanley Global Economics Forum Archives, you'll see that he's been saying pretty much the same thing, every Monday and Friday for the last few years - that Federal Reserve policy has been fundamentally flawed for the last ten years. They have facilitated asset bubbles, which have enabled excess US consumption, which has created burgeoning growth and rampant job creation in the low-wage Asian exporting countries - that this system is wholly unsustainable and we are not doing the right things fast enough to keep these imbalances from getting worse and worse ... that the resulting correction will be more severe than it otherwise could have been.

So, get ready for today's installment of the ongoing Federal Reserve crusade against world imbalances - another quarter point rate hike.

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The Fed is Not To Blame

One of several books I was able to read over the last few weeks was Peter G. Peterson's Running On Empty: How The Democratic and Republican Parties Are Bankrupting Our Future and What Americans Can Do About It. This is an interesting read and is highly recommended to all - Peterson is a former chairman of the Federal Reserve Bank of New York, and, as he mentions about ten times - he's a rich Republican.

It chronicles thirty years or so of failures by both the Democratic and Republican parties regarding fiscal discipline and long term planning. It places the blame for our current economic woes squarely on the politicians, political processes, interest groups, and various changes to American culture. The four solutions to all of our problems are:

• Reform Social Security
• Reform Medicare
• Reform the budget process
• Reform politics

Conspicuously absent from the discussion is the role of the Federal Reserve over the last thirty years. In fact the title of the book seems to absolve the Federal Reserve of any blame - politicians have bankrupted your future. They have borrowed and spent too much money and have made promises they can't keep - where all this money comes from is not important.

How America has turned into a nation full of crazed consumers/speculators who have gotten hooked on cheap money and now believe that they are entitled to cheap money from the government is not addressed.

How we have developed a standard of living that is so far out of whack with the global labor marketplace is not addressed.

No, it's all the politicians fault for not acting responsibly.

How can anyone talk about current and future financial problems in the US without talking about the role of the Federal Reserve since Nixon closed the gold window in 1971 and turned the US dollar, the world's reserve currency, into pure fiat money. We all know what happens when a social democracy is combined with a currency backed by nothing other than faith in a government and an economy (i.e., the currency reverts to its intrinsic value of zero). The role of the Federal Reserve is to delay that ultimate outcome for as long as possible, as Easy Al has said, to "mimic" the gold standard.

Instead of mimicking the gold standard, and limiting the amount of money that can be created and spent by both the government and individuals, this Federal Reserve has done the exact opposite - they have used more money creation as the solution to every problem under the Greenspan Fed. They have enabled all this reckless behaviour.

I guess since I'm not an economist, I just don't get it.

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