Employment, the economy and financial institutions are in far worse shape than widely recognized

The US is almost certainly already in recession, with little prospect of coming out of it any time soon. Indeed, there is every reason to expect the recession to deepen sufficiently over coming quarters to erase every shred of the lingering widespread doubt that continues to persist over the recession's existence or even its ultimate probability. Moreover, in my view, the recession seems likely to persist until at least mid-year next year. That would make this recession unusually long. At this point you might well be asking what I am talking about, especially given last Thusday's report of a 1.9% increase in real GDP in the second quarter, up from a 0.9% increase in the first quarter and a 0.2% decline in the fourth quarter last year. To some analysts that progressive improvement is mistakenly interpreted as indicating that the rough patch in the economy is already over. Nothing could be further from realty.

While recent headline data reports seem to portray a very weak economy, admittedly the reports do not necessarily as yet unambiguously provide the convincing evidence that many demand to actually conclude we are in recession. But that is taking the data at face value. Friday's report of a 51,000 July drop in nonfarm payrolls(the seventh consecutive monthly decline)and a jump to 5.7% in the unemployment rate from 5.5% the month before is perceived as weakness but certainly not convincing evidence of recession. Unfortunately, the problem lies with the data itself because of the ways they unintentionally obscure realty, especially at cyclical turning points.

The reported data in many economic series contain a significant element of estimation that unfortunately have the unintended impact of obscuring both recession and recovery cyclical turning points. The employment report is no exception to this pervasive problem. Because new and many small business are not officially recognized as in existence, they cannot be surveyed or sampled. Thus,the Bureau of Labor statistics makes an estimate of the monthly growth of employment based on its estimate of new businesses. The estimates are derived from old surveys, not current reports. The estimates are not intended to be current or to capture cyclical turning points. Needless to say, they do not. This would not be significant if the numbers of the phantom employment gains involved were not so large as to swamp the real changes that occur in the remainder of the data reflecting the real economy. For example over the past year there was a net official decline of 535,000 in nonfarm payrolls. But this was only after an almost certain fictional estimated increase of 853,000 in unsampled and only estimated new and small businesses, many of which do not exist. Merely assuming that the employment gains of the new businesses did not occur (rather than the more likely prospect that their employment in realty declined) would indicate that the economy's actual job loss over the past year was almost certainly at least 1,388,000. Though the household survey that is used to determine the unemployment rate is different from the nonfarm payroll survey, the actual unemployment rate is undoubtedly also higher than the official data implies.

The reported 1.9% second quarter real GDP rise was also grossly overstated as well as artificially boosted by the temporary economic stimulus. Without these special factors second quarter GDP would probably have declined. Consumer spending would have been substantially weaker without the tax rebates. Also, US exports based on the strength of foreign demand temporarily boosted US real GDP. As US demand weakens further, especially in the absence of tax rebates, foreign demand will also weaken. There is already ample evidence of the beginning of that foreign economic slowdown.

There was one likely miscalculation that by itself could have accounted for all the 1.9% second quarter real GDP growth reported. This was too small a GDP inflation deflater to subtract inflation from nominal GDP. Because the rapid increase in import prices is deducted from domestic prices to calculate the GDP deflater, there was an excessive reduction in the domestic deflater to a 1.1% rise, versus a 2.6% rise in the prior quarter and well under the actual 4.9% consumer price inflation rate the past year. Without these special factors, real GDP would have been negative in the second quarter and will probably show a series of actual declines over coming quarters.

Behind the US recession, driving it to further weakness, is the continuing drop in home prices. The Standard & Poors/Case shiller Home Price Index is down 18% from its July 2006 peak. And with 2.1 million vacant homes available for sale, some 800,000 more more than normal, there is bound to be further declines in home prices. That prospect is further reinforced by the continuing rise in foreclosures, the credit crunch, and the unrealized losses still to be faced by banks, investment banks, credit card issuers insurance companies and other elements of the financial sector. The decline in home prices is already encompassing lenders of conventional mortgages, not just sub-prime and Alt-A loans. Expect more financial institution bankruptcies. In concert, these various strands to the recession make a significant worsening inevitable. Investor caution remains warranted.

Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731

E-mail address: philipbraverman@gmail.com