A Picture is Worth a Thousand Words: The State of the Economy

Availability of timely data is at the core of effective financial and economic analysis.  The Federal Reserve Economic Database (FRED) provides a vast array of economic time series via an intuitive graphical interface.  If you want to get a read on the U.S. economy, FRED is an outstanding resource.  The ability to quickly create customized charts makes it quick and easy to examine a wide range of data.  In this article, I am going to show a number of these charts, while  exploring the overall economic U.S. economic picture.

There is almost no economic variable that is as significant as the yield on Treasury bonds.  When any economic or financial statistic is at or near a historic extreme, this variable becomes of paramount importance.  Treasury bonds are currently at historically low yields and you really get a sense of that by looking at history.  For example, have a look at this FRED chart of the yield on 10-year Treasury bonds over the last 50 years:

chart 1

The story that this chart tells is enormously significant in terms of how the economy arrived at its current state.  In the 1970’s and 1980’s, inflation was high and bond yields reflected that.  Today, the 10-year Treasury yield is 1.6% and the chart shows just how significant that is in terms of the last 50+ years.  Low interest rates and bond yields make it easier for companies, individuals, and governments to take on debt.  Furthermore, falling interest rates allow borrowers to simply roll their debt forward into lower-rates.  The chart above explains one reason the United States has gotten so heavily indebted over the past thirty some years.

Now let’s move to the next picture—the Consumer Price Index (CPI), the standard official measure of price inflation.  In general, we expect to see prices increase over long periods of time reflecting inflation.  When economies are growing and more people are competing for the same goods, prices rise.  The historical average annual rate of inflation in the U.S. is about 3% per year.  This average is not the whole story though, as the chart below shows.

chart 2

This chart shows the percentage change in the CPI from year to year—the annual rate of inflation.  In the 1970s and early 1980s, there were periods when we saw double-digit inflation.  During the recent recession, we saw deflation—a drop in the CPI.  Today, the CPI is around 2.3%, which is pretty tame.  The problem of course is that when the change in the CPI is less than the yield from government bonds, bond investors are actually losing purchasing power by lending the government money.

Even with modest inflation, government bond yields at historic lows are making it very difficult for savers to generate income from their portfolios.  Furthermore, the Fed’s stated purpose of keeping interest rates low is to stimulate the economy.  As the next few charts show, however, the economy appears to be stuck in low gear despite low rates.

A standard measure of the health of the economy is unemployment rates.  A robust economy effectively applies the human capital of its citizens.  We are currently in the midst of a prolonged period of high unemployment, as the chart below shows.

chart 3

The high rate of unemployment, combined with its duration, is something that we have not experienced since the early 1980s.  That was right at the beginning of the emergence of computers and related technology.  The technology boom of the past thirty years has certainly done its part to create jobs, but so has the enormous growth in borrowing—both public and private—that has been enabled by low and falling interest rates.

The unemployment chart very clearly shows that unemployment rises in a recession (shaded areas) and falls in a recovery.  Since 1950, we have never seen unemployment as high as it is today, this far into a recovery.  Unemployment numbers account for people who are looking for work and do not include those who are not in the job market.

At any time, a certain fraction of the population will be out of the job market because they are retired, disabled, stay-at-home parents, or simply too discouraged to look for work.  The percentage of people either employed or looking for work is referred to as the ‘labor participation rate.’  The chart below shows the labor participation rate for males since the late 1940s.  The seasonal cycle in employment is clearly evident in the chart, of course, but it is really striking that we have seen the fraction of adult males actively engaged in the workforce drop from more than 85% in 1950 to 70% today.  There are many causes for this trend.  The U.S. population as a whole is aging and people are living longer in retirement.

chart 4

When we look at the labor participation rate for both men and women, we see a different pattern:

chart 5

With the large-scale entrance of women into the workforce, the overall labor participation rate in the U.S. climbed steadily from the mid 60’s to the late 90’s.  Since the late 90’s, however, the trend has changed dramatically, with a historically-unprecedented decline.

A low labor participation rate is not inherently bad.  It reflects an aging and affluent population.  The problem, however, is that even as a higher and higher fraction of the population is leaving the labor force, unemployment remains stubbornly high.

All of these charts paint an overall picture suggesting that the U.S. economy is in new territory, at least as compared to the past fifty or sixty years.  The combination of negative real yields on bonds with high unemployment, even as the labor participation rate is falling, suggests a long-term economic slow-down, consistent with the ‘New Normal’ scenario first proposed a number of years ago by PIMCO’s Bill Gross and Mohamed El Erian.  I am not predicting that this is, indeed, our future.  My abilities to predict the future are no better than anyone else’s.  The data does suggest, however, that we are in uncharted territory such that the world looks somewhat different than it has in the past.  This situation suggests that we at least question the conventional wisdom with regard to asset allocation. 

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