Mish Interview on Spanish Site "Libertad Digital" Regarding the Global Economy

In Mid-January I received a request from Angel Martín to do an interview for the Spanish newspaper "Libertad Digital".

Dear Mish,

I am a follower of your blog. I work for the economics section of a Spanish classical liberal online newspaper, LibertadDigital.com, with a strong Austrian flavor in economics. We have published exclusive interviews to people such as Jim Rogers, Marc Faber, Antal Fekete, Robert Higgs, or Gerald O'Driscoll.

We plan to open a new newspaper, called Free Market, and exclusively limited to economic and financial issues. It would be a great honor to have an interview with you in the opening of the website (on your predictions for 2011, your perspective on Spain and the European debt crisis, and so on). What do you think about it?

Thank you very much for your time.
Best regards,

Angel Martin Oro

Interview Questions and Answers

I was happy to oblige "Libertad Digital". Here is the interview in Spanish: "No confíen en gobiernos o bancos centrales: son los culpables de la crisis"

Here is the interview in English.

Q: What is your general prediction for 2011? Will the crisis be over at the end of this year?

A: I covered many specific topics for the US and global markets in my post Ten Economic and Investment Themes for 2011

My general long-term thesis is the US will go in and out of deflation for a number of years just as Japan has done.

Stocks are richly price and historically are poised for no gains for another 10 years. That is not a prediction for 2011 as timing is very difficult. However that equity warning is similar to one I made in 2006-2007.

Q: On Europe, what is your view of the European Bailout Funds? Should sovereign states go bankrupt? How could this be done? Will the European Monetary Union and the Euro survive?

A: The Euro is likely to survive, but I can see things that could cause the member group to shrink. One thing I am certain of is there will be haircuts on sovereign bonds. What cannot be paid back won’t. Eventually Ireland and Greece will default.

However, it is important to step back and understand just who is being “bailed out” here. It is certainly not Ireland. It is bondholders of Irish debt that are being bailed out. Those bondholders are UK banks, German banks, French banks, and US banks in that order. The person footing the bill is the average Irish citizen.

Those Irish citizens should not stand for it and they won’t. I made my suggestions for the next Irish Parliament in my post Irish Government Collapses, Six Cabinet Members Resign, Election March 11; How To Negotiate Haircuts

Prior to that, I talked about Ireland on numerous occasions. In general, this is how I see the IMF’s “Trojan Horse Bailout of Ireland”



That comic is from To Ireland With Love

In that post I noted how Iceland came out of its crisis by forcing haircuts on bondholders. Ireland should do the same.

Q: In the United States, is the banking system healthy now, after the Paulson’s Plan and the government interventions? Or do you expect more turbulence and troubles coming from the US banks?

A: The entire global banking system is technically bankrupt. There is $40 trillion in US denominated debt that cannot possibly be paid back. European banks are in no better shape.

That is what the sovereign debt crisis in Europe is all about. Look at Japan. It has a debt-to-GDP ratio of 200%. Yet, Japan’s demographics could not be worse. The Japanese people were savers, but the government squandered it all and 100% more in foolish efforts to defeat deflation.

The US is making the same mistake. Bernanke is crowing now, but US unemployment is still near 10% (if you believe the reported numbers). I don’t. Unemployment in the US is higher.

Q: What about China and the emerging economies (India and Latin America)? Will they be able to sustain such outstanding growth rates?

China is overheating. It has the world’s largest property bubble. I talked about that a number of times recently. Here are a few links.

Shanghai Prepares for Property Tax to Curb ‘Speculative’ Buying; China Addresses Symptom NOT Problem

"Consensus Nonsense"; Is the Yuan Undervalued? Who Wins a Currency War?

China Secretly Buying US Treasuries Via UK Accounts? Trade Deficit Math; "Hot Money" Math

Q: Many people, since 2008, have feared high inflation as a consequence of the expansionary monetary policy of the FED. However, this has not taken place yet. Why were they wrong? And also, will 2011 be a year of very high inflation as some predict?

Fears of rampant inflation in the US are misguided. Yes, the Fed is “printing” but so is China, the ECB, the UK and for that matter everyone else. China is the real culprit regarding commodity prices and inflation.

It’s important to have an understanding of what inflation is. Here is my definition: “Inflation is a net expansion of money supply and credit, with credit marked-to-market”.

“Deflation is a net contraction of money supply and credit, with credit marked-to-market”.

That last phrase “marked-to-market” explains the US stock market rally nicely. Credit never expanded, but Bernanke reignited the junk bond market and bonds banks were holding went from “priced for bankruptcy” to “good as gold”.

This happened even though credit card debt, consumer loans, home equity loans, and consumer debt in general still continue to contract.

This helps explain the recovery in financial assets but not the real economy or jobs. In contrast, prices are soaring in China along with unsustainable levels of credit expansion. Those who focus on prices as well as those who focus solely on money supply both miss the boat.

Greenspan ignored rapidly expanding credit in the housing bubble years. China is doing the same now.

In China, credit is expanding at 35% a year with GDP rising less than a third of that. That is a distinct sign of an overheating economy. India is in the same inflation boat with China.
Australia is dependent on commodity demand from China.

It should be easy to see what happens to Australia when China slows. Notice I said “slows”. There is a good chance China crashes. Moreover, Australia faces a double whammy because its property bubble is starting to implode now.

Those paragraphs should explain how interconnected and unbalanced the global economy is.

Q: What is your view on the Spanish economic troubles? As an investor and analyst, would you trust the current Spanish Government?

A: At first glance, Spain’s woes appear similar to US and Ireland (housing bubble and property speculation) and dissimilar to Greece. However, all of the countries just mentioned are alike in regards to problems with public unions. In the case of Greece, public unions and unsustainable pension problems are the overriding concern. In other countries it is private sector debt. Thus, all of the countries have the same problems; it’s just the order of importance of the problems that differs.

I see no reason to trust any governments or central banks. The Fed took illegal actions and so did the ECB. Jean-Claude Trichet broke every major promise he ever made by cutting interest rates to nothing and by buying sovereign government bonds. Buying bonds was against the Maastricht Treaty. Germany has done things that are arguably against its constitution.

There is even a power struggle at the ECB now as Trichet’s term expires. Axel Weber is the leading candidate but he was against Trichet’s bond purchases. I suspect they may declare an emergency and keep Trichet on beyond his term.

Greece lied to the EU to gain admission. Japan’s policies over the last two years have been a disaster. Are we supposed to believe Spain? Italy? Any central bank? Why?

Q: Since the minimums of March 2009, the US and European stock markets have risen more than 60 %. What would you expect for the foreseeable future?

A: I have a saying: “They don’t know and neither do I”. However, as I stated above, equities are hugely overpriced here. Expect Long-term gains to be minimum and most likely negative.

Q: Finally, what are your recommendations for policy-makers to get out of the financial and debt crisis as soon and healthy as possible? And even more importantly, what must be done to avoid future crisis like this one?

Everyone likes to blame lack of regulation. However, I like to point out that regulation created Fannie Mae, regulation empowered the big three rating agencies, regulation gave tax breaks to homebuilders, Greenspan openly endorsed derivatives, etc. I can go on for hours regarding the failure “of” regulation.

In a free market, there would have been no Fannie or Freddie. Nor would there be 30 year mortgages. The first thing a decent regulator would do is shut Fannie and Freddie down. Instead we just guaranteed their debt.

If you want to see just how screwed up the credit rating agencies in the US are, please read Time To Break Up The Credit Rating Cartel

That is another clear case of government screwing up a perfectly workable system.

I am not against all regulation, however. Regulation that protects property rights and prevents fraud is fine. Glass-Steagall should not have been revoked. It provides a wall to prevent some forms of fraud. However people use Glass-Steagall as a scapegoat. It would not have stopped this crisis at all.

Finally, it is important to understand the root cause of this mess: Fractional reserve lending and the Fed (and central bankers in general). Note too, that it was regulation (legislation) that created the Fed. Together the Fed and fractional reserve lending are the driving forces that allow unmitigated creation of debt. They are all guilty. However, the Fed and the People's Bank of China are the worst.

The result of central banker sponsorship of credit is bigger boom and bust cycles of increasing amplitude. Unfortunately, there will be another crash as the global imbalances and root causes of this mess have not been addressed.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Fed Succeeds in Fostering Massive Speculation in Junk Bonds and Equities

Another day, another market high. The longer this goes on, the bigger the next crash. In the meantime the Fed is openly bragging about its efforts even though Bernanke Warns of "Rapid and Painful Response to a Looming Fiscal Crisis".

Bloomberg reports Fed Spends 40% on Benchmarks as Newest Prove Cheapest

The Federal Reserve’s Treasury purchases already have succeeded in driving investors to junk bonds and stocks. Now, policy makers are focusing on benchmark government securities, helping contain rising yields that set rates on everything from corporate debt to mortgages.

It pains me to see such inaccurately worded statements. No one can be pushed into stocks, in aggregate. Except for new stock issuance, dept offerings, IPOs etc., for every buyer there is a seller, and at the end of the day sideline cash is the same.

Moreover, this has been a futures-driven rally. Volume of actual shares trading hands has been low. However, the Fed has, for the time being, succeeded in reigniting a massive Greater Fool's Game in terms of what speculators at the margin are willing to pay for financial assets.

Bloomberg Continues:

More than 40 percent of the government bonds the Fed bought in January for its so-called quantitative easing were auctioned in the previous 90 days, up from 20 percent in December and 15 percent in November, according to Bank of America Merrill Lynch. The central bank is concentrating on newer securities as its $600 billion program depletes primary dealers’ holdings of Treasuries to the lowest since November 2009.

“They’re getting all the bang for their buck that they can” by purchasing so-called on-the-run bonds, said Mitchell Stapley, the Grand Rapids, Michigan-based chief fixed-income officer for Fifth Third Asset Management, which oversees $22 billion. “When you’re the largest buyer out there, when you replace China in terms of the size of your holdings of Treasury securities, that will happen.”

Bang for the Buck?

In terms of treasury and mortgage yields, the Fed has not gotten any bank for the buck. Yields are way higher except at the very short end of the treasury curve.

However, the Fed has succeeded in creating speculative demand for junk bonds. That in turn has helped lift the stock market.

Quantitative easing has boosted demand for Treasuries as President Barack Obama’s budget deficits exceed $1 trillion, adding to the nation’s $8.96 trillion in marketable debt. Investors bid $3.04 for each dollar of bonds sold in the government’s $178 billion of auctions last month, the most since September, according to data compiled by Bloomberg.

Understanding Demand

It is hard to say there is huge "demand" for treasuries when the Fed is buying them, others are unloading them, and yields are soaring on the high end.

The next Bloomberg quote is correct.

Since Nov. 3, when Fed Chairman Ben S. Bernanke announced the plan to buy government debt to keep the economy from falling into deflation, 10-year yields have increased about one percentage point as expectations for inflation rose. The purchases and signs that the economy is recovering have reduced demand for the safety of government debt in favor of riskier assets and the Standard & Poor’s 500 Index has risen 9.4 percent.

Speculative-grade corporate bond yields fell to 4.68 percentage points, or 468 basis points, more than Treasuries last week, the least since November 2007 and down from 6.22 percentage points in November, according to Bank of America Merrill Lynch index data. Debt rated lower than Baa3 by Moody’s Investors Service or less than BBB- by Standard & Poor’s is below investment grade, or junk.

Fed's Willingness to Foster Speculation

This is what the recovery has come to: the Fed's willingness to foster speculation in financial assets to the point of creating more financial bubbles.

Once again, it will not be the banks that get hurt by the Fed's corrupt policies but those on fixed income and those chasing junk bonds and equities at bubble valuations.

For details, please see

• Hello Ben Bernanke, Meet "Stephanie"


• Negative Annualized Stock Market Returns for the Next 10 Years or Longer? It's Far More Likely Than You Think

In response to my last post, someone commented "The biggest mistake one can make is to expect federal stimulus will end."

Such thinking is common. It is also wrong.

This is the correct way of looking at things: "The biggest mistake one can make is to think it will matter if federal stimulus doesn't end."

Valuations eventually matter, and the market will at some point take matters into its own hands regardless of what the Fed does. Europe (especially Greece, Ireland, and Iceland) provides painful examples.

Rapid and Painful Response to a Looming Fiscal Crisis



Quoting the economist Herbert Stein, Bernanke said: "If something cannot go on forever, it will stop. The federal government must stabilize its budget. The question is whether these adjustments will take place through a process that weighs priorities and gives people adequate time to adjust, or whether there will be a rapid and painful response to a looming or actual fiscal crisis."

The longer the Fed pursues these corrupt policies while egging on Congress to do the same, the bigger the financial bubbles, and the bigger the resultant crash. That is what happened in 2008 and it will happen again.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Negative Annualized Stock Market Returns for the Next 10 Years or Longer? It's Far More Likely Than You Think

Market cheerleaders keep ratcheting up expected earnings, failing to note that much of the recent earnings growth is simply not sustainable.

Reasons for Unsustainable Earnings Growth

• Much of the recent earnings growth is directly related to federal stimulus that will eventually end.
• Much of the earnings in the financial sector are a mirage, based on assets not marked-to-market and insufficient loan loss reserves. The Fed and the FASB have repeatedly postponed rules changes for the benefit of banks and other financial institutions.
• Earnings in both the financial and nonfinancial sectors have margins outside historical norms, based on very low headcounts and outsourcing.

Nonetheless, let's ignore the above factors and assume earnings will keep rising. Does that mean the stock market will go up, or is even likely to go up on a sustainable basis?

Stock Market Cycles and PE Ratios

Crestmont provides stock market returns and PE Ratios, for every year going forward, from every year since 1900.

1. Nominal Returns (not inflation adjusted), including dividends (reinvested), transaction costs, and taxes paid: S&P 500 Nominal Returns + Dividends
2. Nominal Returns (not inflation adjusted), without dividends, transaction costs, or taxes: S&P 500 Nominal Returns
3. Real Returns (inflation adjusted), including dividends (reinvested), transaction costs, and taxes paid: S&P 500 Real Returns Including Dividends

PEs in the matrix tables are Case-Shiller normalized PEs.

The matrix tables listed above are for taxable accounts. Crestmont also provides matrix tables for tax-exempt accounts.

The concept may be hard to visualize until you see it, but as word of warning I have a 24 inch monitor and the matrix tables will not come close to fitting on my screen. To read the text and numbers in the PDFs, you will need to enlarge the size making it impossible to see the entire table at once.

Nonetheless, please open up one of the above tables to get an idea of their size. The diagonal black line running through each table is a 20 year-line.

Essential Ideas

1. In spite of what efficient market theorists say, for a period of at least 20 years, it very much matters whether the starting valuation (PE) is high or low when one starts to invest.
2. However, in any given year (or even for several years), stock market returns may do random things. In other words, just because a market is richly valued does not mean it cannot get more so. Likewise, just because a market is cheaply valued, does not mean it cannot get cheaper.
3. As a result of the preceding point, many think that returns are random. While that may be true in a given year, over a sufficient period of time, expected future returns are anything but random.
4. The stock market fluctuates over long periods of time, between low and high PE valuations. Those cycles can last 20 years, and in that timeframe, people are apt to forget or ignore long-term cycles of PE expansion and PE compression.
5. The bulk of stock market gains frequently come from PE expansion, not from improved earnings.
6. It is important to know where in the cycle one is (whether PEs are in a state of expansion or contraction).

It is invalid to exclude dividends, so I used Crestmont's matrix S&P 500 Nominal Returns + Dividends as the starting point for the following tables and analysis.

The table below shows a sampling of years (some high valuation years and some low) along with annualized returns for two decades.

Annualized Rates of Return for Select Years



Click on any table to see a sharper image

Note how much the starting PE valuation matters. Someone who invested in 1929 received an annualized rate-of-return of 0% for two full decades, even if they religiously reinvested dividends every year.

However, someone investing in 1982 received an excellent annualized rate-of-return for two full decades (12% for the first decade and 9% annualized for 20 years).

Note year 2000. Starting valuations were the highest in history. It should not have been a surprise to discover that 10 years later, the annualized rate-of-return was -2%.

Bear in mind, the Case-Shiller normalized PE for the year ending 2010 is 23. Does that bode well for the next decade?

Of course no one knows what this year or next year will bring.

Take a look at 1996 in the above table. In spite of several years of huge stock market gains, the annualized rate-of-return to date sits at 3.

Cycles of PE Compression and Expansion



Over long periods of time PE ratios tend to compress and expand. Unless "it's different this time", history says that we are in a secular downtrend in PEs. From 1983 until 2000, investors had the tailwinds PE expansion at their back. Since 2000, PEs fluctuated but the stock market never returned to valuations that typically mark a bear market bottom.

Moreover, demographically speaking, the current decade not only starts with very rich valuations, but also comes at a time when peak earnings of boomers have passed. Those boomers are now heading into retirement and will need to draw down savings, not accumulate large houses and more toys.

Of course, the market can of course do anything this year (or the next few years), but history strongly suggests that stock market returns for the next 10 years will be lean years, perhaps negative years.

Annualized Rates-of-Return Starting PE Above 21

The following table shows annualized rates-of-return for the current year, the 10th year, and the 20th year for each year in which the PE started at 21 or higher.

Annualized Rates of Return with Starting PE 21 or Greater
Year	PE	AR 1	AR 10	AR 20
1901	22.7	9	4	3
1902	22.0	-12	4	3
1928	21.3	33	-2	2
1929	27.6	-16	-4	0
1930	21.5	-30	-3	1
1964	22.6	7	1	4
1965	23.3	-3	0	5
1966	21.3	8	2	6
1967	21.6	7	1	7
1968	21.5	0	1	6
1995	22.7	21	7	?
1997	31.0	19	4	?
1998	36.0	18	1	?
1999	42.1	4	-1	?
2000	41.7	-17	?	?
2001	32.1	-16	?	?
2002	25.9	-2	?	?
2003	24.1	17	?	?
2004	26.4	7	?	?
2005	26.0	9	?	?
2006	26.0	13	?	?
2007	26.8	-16	?	?
2010	23.0	?	?	?

Variance over Time

• The first year rate-of-return ranges from -30 to +33.
• The annualized rate-of-return for the first decade ranges from -4 to +7.
• The median rate-of-return for the first decade is +1.

That median rate of return going forward will be influenced in an unknown but likely negative fashion from the current starting point and high PE valuations for the years that have yet to be determined.

Annualized Rates-of-Return Starting PE Less Than 13

The following table shows annualized rates-of-return for the current year, the 10th year, and the 20th year for each year in which the PE started at 13 or lower.

Annualized Rates of Return with Starting PE 13 or Less
Year	PE	AR 1	AR 10	AR 20
1913	11.9	-3	4	4
1914	11.1	7	5	5
1915	11.5	18	7	5
1916	12.0	-3	7	6
1917	8.8	-7	10	6
1918	6.4	20	14	7
1919	6.5	-5	15	5
1920	5.3	-11	13	5
1921	5.4	26	10	5
1922	7.5	6	1	3
1923	7.9	9	4	5
1924	8.4	26	4	5
1925	10.1	16	2	4
1926	11.7	24	5	4
1932	8.1	32	5	9
1933	11.1	13	5	8
1934	12.2	9	5	8
1942	9.2	34	13	11
1943	11.0	10	10	10
1944	11.3	21	11	10
1947	11.2	5	12	10
1948	10.7	2	12	10
1949	9.9	24	5	4
1950	11.2	24	15	10
1951	12.0	23	12	9
1953	12.0	21	10	9
1974	10.9	5	8	9
1975	10.2	19	9	10
1976	11.5	-2	10	10
1977	10.4	0	12	11
1978	9.4	9	11	12
1979	8.9	16	12	12
1980	8.8	10	10	12
1981	8.5	-5	11	10
1982	7.3	33	12	9
1983	9.6	1	10	8
1984	9.4	17	10	9
1985	10.7	25	10	8

Variance over Time

• The first year rate-of-return ranges from -11 to +34.
• The annualized rate-of-return for the first decade ranges from +4 to +15.
• The median rate-of-return for the first decade is +10.

Valuations Matter in the Long Run

Please consider the following snip is from the Sitka Pacific 2010 Annual Review.

Depending on how closely you follow the financial markets, it may be surprising to learn that profits are at new highs even though stock prices, as measured by the S&P 500, are still 20% below their highs. In other words, new highs in profits haven’t translated into new highs in stock prices. If we go back even further, after-tax corporate profits soared 175% from the first quarter of 2000 through the second quarter of 2010. However, during that same time, stock prices fell roughly 15%.

In fact, there is nothing novel about a period of falling stock prices and rising earnings. Since the end of World War II, corporate profits have more or less trended continuously higher, with only minor interruptions during recessions. However, stock prices have gone through long periods in which they trended sideways or down, even though earnings continued to rise. From 1966 to 1980 after-tax corporate earnings rose 244%, but the price of the S&P 500 rose only 18% during that period. In contrast, earnings grew only 112% during the next 14 years from 1980 to 1994, but the S&P 500 rose 327% over that time.

Although very short-term returns are influenced by corporate earnings, beyond the short-term it is not trends in earnings but valuations and trends in valuations that determine stock market returns. In short, when valuations are low and increasing, long-term stock market returns are high. When valuations are high and decreasing, long-term stock market returns are low—even negative at times of peak valuations.

There are many ways to measure the valuation of the stock market, but relatively few ways that have value when they are applied across many types of bull and bear markets. Over the past year we have focused on the price-to-earnings measure popularized by economist Robert Shiller, which uses a 10-year average of earnings. Since earnings have at times fluctuated wildly in the short run, a 10-year average captures a much more reliable snapshot of the long-term profitability of public companies.

As you probably know, the stock market peak 10 years ago was the largest bubble in this country’s history. Previous bull markets ended with a 10-year P/E ratio in the 23–33 range, with the high point being the peak in 1929 at 33, just prior to the Great Depression. However, the bull market that ended in 2000 recorded a peak 10-year P/E ratio of 44, a valuation that was 33% higher than in 1929.

To really understand on a practical level how high valuations were at the peak in 2000, it helps to look at market returns from different valuation levels before the bubble in the 1990s. The chart below has a blue dot for every month from 1881 through 1990. The horizontal axis at the bottom shows the 10-year P/E of the S&P Composite during that month, and the vertical axis to the left shows the subsequent 20-year inflation adjusted return of the market.



Click on chart to see a sharper image

Prior to 1990, each month in which the 10-year P/E was under 10 (to the left of the green line) had a positive inflation-adjusted return over the next 20 years. That means that at those low valuations, you could confidently buy-and-hold stocks for the long term and know that the market would beat inflation over time—often by a significant amount.

However, for 10-year P/E ratios above 22 (to the right of the red line), there is not a single month between 1881 and 1990 in which the market had a positive inflation-adjusted return in the subsequent 20 years. And for P/E ratios above 25, past returns have approached −10% annualized, a rate of return that gives an 88% inflation-adjusted loss over 20 years.

Since 1995, the market had been above 10-year P/E valuations of 22 for 13 consecutive years, until July 2008. After a brief decline in 2009 into valuations that would be considered “average” historically, the market ended 2010 with a 10-year P/E of 23. Although this is about half of the peak valuation in 2000, it is still above valuation levels that have produced positive inflation-adjusted returns in the past.

With a peak 10-year P/E ratio of 44 in 2000, it is no mystery why returns over the past decade have been poor. On a consumer price index adjusted basis, the S&P 500 ended last year 31% below its 2000 peak, for an annualized return of −3%. Although we’ll have to wait another 10 years to see the S&P 500’s 20-year inflation-adjusted return from its record P/E of 44, it is almost certain to be a negative number, and probably a large negative number.

Notes:

• The above chart was produced from data from Robert Shiller: Real Returns (inflation adjusted), including dividends (reinvested).
• The PE of 44 mentioned above is a midyear high and thus differs slightly from the tables I created.
• To reiterate the key take-away from the above chart: 20-year real returns are negative for any starting 10-year PE over 22. At the end of 2010, the 10-year PE was 23.

Swimming Upstream

History shows that stock market valuations range from extremely cheap (10-year normalized PEs near 10 to extremely overvalued, 10-year normalized PEs of 44). Peak to trough changes in valuation occur over long periods as the market goes from one extreme to another.

Here is another chart looks at things from the point of view of PE compression (stocks moving from extremely overvalued conditions to extremely undervalued conditions).

Bear Market in PEs



Click on chart to see a sharper image

The 10-Year PE declined from 44 in 2000 (the richest valuation ever), to a current valuation of 23. That is about a 47% decline in the PE ratio, yet as discussed above, a PE of 23 is a very rich valuation.

When PE valuations are declining, and history suggests we are nowhere near the bottom of the PE compression cycle, generating positive returns in the stock market is much like trying to swim upstream.

Even if earnings increase (a dubious point to start with as noted in the beginning of this article), prices will likely be dragged lower by the weight of declining valuations.

Where to From Here?

Hopefully you now realize that expectations of rising earnings being tremendous for the stock market is a fallacious construct. Such talk ignores high valuations, the long-term trend in valuations, and demographics. Moreover, it's debatable if earnings are likely to rise in the first place.

With that in mind, people chasing this market as well as those fully invested do not realize how lucky they have been.

Last week I received an email from someone who fears being out the market. I heard the same thing in 2007. I suggest people ought to fear being fully invested with no hedges. The same applies to pension funds. Note that most pension plan assumptions are on the order of 8% annualized rates-of return, and pension funds are typically 100% invested, 100% of the time.

However, I do not know where the market is headed this year, nor does anyone else. 2011 may turn out like 1998 or it may turn out like 2008.

Either way, history strongly suggests that 10-year and 20-year returns looking ahead are likely to be low, if not negative.

Investing, like life, is a marathon not a sprint. Sometimes the prudent thing to do is sit on the sidelines waiting for better opportunities, even if it means enduring cat-calls and taunts from those who do not have any understanding of risk or history.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Egyptians Banks Open, Customers Line Up 100 Deep for Cash; Short-Term Interest Rates Expected to Hit 12.5%; Egypt About to Become Net Oil Importer

The Egyptian stock markets will remain closed until February 8, but banks are now open and customers have queued up 100-deep to pull out cash. Withdrawals are limited to $10,000 a day and 50,000 Egyptian pounds (about $8,500 and falling fast).

Please consider Egyptians Line Up for Cash as Banks Open, Pound Falls

Hundreds of Egyptians queued outside banks to withdraw funds as lenders opened for the first time in more than a week amid protests demanding the ouster of President Hosni Mubarak. The pound dropped to the lowest level since 2005.

The pound weakened 1.3 percent to 5.9330 against the U.S. dollar, the lowest level since January 2005, at 5:07 p.m. in Cairo, from 5.857, according to data compiled by Bloomberg.

The central bank published on its website a list of more than 200 bank branches resuming operations today between 10:00 a.m. and 1:30 p.m. Customers are allowed to withdraw up to 50,000 Egyptian pounds and $10,000 a day.

Yields on Egypt’s bills may surge about 30 percent, said Shahinaz Foda, the head of treasury at BNP Paribas Egypt. Credit Agricole CIB expects the pound to slump 20 percent in the “short term.” The currency’s three- month non-deliverable forwards rose to a record last week, suggesting the currency may fall more than 7 percent against the dollar.

Yields on three-month treasury bills should be “not less than” 12.5 percent in upcoming auctions, up from 9.5 percent last month, Cairo-based Foda said yesterday. The yield on the one-year bills may climb to 14 percent from 10.6 percent, she said.

John Sfakianakis, chief economist at Banque Saudi Fransi Credit Agricole Group, said in a note Feb. 3 “Over the short term we expect the Egyptian pound to fall by 20 percent, which would require the central bank to intervene on several occasions.”

Egypt to Become Oil Importer

The Oil Drum had an interesting article last week about Egypt's energy and fiscal situation. Please consider What's Behind Egypt's Problems?

We have all been reading about Egypt in the newspapers, and wonder what is behind their problems. Let me offer a few insights.

At least part of Egypt’s problem is the fact that in the past the government has threatened to reduce food subsidies. Now it is planning to hold food subsidies level and raise energy subsidies, but it is not clear that the dollar amount of subsidy will be enough. The government is taking steps to make food and energy affordable for most, but there is worry that the steps being taken will not be enough.

Egypt’s Declining Financial Situation

There is a good reason why one might expect Egypt to shttp://beta.blogger.com/img/blank.giftart running into problems with energy and food subsidies. Its own financial situation is declining at the same time that the cost of food imports is soaring. If we look at a graph of Egyptian oil imports, exports, and consumption (using a graph from Energy Export Databrowser, which graphs BP Statistical Data), we find that Egypt’s oil use has been rising rapidly, at the same time the amount extracted each year is declining.



Starting about 2010 or 2011, Egypt will change from an oil exporting nation to an oil importing nation, if there are imports available on the world market. The catch is that Egypt isn’t the only one with declining oil production–world oil production has been approximately flat since 2005, and the countries that produce the oil are using more and more of it themselves. The result is that there is less oil available for export, even as countries like Egypt need more.

The oil that Egypt exports provides funds for the subsidies that it offers, so reduced exports mean less funds are available for subsidies.

...
Egypt is reported to be the world’s largest importer of wheat. In 2010, the oil minister stated that Egypt imports 40% of its food, and 60% of its wheat. The problem this year is that world wheat production is down (at least in part due to weather problems in Russia) so world exports are down.

The Oil Drum article also addresses natural gas, energy subsidies, population growth, and other Egyptian budget pressures. It's an excellent article, well worth a closer look.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Sunday Funnies 2011-02-06 Reflections on U.S. Real Estate; Hu Jintao Meets Obama

In case you missed it, please see Phoenix Property Scam Targets Australian and New Zealand Buyers

Hu Jintao Meets Obama



Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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California Group Seeks to End Collective Bargaining; Why Collective Bargaining is Extortion

Unions are upset and protesting mightily about an effort by Ohio State Senator Shannon Jones that would ban collective bargaining in the state of Ohio. The bill would also abolish salary schedules for public employees and instead require merit pay.

I praised the bill in Ohio Bill To Kill Collective Bargaining for State Employees.

Shane Atwell picked up on my post and added some great comments in his article Good News: Efforts in Ohio and California to Abolish 'Collective Bargaining'

One thing he noticed that I had not heard yet is a measure in California that will also end collective bargaining. The Sacramento Bee discusses the situation in Group aims to end collective bargaining for public employees

A Santa Barbara-based organization that wants to end union representation of California government employees has revved up its campaign contribution collection machinery for a run at putting the idea to a statewide vote.

Lanny Ebenstein, UC Santa Barbara economist, head of the California Center for Public Policy and president of the Santa Barbara County Taxpayers Association is named in the state filing as the reform group's treasurer.

If his name seems familiar, it's probably because Ebenstein authored "Reforming Public Employee Compensation and Pensions." a report that purported to show that California public employees' pay and benefits are "unjust."

We spoke to Ebenstein a few weeks ago. His group wants to put up a ballot measure that would end collective bargaining for all city, county, regional and state employees in California. The reason, he says, is that unions have too much influence and the pay and perks their members receive are leeching money from government services, like education.

There is precedent for this: At least 18 states forbid collective bargaining for some categories of government workers, according to the Wall Street Journal. Virginia and North Carolina prohibit it for all public employees. And GOP governors in Wisconsin and Ohio are threatening to change state collective bargaining laws if they don't get union concessions.

Collective Bargaining is Extortion

I certainly commend the efforts of Lanny Ebenstein and the California Center for Public Policy and will support the group as best I can.

I also want to direct your attention to Shane Atwell's rock-solid rationale as to why collective bargaining is extortion.

'Collective bargaining' is not what its name indicates. In fact, it means exactly the opposite of what you'd guess. Collective bargaining refers to the obligation of an employer to recognize the elected representatives of a group of workers and his further obligation to negotiate with those representatives. This last part is what makes 'collective bargaining' extortion.

Under collective bargaining laws, employers have to recognize an elected union and have to negotiate with them.

Imagine if the tables were turned and employers had the right to 'employer bargaining', under which the employer could demand whatever pay reductions or workday increases he wanted, the employees had to negotiate with the employer, and employees couldn't quit!

[Such an arrangement] could only be classified as slavery.

The right to terminate the employer-employee relationship is a fundamental right of both employer and employee. Employment should be mutually beneficial to employer and employee and open to termination by either when it becomes non-beneficial (limited of course by any voluntary contractual agreements).

Collective bargaining laws have achieved two things for unions and union members. First the negotiations strongly tend in one direction until the employer moves his operations offshore [or to another state not subject to collective bargaining]. This ratcheting is inevitable given that employers are forbidden their ultimate tool: terminating employment.

Second, the misnamed [term] 'collective bargaining' has given an aura of moral righteousness to the unions who pretend to be fighting for true American values like the freedom of association. [However], they are fighting for values quite foreign to [the United States], values that come from Marxist collectivism, i.e. the expropriation of the property of employers and the negation of their rights.

[Therefore, wages and benefits garnered under collective bargaining arrangements are fraudulent in nature and should therefore be subject to revision.]

Contact your representatives and urge them to fight collective bargaining. [Please] support ballot initiatives [to restrict or eliminate collective bargaining] when they appear.

Any text in brackets above is mine. Thanks Shane. And good luck to Lanny Ebenstein in his mission to help right the wrongs in California.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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What's Inside the BLS Magic Black Box?

Inquiring minds have asked "I'm curious if you can translate the -339 birth/death adjustment this quarter. It seems completely out of context."

I believe I can shed some light on the overall process and the finalized numbers. However, the black box itself is impenetrable.

Here is the process: The BLS takes seasonally unadjusted numbers for jobs and seasonally unadjusted model-derived birth-death numbers and meshes them inside a magic black box. The box slices and dices the numbers, then spits out the seasonally adjusted "establishment number".

As a side note, when tossing the unadjusted numbers inside its black box, rumor has it the BLS employees collectively sing Oh Ho Ho It's Magic. I cannot confirm that rumor officially. Nonetheless, here is a fitting tribute.



In the monthly "Ta Da!" the BLS cleverly gives us the seasonally adjusted commingled result (that's the official monthly establishment number). The BLS also gives us the not seasonally adjusted birth death model number.

It makes as much sense to subtract those numbers as it does to subtract 3 bananas from two oranges, yet people keep trying.

It would help if the BLS divulged the black box methodology, but it doesn't. This rightfully arouses suspicion.

Interestingly, the BLS cannot give us the seasonally adjusted birth death number because it does not have the number to give! It's all crunched together in the impenetrable black box.

January Effect

The January phenomenon is interesting. The birth-death number for January is always a huge negative number. Do businesses have a propensity to go out of business precisely in January (and only January), come hell or high water, recession or not?

It must be so because for 5 years (until November 2010), the only other month I recall seeing negative a birth-death number is in July.

Flashback December 4, 2009: Jobs Contract 23rd Straight Month; Unemployment Rate Drop to 10.0%

Birth Death Model Revisions 2008 - April thru December



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Birth Death Model Revisions 2009



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In 2008 and 2009, smack in the middle of the recession, the BLS said more jobs were created by new businesses than lost by businesses going out of business, every month but January.

Here is a table I produced that shows the same thing in 2007 .



Presumably, NET new business job expansion occurs like clockwork (except for January). This mysteriously changed for the first time I recall in years of watching, in November of 2010.

Flashback December 3, 2010: After All the Hype, Jobs Up an Anemic 39,000; Unemployment Rises to 9.8%; Quicksand of Stimulus

Birth Death Model Revisions 2010



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I am actually shocked to see birth-death adjustments not only back in the solar system, but also back on planet earth. I cannot recall the last negative number in any month but January or July.

Curiously, smack in the middle of an expansion, we now have one isolated case of net business contraction, although we had NET new business job expansion every month the entire recession, except January.

Hold Your Horses

Please note the BLS revised their model this month, and something entirely new and exciting is happening: The latest revisions show we now have net birth-death job destruction in January, July, September, and November.

Let's take a look.

Flash Forward February 4, 2011: Labor Force and Unemployment Statistical BS

Birth Death Model Revisions 2010 (as reported last month)



Birth Death Model Revisions 2010 (as reported this month)

Once again, this is all massaged inside the BLS black box. All we know is the whole damn thing did not make any sense then, and these revised negative numbers out of the blue now sure do not correlate with anything we have seen before.

I suppose all those self-employed business owners selling trinkets on E-Bay may have collectively tossed in the towel this year, but otherwise it is hard to explain.

Quarterly Benchmarks

The BLS has taken it's black box to the next magic level - quarterly instead of annual benchmarks. Please consider Introduction of Quarterly Birth/Death Model Updates in the Establishment Survey

Effective with the release of preliminary January 2011 employment estimates in February 2011, BLS began updating the Current Employment Statistics (CES) net birth/death model component of the estimation process more frequently, generating birth/death residuals on a quarterly basis instead of annually. This will allow CES to incorporate Quarterly Census of Employment and Wages (QCEW) data into the birth/death model as soon as it becomes available. This more frequent updating will help to reduce what is known as the "post-benchmark revision" in the CES series. There will be no change to the timing or frequency of the current CES monthly or annual releases. Benchmarking to the QCEW will continue to be done on an annual basis. The first monthly estimates to be affected by this change will be for the reference month of April 2011.

2003-2010 Birth-Death Model Annual vs. Quarterly Benchmarks



In fairness to the BLS, the latest revisions (assuming they are correct), only subtracted 405,000 jobs in 2009. That is a decent-sized revision, but not a massive one. This lends credence to the idea that too much attention is given to the birth-death numbers.

Regardless, the quarterly process does seem much more reasonable than anything we have seen before.

Moreover, it would have been interesting to see month-by-month revisions for 2009. Perhaps we would have seen some more negative months. That may have made some of the 2009 months look as if they were from this solar system instead of Bizarro World.

Summation

The BLS refuses to describe the magic in its black box magic. Suspicion will rightfully remain until that happens.

The way the BLS reports these numbers (purposely or not) makes it hard to do math on the monthly numbers. This leads to confusion and wild assumptions.

Quarterly benchmarks appear to be a significant improvement.

Looking back at the data presented above, year in and year out (even the positive years), the weakest and therefore the most likely negative birth-death months going forward are in order January (a lock), followed by November, September, and July.

The January effect may be explainable, the rest is somewhat curious.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Prime Healthcare accuses SEIU of Extortion; Cell Phone Graft, Pay Extortion by California Prison Guards; FireFighter Fraud in Nevada

I have many times accused public unions of winning contracts by extortion, bribery, graft, vote buying, and getting into bed with administrators. Thus, I am not surprised to learn that Top Rated Hospital System, Prime Healthcare Services, Stands Up To Union's Extortion Campaign

Prime Healthcare Services (PHS), the largest for-profit hospital system in California and the only for-profit system among Thomson Reuters' Top 10 Health Systems in 2009, announced today that it has been the victim of an extortion campaign by the Service Employees International Union – United Healthcare Workers West (SEIU) over the past year.

According to PHS' officials, SEIU's extortion campaign began approximately 12 months ago when PHS rejected SEIU's demands for a "quick" deal for SEIU members at PHS' Centinela Hospital Medical Center so that SEIU could avoid a challenge from NUHW, an upstart union formed by disgruntled SEIU members. SEIU initially threatened to expose "dirt" on PHS, disseminate reports based on Medicare data, and claim that these reports showed that Medicare patients were acquiring serious blood infections like septicemia at PHS' hospitals even though SEIU knew that the Medicare data identified conditions present on admission; not hospital acquired conditions.

SEIU stepped up its extortion campaign in February 2010 by having CtW Investment Group (CtW), an investment fund created by SEIU and other unions, make false and misleading statements to Medical Properties Trust (MPT), a publicly traded real estate investment trust which serves as PHS' landlord and/or lender at several of its hospitals.

In a February 2, 2010 letter to MPT's Board of Directors, CtW falsely claimed that PHS' hospitals did not comply with California's earthquake safety laws, had infection control problems, had engaged in Medicare, fraud, and faced potential losses of millions of dollars. After MPT received CtW's letter, it conducted its own investigation into the allegations and found them to be baseless.

In April 2010, SEIU included both the SEC and State Senator Denise Ducheney, a long-time supporter of the SEIU, in its extortion campaign against PHS. In an April 2, 2010 letter to the SEC, CtW repeated its false claims against PHS and urged the SEC to interfere with MPT's planned stock offering.
....

PHS will continue to stand up against SEIU and has made a criminal referral to the United States Attorneys' Office regarding SEIU's activities. At the same time, PHS urges all interested parties to carefully scrutinize SEIU's propaganda and any articles which rely on such propaganda and urges elected officials to investigate SEIU's activities before they have disastrous consequences on the healthcare delivery system.

PHS has acquired financially distress hospitals that were in bankruptcy, near bankruptcy, and/or on the verge of closure and turned them around into well performing community hospitals that provide quality health care to all members of the community and serve a critical role in the healthcare safety net. Rather than attacking PHS, SEIU and those misinformed politicians should be applauding PHS' efforts to save community hospitals and employing more than 8,000 California workers.

California Hospital Alleges SEIU Extortion

Union Watch a project of the California Public Policy Center discusses the situation in its report California Hospital Alleges SEIU Extortion.

In a meticulously detailed press release issued on February 2nd, Prime Healthcare Services (PHS), the largest for-profit hospital system in California, announced they are victim of an extortion campaign by the Service Employees International Union – United Healthcare Workers West (SEIU) over the past year. What PHS is going through is a classic example of tactics the SEIU often employs with companies who won’t accede to their demands.

One of the contributing editors to Union Watch, Dave Bego, has written a book “Devil at My Doorstep” that chronicles his battles with the SEIU when they attempted to unionize the workers in his company. Throughout his book he emphasizes that what his company has gone through is consistent with a strategy of intimidation and extortion used by the SEIU whenever they encounter resistance.

Here are a few of the tactics imposed on Prime Healthcare Services by the SEIU:

January 2010 – Threaten to Tarnish Company Reputation

PHS rejected SEIU’s demands for a “quick” deal for SEIU members at PHS’ Centinela Hospital Medical Center so that SEIU could avoid a challenge from NUHW, an upstart union formed by disgruntled SEIU members. SEIU initially threatened to expose “dirt” on PHS, disseminate reports based on Medicare data, and claim that these reports showed that Medicare patients were acquiring serious blood infections like septicemia at PHS’ hospitals even though SEIU knew that the Medicare data identified conditions present on admission; not hospital acquired conditions.

February 2010 – Make False Claims to Company’s Lender

The CtW Investment Group, an investment fund created by SEIU, falsely claimed that to Medical Properties Trust (PHS’ landlord and/or lender at several of its hospitals), that PHS’ hospitals did not comply with California’s earthquake safety laws, had infection control problems, had engaged in Medicare fraud, and faced potential losses of millions of dollars. MPT conducted its own investigation and found the allegations to be baseless.....

Best Way to Deal with Fraud and Extortion

I commend Prime Healthcare Services for standing up to the extortion efforts of the SEIU.

The best way to deal with fraud and extortion is to eliminate it. Public union extortion will not go away until public unions go away. They should be illegal. Public unions do not serve the public. They serve no one but themselves and they will go to any lengths to do so, including fraud, extortion, and outrageous demands.

Union Prison Guards Smuggle Cell Phones to Prisoners

The Los Angeles Times reports California prison guards union called main obstacle to keeping cellphones away from inmates

Lawmakers struggling to keep cellphones away from California's most dangerous inmates say a main obstacle is the politically powerful prison guards union, whose members would have to be paid millions of dollars extra to be searched on their way into work.

Prison employees, roughly half of whom are unionized guards, are the main source of smuggled phones that inmates use to run drugs and other crimes, according to legislative analysts who examined the problem last year. Unlike visitors, staff can enter the facilities without passing through metal detectors.

While union officials' stated position is that they do not necessarily oppose searches, they cite a work requirement that corrections officers be paid for "walk time" — the minutes it takes them to get from the front gate to their posts behind prison walls.

Putting metal detectors along the route, with an airport-like regimen involving removal of steel-toed boots and equipment-laden belts, could double the walk time, adding several million dollars to officers' collective pay each year, according to a 2008 Senate analysis.

Since then, cellphones have proliferated exponentially in California's state lockups. This year, state Sen. Alex Padilla (D-Pacoima) is calling on Gov. Jerry Brown to "put the [search] issue on the table" in contract negotiations with the California Correctional Peace Officers Assn.

"Everybody coming into the state Capitol building has to go through a metal detector…. You even get searched when you go to a Lakers game," said Padilla, who for three years has sponsored unsuccessful legislation to crack down on the contraband phones. "Why don't we have that requirement at correctional facilities, of all places?"

Brown, whose campaign received generous financial support from the union and who made one of his few public appearances between the November election and his January inauguration at the union's annual convention in Las Vegas, would not say whether searches are under review.

More than 10,000 cellphones made their way into California prisons last year — up from 1,400 in 2007, said corrections spokeswoman Terry Thornton. Two of those wound up in the hands of Charles Manson, who is serving a life sentence for ordering the ritualistic murders of actress Sharon Tate and six others in 1969.

The phones can fetch as much as $1,000 each behind prison walls, according to a recent state inspector general's report, which detailed how a corrections officer made $150,000 in a single year smuggling phones to inmates. He was fired but was not prosecuted because it is not against the law to take cellphones into prison, although it is a violation of prison rules to possess them behind bars.

Analysts for the Senate Public Safety Committee who studied last year's legislation left no room for doubt about who they believed was responsible for most of the unauthorized phones.

"All indications are that the primary source of cellphones being smuggled into prisons is prison staff," they wrote. "The committee has been presented no evidence of visitors who are properly screened through metal detectors being responsible for the problem."

Guard union spokesman JeVaughn Baker said pointing the finger at corrections officers is all wrong.

"Sure, there are instances where officers have brought them in," Baker said. "But to say that prison staff are the most likely smugglers of cellphones is simply inaccurate."

Galling Statements

Look at that galling jackass statement from union spokesman JeVaughn Baker. I suppose the cell phones flew in.

And what idiot negotiated paying unions "walk time" from the front gate? I'll tell you: some administrator or politician in bed with the unions.

Firefighters' e-mails indicate abuse of sick leave, overtime

Please consider Firefighters' e-mails indicate abuse of sick leave, overtime

Some Clark County firefighters appeared to have worked with their supervising officers to improperly use sick leave, according to e-mails obtained by the Review-Journal.

One firefighter in April arranged sick days and overtime days for July.

"I will need July 17, 19 and 21 off (sick of course) and my last day of work will be the 23rd," the firefighter wrote. "I would like to work overtime on July 1, July 5. Thanks for being so nice about this and working with me. I really, really appreciate it!"

In one message, a supervisor wrote:

"There were a couple of vacation slots open on the 21st, but I couldn't put you in them because your request came less than 24 hours in advance. You've been entered as Sick on that day."

In another message, a firefighter said he would "rather take vacation than call off sick."

"You got it," the battalion chief replied.

Many of those firefighters make as much as $200,000 a year collecting overtime the day after they arranged to be sick. Taxpayers have to pay this. And the union is not satisfied. They want more and more and more taxes to pay for this.

Please read the rest of the article for more galling details.

Private Industry Would Not Put Up With This

I am infuriated reading these articles. And I have dozens more that I do not even have time to report on. Every day I see article like this. Private industry would end these practices in one second flat.

Unions have the gall to tell me they "earned" those contracts. Bulls***. It is all bribery, extortion, and graft. Fraudulent contracts should not be binding and benefit haircuts are needed. Unions can face reality or reality will face them in bankruptcy court.

Eventually people are going to elect mayors and governors willing to tell unions to their face "Go To Hell". It's starting in some states already.

The proper way to eliminate the problem is to eliminate public unions entirely. In the meantime any step in that direction is a step in the right direction.

Thus I highly endorse the brave actions of Ohio State Senator Shannon Jones for her bill to Kill Collective Bargaining for State Employees.

It is not easy to stand up to union extortionists who will lie, cheat, and steal to get what they want. However it's a battle that must be fought.

If Governor Brown had any concern for California, he would put proposals on the California ballot to rein in these abuses. Please see California Budget Poker: Republicans May Raise the Stakes in Jerry Brown's Special Election Bet for details.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Labor Force and Unemployment Statistical BS

I had no idea what to expect in today's jobs report. ADP projected 187,000 jobs but has been wildly off numbers reported by the BLS. Economists expected +146,000 jobs. The actual establishment survey report shows +36,000.

I knew huge revisions and methodology changes were coming this month would make gaming the report a crap-shoot. However, the amazing thing in the jobs report was not the number of jobs, but the statistical sleight-of-hand in the unemployment rate.

Statistical BS

The unemployment rate (based on the household survey), unexpectedly fell from 9.4% to 9.0%. How did that happen?

Based on population growth, the labor force should have been expanding over the course of a year by about 125,000 workers a month, a total of 1.5 million workers. Instead, (for the entire year) the BLS reports that the civilian labor force fell by 167,000. Those not in the labor force rose by 2,094,000. In January alone, a whopping 319,000 people dropped out of the workforce.

To get the unemployment rate down from 9.8% to 9.0%, you simply do not count two million workers. Look on the bright side, at this rate we will be back to full employment in no time.

Huge Downward Revisions

One way to make recent numbers look better is to revise the historical data downward. Today we have a third massive backward revision since the beginning of the recession.

"The total nonfarm employment level for March 2010 was revised downward by 378,000 (411,000 on a seasonally adjusted basis). The previously published level for December 2010 was revised downward by 452,000 (483,000 on a seasonally adjusted basis)."

Decade of Revisions Next Year

"The population control adjustments introduced with household survey data for January 2011 were applied to the population base determined by Census 2000. The results from Census 2010 will not be incorporated into the household survey population controls until the release of data for January 2012."

Hallelujah, the recent census report will provide fertile ground to revise away anything the BLS wants.

January Jobs Report

Please consider the Bureau of Labor Statistics (BLS) January 2010 Employment Report.

The unemployment rate fell by 0.4 percentage point to 9.0 percent in January, while nonfarm payroll employment changed little (+36,000), the U.S. Bureau of Labor Statistics reported today. Employment rose in manufacturing and in retail trade but was down in construction and in transportation and warehousing. Employment in most other major industries changed little over the month.

Unemployment Rate - Seasonally Adjusted

Bear in mind, were it not for millions of people allegedly dropping out of the labor force over the last year, the unemployment rate would be over 11% right now.

Nonfarm Payroll Employment - Seasonally Adjusted

Establishment Data



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Index of Aggregate Weekly Hours

The average workweek for all employees on private nonfarm payrolls fell by 0.1 hour to 34.2 hours in January. The manufacturing workweek for all employees rose by 0.1 hour to 40.5 hours, while factory overtime remained at 3.1 hours. The average workweek for production and nonsupervisory employees on private nonfarm payrolls declined by 0.1 hour to 33.4 hours; the workweek fell by 1.0 hour in construction, likely reflecting severe winter weather.

In January, average hourly earnings for all employees on private nonfarm payrolls increased by 8 cents, or 0.4 percent, to $22.86. Over the past 12 months, average hourly earnings have increased by 1.9 percent. In January, average hourly earnings of private-sector production and nonsupervisory employees rose by 10 cents, or 0.5 percent, to $19.34.

BLS Birth-Death Model Black Box

The big news in the BLS Birth/Death Model is the BLS is going to move to quarterly rather than annual adjustments.

Effective with the release of January 2011 data on February 4, 2011, the establishment survey will begin estimating net business birth/death adjustment factors on a quarterly basis, replacing the current practice of estimating the factors annually. This will allow the establishment survey to incorporate information from the Quarterly Census of Employment and Wages into the birth/death adjustment factors as soon as it becomes available and thereby improve the factors.

For more details please see Introduction of Quarterly Birth/Death Model Updates in the Establishment Survey

In recent years Birth/Death methodology has been so screwed up and there have been so many revisions that it has been painful to watch.

It is possible that the BLS model is now back in sync with the real world. Moreover, quarterly rather than annual adjustments can only help the process.

The Birth-Death numbers are not seasonally adjusted while the reported headline number is. In the black box the BLS combines the two coming out with a total.

The Birth Death number influences the overall totals, but the math is not as simple as it appears. Moreover, the effect is nowhere near as big as it might logically appear at first glance. Do not add or subtract the Birth-Death numbers from the reported headline totals. It does not work that way.

Birth/Death assumptions are supposedly made according to estimates of where the BLS thinks we are in the economic cycle. Theory is one thing. Practice is clearly another as noted by numerous recent revisions.

Birth-Death Number Revisions

Inquiring minds note enormous backward revisions in Birth-Death reporting. Here is the chart for 2010 that I showed last month.

Birth Death Model Revisions 2010 (as reported last month)



Birth Death Model Revisions 2010 (as reported this month)



Is this new model going to reflect reality going forward?

That's hard to say, but things were so screwed up before that it is unlikely to be any worse. One encouraging sign is several negative numbers in the recent chart. January would have been negative too, had they shown it. Historically there were only 2 negative number every year, January and July. That anomaly broke November of 2010.

Household Data



In the last year, the civilian population rose by 1,872,000. Yet the labor force dropped by 167,000. Those not in the labor force rose by 2,094,000. In January alone, a whopping 319,000 people dropped out of the workforce.

Households Stats

• The number of unemployed persons decreased by about 600,000 in January to 13.9 million, while the labor force was unchanged. (Based on data adjusted for updated population controls)
• The number of long-term unemployed (those jobless for 27 weeks or more) edged down to 6.2 million and accounted for 43.8 percent of the unemployed.
• After accounting for the annual adjustment to the population controls, the employment-population ratio (58.4 percent) rose in January, and the labor force participation rate (64.2 percent) was unchanged.
  
• The number of persons employed part time for economic reasons declined from 8.9 to 8.4 million in January. These individuals were working part time because their hours had been cut back or because they were unable to find a full-time job.
• In January, 2.8 million persons were marginally attached to the labor force, up from 2.5 million a year earlier. (These data are not seasonally adjusted.) These individuals were not in the labor force, wanted and were available for work, and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey.

In January 2010 the number of people working part time for economic reason was 8.3 million. 12 months later the total has gone up by 631,000.

Table A-8 Part Time Status



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There are now 8,407,000 workers whose hours may rise before those companies start hiring more workers.

Table A-15

Table A-15 is where one can find a better approximation of what the unemployment rate really is.



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Grim Statistics

Given the total distortions of reality with respect to not counting people who allegedly dropped out of the work force, it is hard to discuss the numbers.

The official unemployment rate is 9.0%. However, if you start counting all the people that want a job but gave up, all the people with part-time jobs that want a full-time job, all the people who dropped off the unemployment rolls because their unemployment benefits ran out, etc., you get a closer picture of what the unemployment rate is. That number is in the last row labeled U-6.

While the "official" unemployment rate is an unacceptable 9.0%, U-6 is much higher at 16.1%. Moreover, both the official rate and U-6 would be much higher were it not for huge numbers of people dropping out of the workforce.

Things are much worse than the reported numbers would have you believe.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Unemployment Rate Drops to 9% in Otherwise Anemic Jobs Report; Weather Blamed; Huge Downward Jobs Revisions; 30-Year Treasury Yield at 9-Month High

I will get to my usual jobs report shortly, but first I want to point out some revisions by the BLS.

"The total nonfarm employment level for March 2010 was revised downward by 378,000 (411,000 on a seasonally adjusted basis). The previously published level for December 2010 was revised downward by 452,000 (483,000 on a seasonally adjusted basis)."

It's pretty tough to blame those revisions on the weather, but they did blame today's jobs number (a mere +36,000) on the weather. I will slog through the BLS report later today, but first take a look at the treasury reaction.

Yield Curve 2011-02-04



click on chart for sharper image

Treasury Yields Soar

Bloomberg reports U.S. 10-Year Yield Climbs to 9-Month High on Employment Report

Treasuries fell, pushing the yield on the 10-year note to the highest in nine months, after the U.S. unemployment rate unexpectedly dropped to the lowest level since April 2009, fueling speculation the labor market will improve.

U.S. 30-year bond yields also rose to a nine-month high as Labor Department data showed the jobless rate fell to 9 percent last month and employers added 36,000 jobs, less than forecast, as storms swept the nation.

Last month’s gain in nonfarm payrolls was the smallest increase in four months and followed a 121,000-job rise in December that was larger than initially reported. Payrolls were projected to climb 146,000, according to the median forecast in a Bloomberg News survey of economists. The jobless rate fell for a second month. It was 9.4 percent in December.

“This is one of those lies, damned lies and statistics moments,” said Mitchell Stapley, the Grand Rapids, Michigan- based chief fixed-income officer for Fifth Third Asset Management, which oversees $22 billion. “You saw that 9 percent, and the market’s reaction was ‘that can’t be right.’ You’ve got people dropping out of the workforce. There’s some statistical anomaly at work.”

Payrolls in construction and transportation, industries most affected by bad weather, dropped in January, while factory employment rose the most since August 1998.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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