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Problems with Productivity


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“The fact that you can create that many jobs in the context of growth that is so low points to a significant problem. And the problem is that productivity growth is very low.”—Federal Reserve Chairwoman Janet Yellen, April 10, 2017

Last week, it was reported that U.S. labor productivity, as measured by the amount of gross domestic product (GDP) produced by one hour of labor, declined 0.6% in the first three months of 2017. The decline was more than expected. A problem that Ms. Yellen, along with most Federal Reserve (Fed) governors and presidents, view with strong concern, is getting worse, not better. Moreover, the Fed, along with many economists and economic policy makers, admit that they really don’t know how to fix the problem. Yet in the face of this problem, as noted in their statement on monetary policy Wednesday, the Federal Open Market Committee (FOMC) was quite sanguine with the prospects for the economy going forward, more or less dismissing the rather soft first-quarter data. There seems to be a disconnect here between the Fed’s concern over productivity, which Ms. Yellen has gone so far in the past as to call “miserable,” their outlook for the economy, and their desire to tighten monetary policy as early as next June.

One of the potential reasons that labor productivity remains dismal in the face of increasing employment during this seven-year economic expansion could be that the quality of jobs produced has been dominated by relatively low productivity retail jobs. Nevertheless, during this long, if not spectacular, expansion, manufacturing of durable goods has been growing in sectors such as autos. Additionally, the first half of 2017 experienced a rebound in energy and energy jobs as well.

Perhaps the Fed believes that there will be a continued improvement in the productive quality of jobs that will, in relatively quick time, give us the productivity and economic growth befitting an economy that is at or near full employment. However, in my opinion, for the Fed to believe this, they must be discounting the problems we are beginning to see crop up in auto production and energy as temporal. Are they temporal?

With regard to energy, the Fed, along with many others, has been pretty confident in the last year or so that the price of crude has stabilized and should be somewhere in the mid-$50-per-barrel range. Much of this confidence was derived from OPEC and other major crude producers’ January production cut pact. I personally thought that relying on a Saudi-Iranian-Russian pact to stabilize the price of oil through actual sacrifice was a pipe dream, pardon the pun.

Combined with this was the fact that as soon as crude got to and above $50, U.S. producers would start pumping furiously. We got to $50 at the end of last year and voila, U.S. production picked up in lockstep with a price. Now, awash in oil despite the OPEC-Russia production cut (assuming no one has been cheating, which is probably ridiculous), crude has plummeted back down to $45 per barrel. The supply and demand story probably dictates that mid-to-low $40s for crude is the right level as opposed to the mid-$50s. As far as supply, producers keep finding more efficient ways to pull oil out of the ground, and on the demand side, users are consistently getting more efficient in their consumption. With that said, will the energy industry be in productive energy employment add mode? I don’t think so.

Meanwhile, the auto industry is experiencing a sharp slowdown in auto production as sales continue to slump, dealer inventories are rising, and automakers are pointing to the first summer plant idling in years. I’m not sure why the Fed hasn’t paid attention (at least in their public communications) to the auto sector. The multi-year record-setting auto sale gains we were achieving were certainly driven in part by an improving economy. However, it was also highly dependent on cheap financing—in many cases, cheap and somewhat “loose” underwriting. As long-time auto industry analyst Maryann Keller stated in an interview on Bloomberg News, “It was a low-interest party, but the lenders have pulled back. They have made it more expensive for the borrower to get credit. Some people can’t get financed and for others, it’s too expensive.”

Given the recent credit disasters our economy and financial sector have experienced over the last decade, it seems a bit odd that the Fed or bank regulatory agencies haven’t waved at least the yellow flag on such financing. Whatever the case, it seems that automakers borrowed from the future to set record sales and now the bill has come due. With that bill should come a decline in auto production employment.

With all this in mind (miserable productivity and a potential stall out in productive manufacturing jobs), if the Fed continues to voice confidence in the economy and leans toward a June raise they either:

  • Are not overly concerned with what is going on in energy and autos

  • Recognize these problems but are still trying to get at least another rate hike in, one that the market expects, so they have ammunition for a potential economic slowdown later in the year

While I don’t completely discount the former (they’ve missed the proverbial turn before), I have a feeling it is the latter. Whatever the case, I think that the Fed would be making a policy mistake by going in June without waiting to see if there is a chance to at least get labor productivity in the right direction. If the situation in energy and autos continues to deteriorate, I don’t see that happening.

Member SIPC & FINRA. Advisory services offered through SWBC Investment Company, a Registered Investment Advisor.

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