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Economic Slowdown Coming - Even for the Fatcats

Do they hear the sound of the air hissing out of the economy?

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Now the optimists are touting housing and shale gas as the drivers of recovery. Yet we are at risk of seeing a repeat of the pattern of 2010 through 2011, in which growth in the first three months fades, leading to the question as to how much of that growth was an artifact of seasonal adjustments that don’t fit well with an economy in a balance sheet recession. And the high profit levels that stock mavens have celebrated are part of the problem. We’ve never had a recovery where the labor share of GDP growth had been so low. Some stock-watchers have also pointed to Warren Buffett’s remark in 1999:

In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%. One thing keeping the percentage down will be competition, which is alive and well.

What appears to have changed since then is major industries becoming more concentrated (banking is a prime example), leading to oligopolistic pricing, which is rent extraction, pure and simple.

In addition, Paul Krugman reminds us this evening that cutting government spending when the economy is less than robust is a sure path to a slowdown. And he stresses an angle that is often treated as secondary in policy discussions, namely, the way the long-term unemployed are effectively permanently unemployed. The usual excuse offered is that their skills have become stale, but Krugman contends that the real issue is pure and simple prejudice:

The key question is whether workers who have been unemployed for a long time eventually come to be seen as unemployable, tainted goods that nobody will buy. This could happen because their work skills atrophy, but a more likely reason is that potential employers assume that something must be wrong with people who can’t find a job, even if the real reason is simply the terrible economy. And there is, unfortunately, growing evidence that the tainting of the long-term unemployed is happening as we speak.

One piece of evidence comes from the relationship between job openings and unemployment. Normally these two numbers move inversely: the more job openings, the fewer Americans out of work. And this traditional relationship remains true if we look at short-term unemployment. But as William Dickens and Rand Ghayad of Northeastern University recently showed, the relationship has broken down for the long-term unemployed: a rising number of job openings doesn’t seem to do much to reduce their numbers. It’s as if employers don’t even bother looking at anyone who has been out of work for a long time.

To test this hypothesis, Mr. Ghayad then did an experiment, sending out résumés describing the qualifications and employment history of 4,800 fictitious workers. Who got called back? The answer was that workers who reported having been unemployed for six months or more got very few callbacks, even when all their other qualifications were better than those of workers who did attract employer interest.

So we are indeed creating a permanent class of jobless Americans.

Another open question is the odd continued rise of stock prices even as corporate earnings weaken. Why are investors paying more for companies whose earnings are declining in aggregate? In normal bull markets, you see a new leadership group emerge, and late in cycle, investors increasingly favor conservative stocks. This time the leaders are defensive plays, high quality companies that pay healthy dividends. While bulls say that this is predictable given ZIPR, we’ve had ZIPR for years now. Why should these stocks be worth more now?