2009 Predictions & Austrian Theory Of Unemployment

The new year is here and most are well received to say goodbye to 2008 as it was a horrendous year, filled with gloomy headlines. For the new year, predictions are being set for where markets and the economy is headed. Before I make any 09' predictions (gulp), let us examine the economics of unemployment. Please see the graph below:

This graph taken from Murray Rothbard's "America's Great Depression" displays wages vs the quantity of labor. Equilibrium employment is set at point IE. Assuming prices and wages are bid up through speculative business endeavors via money inflation ie the extension of credit and malinvestment results. The correction is correction in prices as a result of the malinvestment once the speculators realize the error in their judgement when they were fooled by new money created out of thin air. As a result, higher order goods must fall ahead of consumer goods and profits are reduced.

At this point business owners (speculators) must cut back in their factors of production. One such factor is labor. The owner has three choices:

1. Reduce the wages of their labor
2. Reduce the number of laborers employed by the business
3. Reduce the number of hours of their labor

If choices one and two are chosen then the return to equilibrium much quicker than in the third scenario. To illustrate from our starting point at IE, the wage would have been driven up during the credit induced boom to point AC. Once the correction starts and assuming there is no intervention to prop wages up, the first choice of reducing wages will produce the least pain in the adjustment process and the demand curve moves back to point IE.

However, if laborers do not accept the lower wages then unmployment will increase. However, the laborers will realize their error once they discover demand for labor has been diminished. Ultimately, laborers must accept the lower wages as a result of the lower demand for labor from employers at the previous higher wage. So the unnecessary unemployment has been prolonged by laborers high wage expectations. But the decrease in demand at the higher wages eventually leads to lower wages, but at a slower rate than in the first scenario.

There is an opposite side to the above illustration leading to increased unemployment, that is if employers demand for labor at the higher wage decreases so much that return to profitability is not obtainable without necessary lay offs of their labor pool. However, it will play out in a much similar fashion to if it were laborers holding out for the higher wage, as eventually profitability would return and demand for labor would return with it, albeit, at the new lower wage rate.

Now the third scenario is the most troubling. Usually, the artifical propping of the prevailing high wage rates is on the agenda of unions and instead hours are cut. But now, the business has lost productivity at the expense of maintaining high and unprofitable wage rates. This only acts to prolong the inevitable correction and could even lead to business losses and bankruptcy if the wages are maintained.

The end result is a return to market equilibrium of wage and quantity of labor at IE. Overshooting is possible, as shown by the graph, driven down to point JG. Over the long run though, demand for labor will return strong and wage rates will be bid back up to their equilibrium level, first to point JH and then back to IE.

Indeed, this third scenario couldn't be more obvious today than with the US automakers, who through union pressures have bloated labor costs. Concessions have yet to be made.

Evidence is found where Small Cuts Help Stave Off Layoffs:

At Pretech, a concrete manufacturer in Kansas City, Kansas, that has not had a layoff in 15 years, part of the rationale is pride. The company has cut overtime, traded a $5,000 holiday party for an employee-only barbecue lunch, and trimmed its pipe-making operation to four days from five, which allows it to save on heating and electrical costs.

Even as layoffs reach historic levels, some employers in the United States have found an alternative to slashing their work forces. They're nipping and tucking instead.

A growing number of employers, hoping to avoid or limit layoffs, are introducing four-day workweeks, unpaid vacations and voluntary or enforced furloughs, along with wage freezes, pension cuts and flexible work schedules. These employers are still cutting labor costs, but hanging onto the labor.

In some cases, workers are even buying in. Witness the unusual suggestion made in early December by the chairman of the faculty senate at Brandeis University, who proposed that the school's 300 professors and instructors give up 1 percent of their pay.

"What we are doing is a symbolic gesture that has real consequences -- it can save a few jobs," said William Flesch, an English professor.

He said more than 30 percent had volunteered for the pay cut, which could save at least $100,000 and prevent layoffs for several employees. "It's not painless, but it is relatively painless and it could help some people," he said.

At Fedex, Kindest Cuts Are Smartest, Too:

FedEx mightn't look like the kindest company after announcing wage cuts. But the move could turn out to be one of the smartest corporate responses to the recession -- and may become widely mimicked.

If executed well, cuts in wages could even help the economy out of recession, not to mention benefiting the shareholders in the companies that carry out the cuts.

In response to terrible shipping trends, FedEx said next year senior execs would have salaries pruned by 7.5% to 10%, while other salaried employees would face a 5% reduction. Hourly workers aren't included in these cuts.

From an economic perspective, targeting salaries makes sense at FedEx. Wages and benefits are the largest single operating expense by far -- and are typically equivalent to just over a third of revenue.

Why might this approach work? It could help avoid the disruptive and expensive process of firing lots of workers in a trough -- and the added cost of rehiring them when the recovery occurs. FedEx's cuts for its better-paid employees also might give management credibility to ask for cuts elsewhere if the recession drags on.

The macroeconomic benefit from cutting wages comes from three sources. First, if it does indeed lead to fewer layoffs, aggregate consumption may take less of a hit. Second, banks could face lower losses from debt defaults. Third, one of the good things about recessions is that they can bring certain prices down to sustainable levels, setting the foundation for an economic bounce back. It makes little sense for wages to be exempt from that adjustment. "The faster you get prices, including the cost of labor, to equilibrate, the faster you can get on with the recovery," says Paul Kasriel, director of economic research at Northern Trust.

The risk is that wage cuts stoke labor discontent and lead to production disruptions in a time of economic weakness. The threat of a weak economy mightn't be a deterrent to industrial action. After all, it didn't deter the most recent strikes at Boeing and American Axle.

Agilent Cuts Workers' Pay By 10%:

Agilent Technologies will cut employee pay 10 percent worldwide starting Jan. 1 because of the slumping world economy, company officials said Tuesday.

Agilent, Sonoma County's largest tech employer, has about 1,350 workers in Santa Rosa, headquarters for its wireless unit.

It's the first time Agilent has ordered an across-the-board, companywide pay cut since the depths of the dot-com bust. The company slashed salaries by 10 percent between November 2001 and August 2002.

Agilent also cut thousands of jobs during the tech crash.

“By taking a small reduction in pay, our intent is to avoid the necessity of more drastic action, including across-the-board layoffs,” said Jeff Weber, Agilent's spokesman in Santa Rosa.

The pay cut is expected to last through Oct. 31, 2009, the end of Agilent's current fiscal year, and will save about $110 million, or 1,100 jobs, Weber said.

The decision means an average wage cut of about $5,500 for the company's 20,000 employees.

Agilent CEO Bill Sullivan notified employees of the pay cut Monday, Weber said.

"This is an approach we've used before," Weber said. "I've talked to a few people, and in general employees agree with the decision."

Pretech, FedEx, and Agilent command my respect for not adding to the roll of unempoyed. Their wisdom, if accepted universally will help speed the recession (depression?) enormously. Unfortunately, not all companies get it; Visteon Shifts To Four Day Work Week:

U.S. auto parts supplier Visteon Corp. said it will shift 2,050 jobs to four-day work weeks to save 20 percent of its labor expenses.

The move makes the company the first major auto-supplier to trim its labor costs in the first quarter of the year, The Wall Street Journal reported Friday. The company informed its staff the new schedule will start on Monday.

Visteon, which spun off from Ford in 2000, makes instrument panels and climate-control parts for cars.

This is a way we can make necessary reductions in operating costs while minimizing layoffs, Visteon spokesman Jim Fisher said.

The company, he said, will re-evaluate the move at the end of the month.

Other parts suppliers, such as American Axle & Manufacturing Holding Corp. and Tenneco Inc., are searching for ways to cut production in response to slumping auto sales and production cuts announced by General Motors Corp., Ford Motor Co. and other automakers

Eventually, Visteon will either end up laying off more employees or cutting wages anyway. Either way, lower wages will result. Microsoft has proved very bold,

Now finally, though most likely ill-advised, I will make some predictions for 2009. Please note, this is my first such attempt at publicly making predictions and many of them may be common sensical.

• States and municipalities with bloated payrolls and massive budget shortfalls will be forced to lay off large numbers of their employees and contractors. Many of these jobs should never have been created in the first place. Unemployment will reach double digits on the official U-3 number.
  
• Stocks will continue to decline in 2009, with a brief rally during most of January. The Dow potentially will fall to 6,000 and the S&P to 500.
• Gold will reach 1,500 as demand for hard assets with intrinsic value increase. Silver is also set to rise in 2009.
• The Fed will continue to expand its balance sheet to even more unprecedented levels and inflationists will continue to scream. However, the reality will be deflation and the Fed's attempts will not work and the market will start to lose credibility in the Fed.
  
• The dollar will continue to outperform other currencies for the good part of 2009, as the race to global ZIRP continues and massive monetary stimilus is pursued, which makes the dollar relaively attractive for the time being.
• Treasury yields on the long end of the curve will continue to fall. Flight to safety and Fed intervention will be the main determinants. At some point, maybe late 09', this may start to reverse as the US's long term prospects become even more ill.
  
• Towards the latter half of 2009, protectionist proposals and possible tax increases may begin to gain support, despite public disapproval. This will set the stage for public upheaval and government distrust.
• Family values and fiscal sanity will return to American households. This is a good thing and welcomed with open arms.
  
• Housing prices will continue to fall, and will not bottom in 2009.
  
• Commercial real estate defaults will start to soar and become the next crisis, along with credit cards, home equity and student loans
• Banks will continue to hoard their bail out dollars as more write downs impair their balance sheets

If I am wrong on many of these predictions, I will actually sigh with relief. However, the Fed and the government cannot solve the problem with a magic wand (aka the printing press and debt issuance). Rather if they do, they're attempts will only have pushed the problem down the road and will have actually created a larger problem in years to come.