Remember that old clock with hands, one for minutes and one for hours? There is a saying that even when it breaks down, it is right twice a day.
If an economist cries ‘recession’ often enough, like that old clock on the wall, he will be right from time to time. Peter Schiff, economist with Euro Pacific Asset Management, went on Fox Business recently and shared his very pessimistic view of the near-term future for the U.S. economy. Schiff also suggested that the Federal Reserve has failed to bring inflation under control and that the most recent numbers for the U.S. labor market point squarely in the wrong direction.
The Fed, Schiff explained,
is not making any progress in its inflation fight because consumers keep spending and reducing their savings in spite of the rate hikes … The rate hikes are supposed to reduce spending and increase savings. That’s how they bring down inflation. But nothing has worked, and so inflation is going to get worse.
Peter Schiff is not just any economist. He has made a name for himself as having correctly predicted the mortgage loan crisis in the American economy back in 2008. He often makes media appearances and bold statements about the state of the economy. One of his favorite pastimes is to predict recessions. Whether or not his predictions turn out to be accurate, does not seem to be relevant to his popularity in media:
- In November 2021, Schiff informed us that inflation would send the U.S. economy into a recession;
- In May 2022, Schiff declared that the recession was “already here” and would only get worse.
- In July the same year, Schiff said that the U.S. economy had been “in a recession all year” and predicted that the rest of last year would be even worse;
- On August 31st this year, Schiff explained that the latest data for the U.S. labor market is only the beginning: the dollar will ‘crack’, inflation will rise and so will interest rates, and the economy will fall “deeper” into a recession.
A day later, he told Fox Business that the Federal Reserve is making “no progress” in fighting inflation.
Predictions about a recession makes for good entertainment, but not for good practice of economics. Over the past two years, Schiff’s predictions of a sharp economic downturn have fallen flat to the ground: the U.S. economy has dodged the recession bullet time and time again. As I explained in a two-part article in September last year, and in another piece this past spring, one of the most common mistakes among those who predict recessions is that they simply do not understand the GDP data they use as a basis for their prediction.
A less common mistake is to not properly analyze labor-market data. As we will see below, rising unemployment does not necessarily mean a recession is here.
Before we get to those numbers, though, let me set the record straight when it comes to Peter Schiff’s bombastic attack on the Federal Reserve. In his interview with Fox Business, Schiff simply stated that of all the Fed’s attempts to bring down inflation, “nothing has worked.”
This statement is remarkable and untrue in equal proportions. It simply could not be further from the truth. Figure 1 shows U.S. inflation, measured as personal-consumption expenditures (red), which is the inflation measurement Schiff prefers. This inflation measurement is compared to the Fed’s monetary expansion (green):
Figure 1
Sources of raw data: Federal Reserve (M2), Bureau of Economic Analysis (PCE Inflation)
There is an uncanny correlation between the monetary expansion and contraction on the one hand, and inflation on the other. There is a reason for this: the former causes the latter. In our article “The Fiscal Transmission Mechanism of Inflation” (American Business Review, May 2023) Robert Gmeiner and I explain theoretically, and prove empirically, how printing money and using it to monetize budget deficits causes inflation just as Figure 1 exemplifies.
In plain English: America has just been through an ugly episode of monetary inflation driven by fiscal deficits. This is important for two reasons: first, Schiff claims that the Federal Reserve has failed to bring down inflation, which is patently untrue; secondly, in his statement that rising interest rates bring down inflation, he shows that he does not understand monetary inflation.
Since monetary inflation is caused by the central bank printing too much money, it can only be fought by means of ending money printing. When the printed money is used for financing budget deficits, it can only be eliminated if the Treasury and the Federal Reserve stop using newly printed money to finance deficits.
This is what the Federal Reserve has done, and, as Figure 1 shows, it has worked just as theory and empirical evidence suggest. Consequently, U.S. inflation has dropped substantially in the past year. Again using the national-accounts based PCE definition of inflation (which is broader than the standard CPI, Consumer Price Index), it topped at 7% in June last year and has come down quite a bit since then.
To be clear, inflation has not been stamped out of the economy. The figure for July is 3.3%, a marginal increase from just below 3% in June. This, however, is nothing to be concerned about. It is common that when inflation is on its way down from high levels, as the rate is falling it occasionally ratchets upward, only to fall again in subsequent months.
If we see another increase when the August numbers are released, we may have a bit of a problem on our hands. Until then, it is plain wrong to claim that the Federal Reserve has failed to bring down inflation.
Schiff is closer to facts when he talks about the labor market, but I am still not convinced that we have a full-scale recession on hand. There are details in the numbers from the U.S. labor market that suggest a ‘breather,’ i.e., that the economy will slow down for a little bit but not fall into negative GDP growth for two consecutive quarters, one of the key ingredients of a recession.
There are also indications that immigration is causing a recession mirage in the labor-market numbers. To see why, let us start with the latest numbers for unemployment. They do, namely, point to a recession.
Figure 2 compares the 2018/19 part of the strong Trump economy (the green line) and the Biden economy in 2022/23 (red). These numbers are not adjusted for seasons, which means that Figure 2 displays how the rate in the real world goes up and down like a small rollercoaster over the year. These variations with the seasons are the same in both periods—up until August this year:
Figure 2
Source: Bureau of Labor Statistics
This looks like the beginning of a recession, does it not? To reinforce that impression, another key indicator from the labor market, namely the full-time share of total employment, sends the same message.
As I explained back in July, the June figure for full-time employment was the second highest for that month in the past ten years. This pointed to a strong economy: a high rate of full employment is a sign that employers are confident about the future, and that there is a shortage of workers in the workforce. When we add labor market data for two more months, July and August, we get a different picture. Suddenly, this variable sends us a new signal, one that we should be careful not to under-estimate. It tells us that we have reached a peak for the full-time share for employees:
Figure 3
Source: Bureau of Labor Statistics
This peak is not entirely surprising: back in June I noted that we had just seen a small shortening of the average work week. It was an isolated event at that time, too weak to tell us anything substantive about the overall state of the economy. We have more data now, pointing to this marginally shorter work week persisting over the summer. If we include the peak for the full-time share and the uptick in unemployment, we have a traditional picture of a recession-bound labor market before us.
Should we not simply declare a recession? No, not yet. As mentioned, due to some anomalous figures for labor supply I am reluctant to do so until I see more substantive evidence.
Here is the problem. On the one hand, unemployment is indeed higher. There were 6,623,000 people out of work in August this year—367,000 more than the same month last year. This is still a low figure; for comparison, when President Trump took over the economy from President Obama, there were almost eight million people unemployed in the U.S. economy. But it is also a rather hefty increase.
On the other hand, the civilian workforce has grown significantly in the last year alone. From August 2022 to August this year, the labor supply grew by 3,078,000 individuals, a 1.9% growth. Sticking to the month of August (to avoid seasonal influence), in the past ten years the workforce has only grown at this rate once, and that was last year at 2%.
For 2022 as a whole, U.S. labor supply grew by 1.9%; so far this year, the workforce is 1.64% larger than it was for the same period last year. Compare this to the long-term average growth rate in labor supply, which is just below 0.5% per year.
Where does this accelerated workforce expansion come from?
There is no reasonable explanation other than immigration. We are probably witnessing the consequences of President Biden’s immigration policy, which essentially consists of a presidentially enforced open border with Mexico. It is, of course, dicey to make this suggestion so long as those immigrants are illegal and therefore do not have a permit to work in the United States. It means, namely, that the new workers added to the workforce are illegally employed.
At the same time, there are no other apparent sources for the unusual workforce growth that has taken place over the past 18 months. Besides, it does not exactly come as a shocker to Americans that employers hire people illegally.
Let me repeat that my conclusion is based on a statistical anomaly—the unusual expansion of the workforce—and the lack of any other apparent explanation. Nevertheless, it is valid to raise the question to what extent the very large immigration in the last two years is beginning to affect the U.S. economy.
If labor supply grows fast enough to outpace labor demand, we end up with rising unemployment. This does not mean that the economy is weakening—that would happen if labor demand fell while labor supply remained constant, or at least grew at its normal rates. The U.S. economy is not in the latter situation, but in the former: there were 2.7 million more people employed in America in August this year than in August last year, suggesting that labor demand remains strong. Therefore, the rising unemployment we now witness is more likely the result of the accelerated growth in supply than anything else.
But what about the full-time ratio, and the shortening work week? These are indeed indicators of a weakening labor market. Together with the rising unemployment rate, they tell us—again—that the economy is not weakening, but that the labor market is saturated.
If this trend continues, we should expect household incomes to start falling, at least on the margin. We are not there yet. Average paychecks grew by an annual 3.9% in August, higher than the 3.3% average for the past ten years. This means that America’s families on the whole are now beginning to catch up with inflation, but if labor supply keeps growing at current rates, millions of workers—legal workers—could start seeing their wages decline.
