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Jobless Numbers May Signal Next Risk: Inflation

January 07, 2010 | "Forbes.com"

It’s a signal of just how bad the economy was last year that investors will probably cheer if the Labor Department announces Friday that the December unemployment rate came in at 10%.

Never mind that you have to go back to the recession of 1982 to see similar jobless levels. After apparently hitting a peak of 10.2% in October, unemployment fell to 10% in November. Another month like that could indicate the economy has stopped shrinking and is even beginning to expand.

Now the question looms: Is inflation next? With the Treasury and Federal Reserve essentially printing U.S. currency and handing it to banks and overstretched lenders like Fannie Mae ( FNM - news - people ), there is always the chance that too many dollars chasing a fixed amount of goods will lead to higher prices. Inflation is at least as much based on perception of the future as conditions today, said Kevin Kleisen, an economist with the Federal Reserve Bank of Saint Louis and author of a recent report that suggests people should start thinking about the unthinkable.

“Right now inflation expectations are fairly low and stable, but if the market gets spooked--either from the Fed not withdrawing stimulus fast enough, or the rising budget deficit--that could lead to higher inflation expectations,” Kreisen said.

Friday’s release might have something for inflation bulls and bears. Jobless numbers are highly volatile from month to month and are calculated using a different survey than for nonfarm employment. So don’t be surprised if Friday’s release shows two different trends. Employment could rise while unemployment ticks up as well, said David Resler, chief economist for the U.S. at Nomura Securities in New York.

“Theres a chance the unemployment rate will dip below 10%, but I’m not sure we’ve seen the peak yet,” said Resler. “If you go by history, it could go higher even if the economy is improving.”

The Labor Department surveys 380,000 employers to determine its nonfarm payroll estimate, Resler said, so the number is a highly accurate picture of how many people are employed. It hasn’t risen in two years, so any increase for December would be an important change, he said. The nation has shed 7.2 million payroll jobs since the onset of the recession.

The unemployment estimate is derived from interviews with 60,000 households and often diverges from payroll. A sustained increase in temporary employment--the sector added 52,000 jobs in November--would provide the classic leading indicator that businesses believe the economy is improving and are willing to risk adding jobs, Resler said.

Only a stunning drop in unemployment to below 9.5% (still well above the 6.8% in November 2008) would cause economists like Resler to revise their views about low inflation. And that’s unlikely.

Other signs indicate people are beginning to think about prices rising instead of falling, however. Yields on Treasury Inflation Protected Securities (TIPS) turned up in December after falling almost continuously since October 2008, suggesting investors no longer believe the consumer price index is going to fall in 2010. Perhaps more ominously, 30-year Treasury rates have risen from below 3% at the beginning of 2009 to a recent 4.6%, while 30-year mortgage rates have risen for four weeks straight and now are at about 5.3%.

Rising long-term rates could just mean businesses are finally increasing their demand for money. But they could also reflect fears about inflation, which undermines the purchasing power of future dollars and drives up interest rates now. Higher rates would undermine the recovery and reduce future growth rates, making it harder for the government to finance deficits, said Carmen Reinhart, an economist with the University of Maryland and expert on the relationship between debt levels and economic growth.

“With high debt levels, people expect a fiscal response,” which could include higher taxes and lower government spending, said Reinhart, who presented a paper on the subject at the meeting of the American Economic Association in Atlanta earlier this week. As the level of government debt rises past 90% of gross domestic product (it’s currently around 84%) Reinhart and her co-author, Kennneth Rogoff of Harvard, find economic growth is trimmed at least 1%.

One area unlikely to see any increase in employment is the besieged manufacturing sector, Resler said. Employment there has been declining for decades and that long-term trend is unlikely to reverse. The good news: Productivity has increased so much, especially in recent years, that U.S. manufacturing output is higher than it ever has been. Good for consumers, not so good for those pulling a paycheck.

Daniel Fisher

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