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Unemployment is now at 7.8%, about where it was in early 2009.  On the face of it, this is semi-good news.  Unemployment is still sky-high by historical standards, but it’s at least been moving lower.  However, the numbers are actually quite ugly once you dig beneath the surface.

First off, unemployment is only lower because labor force participation has dropped.  What this means in plain English:  “unemployment is falling because we stopped counting some people who gave up on finding jobs.”  The labor force participation rate was 65.7% in Jan 2009.  It’s 63.6% now.  Meanwhile, unemployment was 7.8% in Jan 2009, and it’s 7.8% now.  What this says is that the 7.8% in 2009 was actually a lot better than the 7.8% in 2012, since we were counting 2.1% more of the population then.

If you don’t count the people who dropped out of the workforce, then the unemployment rate would be around 10.7%.  Of course, this isn’t totally fair either because it makes sense that the labor force participation rate might be trending downward somewhat over time due to retiring Baby Boomers.  So I think the truth is probably somewhere in between — but regardless, it’s clear that unemployment hasn’t been falling because of rapid job creation  over the past few years.  It’s falling mostly because of people exiting the labor force.  That’s not a good sign.

There is some good recent news here, at least.  Labor force participation has held steady through most of 2012, so the fall from 8.3% to 7.8% this year seems to be based a bit more in reality than the falls in 2009, 2010, and 2011.  This is likely a result of construction activity picking up.  However, I’d put a huge caveat here, too.  Many of the gains are coming in part-time work, and the jobs we’re adding seem to be very low quality.

There’s also another matter here.  A week ago, I wrote an article arguing that inflation is starting to pick up.  M2 money supply has been growing between 8% – 10% over the past year, normally a sign that we’re about to see a significant spike in inflation in the next 12-36 months.  Inflation normally does result in some job creation, but it comes at a heavy cost.  Once you factor in inflation, many people are actually making lower real wages and worse off.  So if inflation picks up, yes we might see unemployment drop, but it will be offset by a fall in real wages.

Overall, this month’s unemployment data might be slightly good news, but it should be taken in context.