Understanding Unemployment

On the first Friday of every month, we receive the monthly unemployment number. This is arguably the most important piece of economic data the markets receive.

On Oct 2, we received a worse than expected number of 260,000 jobs lost for the month. This brought the unemployment rate to a disturbing 9.8%.

You may have already heard that this number underestimates true unemployment, so let's talk about how this number is calculated.

The official unemployment number that you hear every month is called the U3 unemployment. In this survey, the government does not count the number of people that are:

-"Discouraged" workers: those that are out of work and have given up looking for a job because the economy is so bad.

-"Part Time" workers: if an executive of a major bank lost his job, but can only find work two days a week stocking goods at Wal-Mart, he is considered employed.

There is a second number the government calculates that factors in these two important groups of potential workers, called the U6. The U6 this past Friday crossed over 17%.

Now have we reached the real unemployment number reported by the government? Not yet, we're almost there.

In the late 90's, the Clinton Administration wanted to add one more tweak to the calculation, the famous Birth-Death Model.

This model assumes that since a certain number of people are born every month, those people ultimately will become small business owners that hire X amount of people. The government adds this X amount every month to new jobs created.

Anyone with any sense knows that small businesses are not hiring right now, and there is no credit for new small businesses to be created. (Meredith Whitney wrote an article in the Wall Street Journal on Friday explaining this concept. Article to Left).

So, to understand the true unemployment rate, we need to take the government reported U6 number and subtract their phony birth death model. Fortunately, John Williams of shadowstats.com has taken the time to create this number. The following chart shows all three unemployment numbers:

Red Line: U3
Grey Line: U6
Blue Line: Real Unemployment

The true unemployment number is just under 22%. The peak reached during the Great Depression was 25%.

A major reason for this number moving up so high recently is the number of "discouraged" workers who have given up looking for work completely.

The most recent data shows that 32% of homeowners are currently underwater, meaning they owe more on mortgages than their home is worth. With unemployment at 21%, how long will these homeowners continue to make payments on homes that are underwater?

That's a topic for another day.

(All the numbers discussed here do not factor in the commission workers such as real estate agents and mortgage brokers that are making nothing now that the real estate market has collapsed. Adding those "unemployed" we have already crossed the numbers from the Great Depression).