We typically associate higher unemployment with hard economic times. Right now, the unemployment rate is very low, so does that reason that the economy is strong?

First, we have to distinguish between correlation and cause and effect. Higher unemployment doesn’t cause the economy to be bad. Perhaps a bad economy can cause higher unemployment, but even here we have to be careful with the details.

Another mistake that feeds into this is that the economy is weak when we are in a recession, and the economy is at least relatively strong when we aren’t in a recession. But a recession is a correction from previous mistakes. It is a process of correcting the allocation of resources.

A recession is just when the worst of the pain is typically felt because of the adjustment that is occurring. But the mistakes were already made, mostly with central bank policy and government policies/ spending overall. In fact, if the government and central bank do not intervene much, the recession is the healing process.

Reallocating Resources, Including Labor

Part of having a correction and reallocation of resources towards consumer demand is having higher unemployment. This is because work is shifting to areas of greater productivity and away from activities that are unsustainable.

Let’s say that food prices are skyrocketing in an artificial boom phase while people are getting swimming pools put in their backyards. When the recession arrives, the price for pools (the labor and materials) goes way down due to far less consumer demand. People aren’t buying luxury goods and services as they were during the boom time.

Yet, food prices may not be going down as much or at all. People still need to eat, and you can only make so many substitutions in terms of food. So the market is sending a signal that we need fewer pools and more food. The people who were building pools need to go work for food production companies and grocery stores.

To be sure, we live in a world with a high division of labor. So the exact people who are no longer in demand for installing pools do not have to be the same people who go into the food production business. But the wages will start to reflect where workers are needed.

In the transition, no matter how it shakes out, there will be higher unemployment as people shift to other jobs. So it is especially painful for those who have to change jobs and are left unemployed in between.

Today’s Job Market and Wages

The reason the low unemployment rate right now is not indicative of a strong economy is because wages are not keeping up with price inflation.

Some people don’t trust the government’s statistics on unemployment, but I think the trend is close enough. Most people who want a job today can get a job. It just may not be the job they want or at the wage they desire.

So the unemployment is low, but wages aren’t keeping up. And it is deceptive because of the inflation game. You may be getting a 5% annual raise at work, but that means that your salary is actually declining because you owe taxes on that money, and it is below the rate of price inflation, even according to the government’s own statistics.

The fact that unemployment is low does not tell us how strong the economy is. The one positive aspect is that it means the labor market is clearing. In other words, any interventions by the state are not enough to cause significant unemployment.

It’s interesting that the inflation created by the government/ Federal Reserve actually negates much of the harm from minimum wage laws.

Even if there were no minimum wage laws, most people would be getting paid at or above the current minimum wage anyway at this time. This is why the labor market is clearing. And to be sure, it is good in this one sense. It is better for people to be working than not working, no matter the conditions of the overall economy.

But the low unemployment rate doesn’t mean that living standards aren’t declining. Since real wages are going down, people are not able to maintain their same lifestyle without saving less or going into debt.

A Recession Ahead?

It looks likely that there will be a recession in 2023 or 2024. The yield curve is highly inverted, which is the best indicator.

If and when we get a hard recession, the unemployment rate is likely to increase. It is possible it may not be as bad as in other recessions even if the recession itself is as bad or worse.

The key is that wages have to be flexible for adjustment. There is always a demand for labor at some price. It’s just a question of how low that price (the wage) will go.

From an individual standpoint, the best thing most people can do to prepare for a recession is to secure their employment to the best extent possible. If you have marketable skills that are in high demand, then there is less to worry about. But it still doesn’t mean that your salary might not go down.

If price inflation continues higher, then perhaps nominal wages will just stay about the same as part of the adjustment. This would be a drop in real wages to the extent there is price inflation. But most people would rather take a pay cut than lose their job. At least they have options.

In conclusion, don’t let the low unemployment rate fool you. Real wages are still going down, and the unemployment picture could change quickly with a recession.