​Bullish Economy and Inflation Faces Bullish Technology

May 14, 2017 06:30

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Dear Traders,

As unemployment levels in the US and EU are decreasing quickly, headlines about the potential impact of technology on business, employment levels, and products are, in fact, rising.

Will the cautious rebound of Western economies continue and trigger wage growth and hence inflation? Plus how will technology impact the the falling unemployment levels?

This article discusses a quick summary of the economic potential for the US and EU in the face of automation, robots, inflation, and employment increases. Be sure to check out next week's article that discusses the impact on the financial markets.

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What Are the Three Major Trends That Impact Employment?

Businesses from the United States and Western Europe have seen dramatic changes since the 1980s - primarily due to three major trends:

  1. Technology: automation, robotics, and technological advancements are replacing old processes and jobs.
  2. Globalisation: the practices of outsourcing (giving the task to another company) and offshoring (moving the job to another country) - and sometimes both at the same time - are moving jobs to different places.
  3. Demographics: the largest increase of the world's population has occurred outside of the West.

These three trends have significantly impacted the global job market because it increased the pool of global labour (demographics), it allowed companies to move jobs to different countries (globalisation), and human labour is increasingly being replaced by automation, robotics, information and technology.

But will these trends also impact the future? Here's an overview:

  1. The technological and demographical trends are expected to continue in the coming decade(s).
  2. Offshoring could reach a limit and become less appealing as the wage gap between the West and the rest of the world becomes smaller. According to Ross, "wages for manufacturing jobs [in China] have soared between fivefold and ninefold in the past decade." *
  3. Furthermore, technological advancements are not only impacting the West but could also disrupt economies that have so far benefited from offshoring.

Will Economy's Current Position Lead to Inflation?

Unemployment rates in the West received a major blow during the Great Recession in 2008/09. Rates eventually increased by up to 10 per cent in the United States by 2010, to nearly 11 per cent for the European Union by 2013, and to 12 per cent for the Eurozone by 2013 - see image below.

employment.pngSource: Eurostat - statistics explained.

Unemployment rates have, however, declined sturdily over the past 6 to 7 years in the US and the past 4 years in the EU and Eurozone - as the above image shows. The rates have in fact almost reached their pre-recession levels.

The investment bank, Goldman Sachs, has mentioned in their research paper that there's a "two-thirds chance that the recovery will be the longest on record [as the] current expansion has lasted 95 months"**. The current record is 120 months from 1991 to 2001, when analysing 33 business cycles from 1854 (95 months is the third longest to date).

With offshoring potentially reaching certain limits and unemployment levels also reaching lower levels, the wage expectations from employees in the US and parts of the EU could finally start to pick up.

Wage growth might finally, albeit slowly, increase, which in turn could lead to US and EU economies hitting or breaking above the Central Bank's inflation target of 2 per cent.

In that scenario, central banks and governments could finally have achieved their decade long pursuit of fighting a recession, deflation, and rising unemployment...

… But would they have time to sit down, relax, enjoy the 'win'?

Probably not.

Will Technology Play an Increased Role?

Although there are reasons to see bullish employment levels and inflation continue in the near future, there are two major characteristics that stand out in this economic recovery:

  1. It was a slow but lengthy recovery when compared to other recessions in recent history.
  2. Critics also add that the new jobs have also been added in low paying service jobs.

Point 1: the slow and lengthy recovery is, according to Goldman Sachs, increasing the "medium-term risk of recession", as output and employment growth hit high levels. Currently they estimate a 31 per cent chance for a US recession in the next nine quarters and that number is rising**.

employment 4.png
Source: CNBC and Goldman Sachs.

The current risk of 31 per cent, however, still seems rather low compared to previous recession periods, which had reached levels of 50-80 per cent before a recession did occur. A simple guesstimate, therefore, could make 2019-2020 a more likely point in time for such a recession to occur.

Point 2: there are two main factors to consider when analysing this growth in employment. Firstly, Carl Frey indicated that only 0.5 per cent of American workers are employed in industries that have emerged since 2000.***

Secondly, the image below - taken from a Bloomberg study - shows how the output (grey field and red line) mostly increased, whereas employment change (black line) was always negative.*+ The same pattern is visible in most of the manufacturing sectors studied.

employment 2.png
Source: Bloomberg Change in employment and output in US manufacturing industries.

Conclusion: we are seeing a recovery, but the jobs seem to be created in the low paying service sector and not in manufacturing or new technology.

Furthermore, the costs of automation, robotics, information, and technology are rapidly falling. Analysing and using big data, building robots, applying new technologies, and more are becoming cheaper by the minute, with accelerating speeds. The MetaTrader 4 Supreme Edition plugin is a fine example of such technology being applied to trading charts.

As Ross explains in his analysis of future industries, "as the capex (capital expenses or purchasing costs) of robots continues to go down, the opex (operational expenses or wages) of humans becomes comparatively more expensive and therefore less attractive for employers." *

Or in other words, the continuous decrease of technology costs combined together with a potential increase in wages could change the calculations of many companies: it will, therefore, become more and more appealing to replace and automate human labour.

What's Next With Cheaper Tech and Expensive Labour?

All in all, the economy, wages, and inflation might seem (slightly) bullish now, but technology could be an even bigger bull.

During the next one to three years wage demands could grow and employment levels could inch lower, marking slightly lower lows, but nearing a potential bottom.

However, once a recession hits the US and EU, the landscape could drastically change and a negative feedback loop might emerge.

Ironically, the recession could accelerate the implementation of robots and automation to save costs, which in turn could accelerate the recession.

A new recession could turn out to be an 'external shock' that kick-starts an avalanche of change, in the shape of the implementation of new technology.

Finding an adequate response to the potential recession could be a tough challenge with monetary policy from central banks perhaps overused and exhausted after 10 years of expansive policies and fiscal policy from governments stretched thin as the debt levels have ballooned in this decade, also.

In any case, here are some key aspects and questions to keep in mind:

  1. Will unemployment rates find a bottom in the next one to three years?
  2. Will the unemployment rates move up slowly or quickly?
  3. Will they break above the peak of the 2008 Great Recession or stay far away from those high levels?

employment 3.png
Source: Eurostat - statistics explained on the left side 2017 and earlier. The right side with (2018 to 2020) are potential projections and forecasts made by the author based on the trends mentioned in this article.

The image above shows a scenario where unemployment decreases in 2017, mostly flattens in 2018, slightly increases in 2019, and accelerates in 2020 – which I would consider the most likely path at the moment. However, long-term forecasts like these are bound to be updated frequently.

Nobody really knows the answer to this and it also depends on one's view:

  • "Positive view": traditional economists point out that a fear of technology replacing jobs has been around for centuries but new types of jobs have always been created.
  • "Negative view": technologists refer to the fact that the current intensity (number of tasks) and width (number of sectors) is on a different scale than ever before.

Everyone will have to make their own judgment over what outcome is the most probable based on the incoming stream of data received each day, month and quarter...

Next week I will share my personal view and how this will impact trading and the financial markets. Be sure to check it out!

Remember, you can also join our live trading webinars and download our 60+ extra plugins with the MetaTrader 4 Supreme Edition, including Volatility Protection Settings, for free.

Cheers and safe trading,

Chris Svorcik

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(*) "The Industries of the Future" in page 37 by Alec Ross, published by Simon & Schuster in 2016.

(**) CNBC article

(***) Oxford Martin source

(*+) Bloomberg study