Markets
Visualizing the Link Between Unemployment and Recessions
The Surprising Link Between Unemployment and Recessions
The U.S. labor market is having a strong start to 2023, adding 504,000 nonfarm payrolls in January, and 311,000 in February.
Both figures surpassed analyst expectations by a wide margin, and in January, the unemployment rate hit a 53-year low of 3.4%. With the recent release of February’s numbers, unemployment is now reported at a slightly higher 3.6%.
A low unemployment rate is a classic sign of a strong economy. However, as this visualization shows, unemployment often reaches a cyclical low point right before a recession materializes.
Reasons for the Trend
In an interview regarding the January jobs data, U.S. Treasury Secretary Janet Yellen made a bold statement:
You don’t have a recession when you have 500,000 jobs and the lowest unemployment rate in more than 50 years
While there’s nothing wrong with this assessment, the trend we’ve highlighted suggests that Yellen may need to backtrack in the near future. So why do recessions tend to begin after unemployment bottoms out?
The Economic Cycle
The economic cycle refers to the economy’s natural tendency to fluctuate between periods of growth and recession.
This can be thought of similarly to the four seasons in a year. An economy expands (spring), reaches a peak (summer), begins to contract (fall), then hits a trough (winter).
With this in mind, it’s reasonable to assume that a cyclical low in the unemployment rate (peak employment) is simply a sign that the economy has reached a high point.
Monetary Policy
During periods of low unemployment, employers may have a harder time finding workers. This forces them to offer higher wages, which can contribute to inflation.
For context, consider the labor shortage that emerged following the COVID-19 pandemic. We can see that U.S. wage growth (represented by a three-month moving average) has climbed substantially, and has held above 6% since March 2022.
The Federal Reserve, whose mandate is to ensure price stability, will take measures to prevent inflation from climbing too far. In practice, this involves raising interest rates, which makes borrowing more expensive and dampens economic activity. Companies are less likely to expand, reducing investment and cutting jobs. Consumers, on the other hand, reduce the amount of large purchases they make.
Because of these reactions, some believe that aggressive rate hikes by the Fed can either cause a recession, or make them worse. This is supported by recent research, which found that since 1950, central banks have been unable to slow inflation without a recession occurring shortly after.
Politicians Clash With Economists
The Fed has raised interest rates at an unprecedented pace since March 2022 to combat high inflation.
More recently, Fed Chairman Jerome Powell warned that interest rates could be raised even higher than originally expected if inflation continues above target. Senator Elizabeth Warren expressed concern that this would cost Americans their jobs, and ultimately, cause a recession.
According to the Fed’s own report, if you continue raising interest rates as you plan, unemployment will be 4.6% by the end of the year.
– Elizabeth Warren
Powell remains committed to bringing down inflation, but with the recent failures of Silicon Valley Bank and Signature Bank, some analysts believe there could be a pause coming in interest rate hikes.
Editor’s note: just after publication of this article, it was confirmed that U.S. interest rates were hiked by 25 basis points (bps) by the Federal Reserve.
Markets
Visualizing the Rise of the U.S. Dollar Since the 19th Century
This animated graphic shows the U.S. dollar, the world’s primary reserve currency, as a share of foreign reserves since 1900.
Creator Program
Visualizing the Rise of the U.S. Dollar Since the 19th Century
As the world’s reserve currency, the U.S. dollar made up 58.4% of foreign reserves held by central banks in 2022, falling near 25-year lows.
Today, emerging countries are slowly decoupling from the greenback, with foreign reserves shifting to currencies like the Chinese yuan.
At the same time, the steep appreciation of the U.S. dollar is leading countries to sell their U.S. foreign reserves to help prop up their currencies, in turn buying currencies such as the Australian and Canadian dollars to help generate higher yields.
The above animated graphic from James Eagle shows the rapid ascent of the U.S. dollar over the last century, and its gradual decline in recent years.
Dollar Dominance: A Brief History
In 1944, the U.S. dollar became the world’s reserve currency under the Bretton Woods Agreement. Over the first half of the century, the U.S. ran budget surpluses while increasing trade and economic ties with war-torn countries, expanding its influence as the world’s store of value.
Later through the 1960s, the U.S. dollar share of global foreign reserves rapidly increased as political allies stockpiled the dollar.
By 2000, dollar dominance hit a peak of 71% of global reserves. With the creation of the European Union a year earlier, countries such as China began increasing the share of euros in reserves. Between 2000 and 2005, the share of the dollar in China’s foreign exchange reserves fell by an estimated 15 percentage points.
The dollar began a long rally after the global financial crisis, which drove central banks to cut their dollar reserves to help bolster their currencies.
Fast-forward to today, and dollar reserves have fallen roughly 13 percentage points from their historical peak.
The State of the World’s Reserve Currency
In 2022, 16% of Russia’s export transactions were in yuan, up from almost nothing before the war. Brazil and Argentina have also begun adopting the Chinese currency for trade or reserve purposes. Still, the U.S. dollar makes up 80% of Brazil’s reserves.
Yet while the U.S. dollar has decreased in share of foreign reserves, it still has an immense influence in the world economy.
The majority of trade is invoiced in the U.S. dollar globally, a trend that has stayed fairly consistent over many decades. Between 1999-2019, 74% of trade in Asia was invoiced in dollars and in the Americas, it made up 96% of all invoicing.
Furthermore, almost 90% of foreign exchange transactions involve the U.S. dollar thanks to its liquidity.
However, countries are increasingly finding alternative options than the dollar. Today, Western businesses have begun settling trade with China in renminbi. Looking further ahead, digital currencies could provide options that don’t include the U.S. dollar.
Even more so, if the U.S. share of global GDP continues to shrink, the shift to a multipolar system could progress over this century.
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