Why Unemployment Will Hit 11 Percent

Boy, are we optimistic. The economy has been losing jobs for 23 months, and it's still not clear when that gruesome trend will turn around. Yet the stock market is skyrocketing, and investors are telling themselves that stocks are a "leading indicator," so a vigorous recovery must be right around the corner.

That corner keeps slipping further into the future. Economists have been heralding a turnaround for six months, largely because key measures like home prices, retail sales, bank losses, and job cuts have been deteriorating more slowly than they used to. But there's a big difference between a slowing rate of decline and actual improvement, and the economy remains in worse shape today than many prognosticators ever foresaw. Back in the spring, for instance, the Federal Reserve predicted that, in the worst possible case, unemployment would average 8.9 percent for 2009. We soared past that level in April, and it's been worse than the Fed's worst case ever since.

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Recent unemployment reports show that we're losing fewer jobs than earlier this year, when more than 500,000 jobs were vanishing monthly. As a rule of thumb, however, the economy needs to add at least 100,000 jobs a month for the unemployment rate to stay stable, since the overall labor force grows over time. So it will take more than 100,000 new jobs every month to start pushing the unemployment rate back down. That's probably months away.

As much as we want to believe that companies will start hiring again soon, there's practically no evidence that they're planning to. Corporate earnings have been rising sharply, with many companies turning in much better numbers than Wall Street analysts expected in a grinding recession. But mostly that's because companies have found new ways to cut costs and increase productivity, getting more done with fewer workers. Many companies, including big employers like IBM, Johnson & Johnson, Pepsi, and Alcoa, have had lower revenue but higher profits this year. Business is down, but they're more efficient than ever. Why would they start hiring again if they're getting more output from fewer workers and raising their profit margins?

[See why stocks are surging as jobs disappear.]

Concern about unemployment itself becomes a circular reinforcing factor, or "negative feedback loop," since soaring joblessness means people have less money to spend, which keeps the economy weak. That in turn is likely to discourage companies from expanding their payrolls. Companies that have just gone through painful layoffs aren't likely to start hiring until they're sure that a strong recovery is underway and new workers will be absolutely needed.

So as jarring as it is to have double-digit unemployment rate—the worst numbers since 1983—it's almost certain to get worse. "There is scant evidence that the unemployment rate is set to stabilize," Ryan Sweet of Moody's Economy.com wrote in a recent analysis. Even when companies do start hiring, the unemployment rate will probably keep going up, perpetuating a sense of gloom and threatening an actual recovery. That's because many unemployed people are so disconsolate that they've stopped looking for work, so they're not counted in the labor force, which is used to calculate the unemployment rate. Once companies do start hiring, many of those folks will start looking for work again, which will expand the labor force and increase the proportion who are still on the sidelines.

Moody's has downgraded its forecast, now predicting that the unemployment rate will peak at 11 percent sometime in the second half of 2010. That would surpass the peak jobless rate during the 1982-83 recession and be the worst job number since 1940. Back then, the industrial mobilization that came with World War II rapidly brought the unemployment rate down. Jobs came back pretty quickly after the 1983 recession as well. After unemployment peaked at 10.8 percent near the end of 1983, it fell by 2.3 percentage points within 12 months as manufacturers and other firms began calling back laid-off workers. A prosperous decade followed.

[See 7 ways to survive the jobless recovery.]

This time, it could take longer to recover once we finally reach the point of maximum pain. Many economists believe that a good chunk of the 8 million jobs lost during this recession won't come back, as a greater portion of the world's work gets done overseas and American businesses muddle along. Moody's predicts GDP growth of just 1.6 percent in the first half of 2010, which will further discourage hiring. And the government, usually the last-resort spender in a recession, has blown its wad, with the gargantuan federal deficit making any further stimulus unlikely. If we're not careful, optimism could become nearly as scarce as jobs.

Updated on 12/07/09: This story has been updated to include the latest economic figures.