Initial U.S. jobless claims were down again in the latest weekly report. They dropped by 12,000 and now stand at their lowest level since the first week in January of this year. Continuing claims were also lower (-139,000) and are now back to where they were in March. Some analysts have concluded that initial jobless claims, at a level of 500,000 – which is about their current position, combined with an unemployment rate of around 10% -- point to an imminent end to job layoffs.

U.S. labor markets

This does not mean a quick end to the problems in U.S. labor markets. The unemployment rate is at a 26-year high, which will lead to continuing after-effects. As firms start to experience better activity levels, their first employment moves will be to increase temporary hirings and/or to offer current workers more overtime. This is a means to ensure that output targets are met without being committed to too much staff if the recovery proves to be illusory or only tentative.

To provide further boosts to the U.S. economy, Washington is expanding jobless benefits by as much as 20 weeks and extending the first-time homebuyer tax credit. The Federal Reserve has also made clear its commitment to stimulus by keeping interest rates at historically low levels. The unemployment rate is one of the key indicators that the Fed will be monitoring with respect to the timing of an adjustment in its stance to a more hawkish position (i.e. higher interest rates).

Greenback devaluation

However, the low federal funds rate is one among several factors that are having deleterious impacts on the value of the U.S. dollar. The greenback is on a potentially destabilizing path of devaluation. It is crucially important that world currency mechanisms work to act as shock absorbers. Central bankers know this and appear to be taking appropriate steps to ease problems.

For the world economy to heal there must be more flexible currency markets. Specifically, Asia’s exchange rates need to find their proper equilibrium levels. Coming out of the current APEC (Asia-Pacific Cooperation Group) meeting in Singapore, there are indications that the Chinese government is about to let the yuan climb in value versus the U.S. dollar. After July 2005, the yuan rose 21% versus the greenback before being pegged at 6.83 for the past year.

Yuan set to rise in value

Chinese currency inflexibility has contributed to global economic problems in several ways. Prior to the recession, it fueled huge foreign purchases of Chinese goods, adding to stockpiles of foreign exchange holdings by the Chinese government. That money was invested in American Treasuries, allowing U.S. interest rates to stay lower than would otherwise have been the case. Subsequently, the low interest rates contributed to a bubble in credit markets and the cycle of U.S. consumers making huge purchases offshore became self-perpetuating.  

The degree of adjustment of the yuan that the Chinese government will allow is likely to be slow and modest. There is a good reason for this. The Chinese government will not want to see its holdings in U.S.-denominated paper assets drop in value in any kind of alarming fashion. Nevertheless, an upward adjustment in the yuan will be a positive step. For one thing, it will encourage Chinese consumers to purchase foreign goods to a greater degree.

This will be the first phase of a shift in the Chinese economy away from a mostly export-oriented focus towards a more consumer-driven society. The latter is typically the hallmark of maturity in industrialized nations. It will also force greater interest rate discipline on the U.S., which will be helpful longer term. The likelihood of asset bubbles will diminish accordingly.