We got some bad news today on Initial Claims for Unemployment Insurance as the number jumped by 18,000 to 460,000, reversing the gains of the last few weeks. Further, last week’s numbers were revised higher by 3,000.

The four-week moving average — which, given the inherent volatility of the weekly measures is generally considered a better measure to watch — rose by 2,250 to 450,250.

As the graph below shows (from http://www.calculatedriskblog.com/) we are still in a much better place than we were a year ago, when the four-week average stood at 643,000. After declining sharply and steadily in the last eight months of 2009, the behavior of initial jobless claims has turned erratic in 2010.

It looks like we might be starting to follow the pattern of the previous two recoveries, where after an sharp initial decline, the level of initial jobless claims was stuck on a high plateau that lasted well over a year. That would be very bad news, as it would signal a long period of a “jobless recovery.”

While retail sales have picked up recently, as shown by the much-better-than-expected numbers coming out of almost all of the major chain stores today, ranging from high-end retailers like Nordstrom (JWN) to discounters like TJX Companies (TJX). However, without jobs and growing incomes, it will be very hard to sustain that momentum.

Continuing Claims

The news was better on the Continuing Claims front. Regular state-paid continuing claims dropped by 131,000 to 4.550 million, and are 1,294 million below a year ago. Those claims run out after 26 weeks.

In March, 44.1% of all the unemployed had been out of work for more than 26 weeks, and half had been looking for 20.0 weeks or more. Clearly that measure gives a very incomplete picture. After 26 weeks people move over to extended claims, which are paid by the Federal Government as part of the Stimulus program.

The extended claims not only serve an important humanitarian purpose, but are very effective at stimulating the economy. In fact on a dollar spent per job created or saved, the CBO [Congressional Budget Office] estimates that extended benefits are among the most effective measures the government can take.

If people have no income at all, then the only way they can survive is to draw down savings or run up their credit cards. Most people who have been laid off were living paycheck to paycheck…while they still had paychecks. High-school drop outs, or even people with only a high school diploma generally don’t earn enough to put a lot aside for a rainy day. In May, the unemployment rate for dropouts was 14.5%, and for high school grads who never went to college it was 10.8%.

Most of the meager savings done in this country is done by those with college educations, and their unemployment rate was only 4.9%. After rising sharply in later 2008 and early 2009, the overall savings rate has fallen sharply. That has helped to jump-start the economy, but is very bad long term.

With no income, savings depleted and credit cards maxed out, these people would not be able to pay their electric bills, their mortgage or rent. They would not be able to go to Kroger’s (KR) to buy food, and would have to rely on the already very over-stretched food banks. They would be homeless, and there would be more empty homes and apartments, putting further downward pressure on rents and housing prices.

The decline in housing prices would further destroy the housing wealth of those who are still in their homes. More of them would become underwater on their mortgages. The further underwater someone is on their mortgage, the more logical it is for them to simply walk away from the house. The downward spiral would accelerate.

Between regular benefits and extended benefits, there are now 10.358 million people getting a lifeline. Those benefits have played a key role in stopping the vicious cycle. There is even some evidence, like the strong chain store sales numbers, that we have started a virtuous cycle, but that virtuous cycle is not very well established yet.

The “New Welfare”?

There is a danger that extended benefits could turn into a new welfare system. However, while benefit levels vary by state, generally they are no more than 60% of what people were making before they lost their jobs, up to a maximum of about $400 per week. That should leave plenty of incentive for people to want to find a new job rather than just stay on unemployment.

The problem is that there are still not a lot of job openings. The rate of firing has slowed dramatically from a year ago, but the pace of hiring has not really picked up that much (although the March employment report was certainly encouraging).

Unemployment remains a far bigger problem than inflation. As such, the Fed is doing the right thing by holding short-term interest rates near zero. Raising rates too soon — and by “too soon” I mean anytime in 2010 — would be a serious mistake, and an abdication of the Fed’s legal mandate to foster conditions conducive to full employment.

Extended benefits are better than nothing, both for the individual getting them, and for the economy as a whole. They are, however, a very poor substitute for real gainful employment, again for both the economy, and for the individual.

Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.

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