Wednesday, September 3, 2008


A recent Business Week article highlighted the importance of our rising labor productivity, which is mitigating some of the pain of the current economic slowdown. In a word, it means higher profits for companies and higher wages for their workers. And it will help to push future inflation lower

This is likely to help future growth, rather than the current economy, what with alarums over the possibility that Fannie Mae and Freddie Mac might be nationalized. All that negative news is making so-called conforming and jumbo-conforming conventional mortgages that are insured by Freddie and Fannie more expensive, as investors grow leery over the possibility of their failure.

Mortgage rates should in fact be trending down to historic lows with the 10-year Treasury bond yield now around 3.8 percent. Conforming 30-year fixed rates were in the 5.25 to 5.50 percent range in 2003, the last time Treasury rates were this low, versus 6.25 percent today.

A drop in inflation will also lower interest rates, especially for bonds that are sensitive to inflation trends. The current inflation spike is due to many factors, including the Iraq War and devalued dollar. Higher labor productivity is part of the technology revolution that has transformed the U.S. economy and kept inflation lower than it was in the 1980s and 1990s.

Productivity, measured as output per hour worked in private nonfarm businesses, has increased 2.8 percent in the second quarter from one year ago, versus its 1.1 percent annual rate of the past 2 years. This is good news when we are in the midst of an economic slowdown.

In fact, the current consumer inflation rate of 5.8 percent could be much higher without the savings in labor efficiency, caused by businesses continuing to invest in high technology to cut costs. Fed Chairman Ben Bernanke was optimistic about inflation prospects at the Fed’s recent annual Jackson Hole Conference.

“In this regard, the recent decline in commodity prices, as well as the increased stability of the dollar, has been encouraging. If not reversed, these developments, together with a pace of growth that is likely to fall short of potential for a time, should lead inflation to moderate later this year and next year.”

What are the prospects for growth in this economy that is going to be “short of

potential for a time”? The Conference Board’s July Index of Leading Economic Indicators (LEI) showed “slow growth the rest of the year, and possibly an economy grinding to a halt,” said its press release. Seven of its ten indicators that help to predict future economic activity have been negative over the past 6 months.

But second quarter GDP economic growth may be revised to as high as 3 percent from its 1.9 percent initial estimate, due to higher exports than originally estimated. This second GDP “preliminary” revision will be released by the Commerce Dept. August 28. Q1 growth was just 0.9 percent.

What does that tell us? Some parts of the economy are still growing, including exports, some manufacturing sectors tied to exports, and health care. But the financial industry needs more capital to make up for its horrendous losses (and a recovery of its stock prices) before the rest of the economy (including housing) recovers.

© Harlan Green 2008

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