Why the Fed’s Obsession With Inflation?

Popular Economics Weekly

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The Federal Reserve’s December FOMC statement, said, after increasing their overnight rate another one-quarter percent: “Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee judges that some further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term.”

Why is there still worry over inflation, 40 years after the 1970’s wage-price spiral that caused so much pain, and initiated the Fed’s obsession with keeping a low inflation target in the first place?

One has only to look at the decline of real wages and salaries since the 1980s to realize the Fed puts most of the inflation blame on real wages, the incomes of the working and middle classes. They use the outmoded formula that labor costs make up two-thirds of product costs; ergo, every time wages begin to rise the Fed must raise rates to keep wages from rising higher to prevent more inflation.

But the history of the Consumer Price Index gauge of retail inflation from 1929 portrayed in the above graph proves that inflation has been almost non-existent above 2 percent, with occasional bumps to 4 percent during boom times; except for the sharp spike in 1980 due to the wage-price spiral precipitated by the jump in oil prices of the 1970’s Arab oil embargos.

Then what are the “strong labor conditions” the Fed seems to be worried about that merit the quarter-point raise this week? The unemployment rate is 3.7 percent, but wages are barely rising above today’s 2 percent inflation rate these days, even in a fully-employed economy. And the Fed predicts 2 percent inflation through 2021 in its just-released predictions with full employment also continuing through 2021.

They must not really believe wage costs determine inflation, if they predict low inflation will persist with full employment in the 3 percent range, per their above matrix. That can’t happen. The “strong labor market conditions” haven’t pushed up production costs, with so-called unit-labor costs rising just 0.9 percent Q-to-Q.

So what is the Fed to do? It should not tie their inflation predictions to wage increases, for starters. Inflation is caused by much more than rising wages. In today’s low inflation environment where robots are replacing many workers, the costs of production are tied more to the costs of robots, rather than labor personnel.

Tesla’s new Fremont, CA fully-automated Model 3 electric vehicle factory that was set up in just 3 weeks is evidence robots now control the cost and pace of production more than the personnel.

Harlan Green © 2018

 Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Labor Productivity is the Golden Fleece

Financial FAQs

Graph: Econoday

Rising labor productivity is the golden fleece of economic growth, the pot of gold at the end of the rainbow, because major economists maintain it is really the only way workers can raise their standard of living. This means raising incomes above the inflation rate, which is where average household incomes have been stuck since the end of the Great Recession.

The sheep’s fleece was an ancient Greek method of extracting gold from flowing streams.  The heavier gold flakes would stick to the fleece, hence the Greek myth of Jason bringing home the Golden Fleece came to signify the accumulation of wealth and power.

For that reason it’s good news that labor productivity seems finally to be recovering. Workers’ output rose at a very hot 4.8 percent rate in the second quarter, up from an already solid 2.6 percent rate in the first quarter. Hours worked rose at a 1.9 percent rate vs. the first quarter's 2.6 percent.

But we don’t see its benefits being passed on to wage and salary earners. Wages have stagnated and income inequality increased because workers’ productivity hadn’t risen substantially since 2010, as the graph shows; when benefits from ARRA, the $831 billion American Recovery and Reinvestment Act enacted during the first year of President Obama’s administration, petered out. It was much too inadequate to help restore states’ and consumers’ personal wealth from the worst recession since the Great Depression.

“Obama officials and Congress clearly made a big mistake early in the recession by focusing more intently on saving banks — and, thus, bankers and investors — and much less on directly helping families facing foreclosures and layoffs,” says a recent NY Times Op-ed. “Later in the recovery, the decision by Republican leaders in Congress to oppose every Obama proposal prevented the government from doing much to help people regain what they had lost or to heat up the tepid recovery with infrastructure spending and other stimulus measures.”

More government public sector aid was necessary, in other words, because the private sector was recovering from their losses and had little money to invest.

And “Government puts a lot of money into basic research, whereas businesses tend to fund late-stage development that can be quickly commercialized,” says MarketWatch’s Rex Nutting. “However, federal funding for research hasn’t kept pace with the growth in the economy; in the past 10 years, federal R&D investments have risen just 0.3 percent per year after adjusting for inflation.”

A major reason for the rise in productivity at the moment has to be that companies are investing more in new plants and equipment; in part because of the Republican tax cut in corporations’ nominal tax rate, but also because there is a huge deficit in skilled workers that has required businesses to invest more heavily in technologies that replace those missing workers. There are now about one million more job openings than jobs being created each month.

So workers aren't really benefiting from the productivity increase, as nominal compensation fell to a 2.0 percent rate from 3.7 percent in the first quarter, according to Econoday. When adjusting for inflation, real compensation rose 0.3 percent and was little changed from the first quarter's 0.2 percent rate.

Why?? Firstly, many more low-paying service sector jobs are being created than manufacturing jobs; which have been shipped overseas by corporations where wage and benefit costs are a fraction of Americans’. It is a major reason President Trump has initiated tariff increases in the hope foreign manufactures become less competitive in a bid to bring home some of those manufacturing jobs.

But that may or may not succeed, as a burgeoning trade war with higher tariffs would probably raise prices and inflation to a level that would nullify any benefits from more domestic jobs. Nobel economist Paul Krugman has said that it could eliminate 8 to 9 million jobs from companies that would shrink as a result of the increased tariffs, due to foreign businesses looking elsewhere for cheaper products not affected by the tariffs.

Increasing the national minimum wage from $7.25/hour last set in the 2009 would definitely help the lower wage sector, which Big Business has been resisting. Workers are producing more than ever, at present. But that doesn’t mean their standard of living will rise because of it, unless employers pass on more of the productivity increase to their employees

Harlan Green © 2018

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Is 4% GDP Growth Real?

Popular Economics Weekly

Graph: Econoday

Many economists, including Trump economic advisor Larry Kudlow, are predicting up to 4 percent economic growth over the next few quarters. Why? Full employment is enticing consumers to buy more, with booming retail sales and consumer confidence.

“Sales at health & personal care stores were unusually strong in June, up 2.2 percent following a series of very strong gains in the 1 percent range,” reports Econoday. “Nonstore retailers, in a sign of e-commerce strength, rose 1.3 percent in June and continue to make ground compared to other components. Gasoline stations, boosted by high gas prices, saw a 1.0 percent rise in June sales following a 3.0 percent spike in May. Building materials, at plus 0.8 percent in June, and furniture store sales, up 0.6 percent, are both positive indications for residential investment.”

The problem with understanding the significance of retail sales is that they aren’t corrected for inflation, and consumer (CPI) inflation is approaching 3 percent, so 6 percent nominal annual retail sales is closer to 3 percent in real sales. And that is probably the high end, as consumers’ real average paychecks are increasing 2.7 percent, so any increase in buying is limited by the amount consumers can borrow with rising interest rates, as I’ve been saying.

Is 4 percent GDP growth possible for the next several quarters, as Kudlow, et. al. are predicting? It depends on how long can this business expansion continues, says Brookings economist Robert Shapiro.

“Trump’s middling record on GDP and investment raises the question of how much longer the current expansion, now just two months shy of entering its tenth year, can last,” says Shapiro. “Developed economies move in business cycles, and so they weaken eventually as a matter of course. That’s where the United States is today. This late in any economic expansion, the pool of available workers for new jobs is modest, most attractive investment opportunities have been taken, and any pent-up consumer demand for large durable purchases has been exhausted.”

Graph: MarketWatch

In fact, wages are falling after inflation by another measure. According to the Labor Department, median weekly earnings fell 0.6 percent in inflation-adjusted dollars in the second quarter, compared to the same time period of 2017. That’s the third straight quarter where inflation has outpaced wage growth, according to MarketWatch’s Steve Goldstein.

This is an important statistic because real personal income growth is one of the four pillars that measure the onset of a recession. Nonfarm employment, industrial production and real retail sales are the other three pillars. All four indicators must peak for a recession to begin. So far, median weekly earnings show weakness, but the other three still show growth.

A more public sign of recession is when there are two consecutive quarters of GDP decline. So to be clear, weakness is showing in just one of the four legs, and there are predictions of at least two more quarters of positive GDP growth.

But then there is the looming trade war. The International Monetary Fund has just warned that President Trump’s trade wars with everyone could cost the world’s economies some $430B in lost growth. The Washington-based organisation said the current threats made by the US and its trading partners risked lowering global growth by as much as 0.5 percent by 2020, or about $430bn in lost GDP worldwide.

It has escalated from $3.6 million in tariffs first imposed in January against 18 types of Chinese solar panels and washing machines to more than 10,000 products worth some $362 billion, as China, Canada and the European Union have retaliated with their own tariffs, according to the latest New York Times estimate.

And 2020 is the year of our next presidential election. So investors can gamble that President Trump won’t continue to double down on his trade wars, if he wants to be re-elected. But it is a very high-stakes gamble.

Harlan Green © 2018

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

A Decent Employment Report

Financial FAQs

The Bureau of Labor Statistics reported that 156,000 additional nonfarm payroll jobs were created in August, which was less than expected, but will be enough to keep markets happy. And the unemployment rate edged up to 4.4 percent from July’s 4.3 percent as more workers began looking for work (77,000), but weren’t yet absorbed into the workforce. Almost all the job gains occurred in manufacturing, construction, professional and technical services, health care, and mining.

Graph: Marketwatch

A major positive in the report is a 36,000 surge in manufacturing payrolls that includes a 10,000 upward revision to July to a 26,000 increase and a 9,000 upgrade to June to a gain of 21,000. It’s a positive sign because manufacturing jobs pay higher wages.

Construction payrolls are also solid, up 28,000 in August following a 3,000 decline in July, which mirrors the surging housing market. The new-home construction rate is now above 1 million annual units, which helps replenish depleted housing stocks (and helps to slow price growth).

But retail hiring has declined for six straight months as retail stores continue to close. This is while Amazon has announced plans to hire an additional 50,000 employees to work in its distribution centers.

This was a good jobs report, in other words, and suggests the ongoing recovery, now in its eighth year, shows no signs of weakening. Wages aren’t rising any faster than 2.5 percent; which is a mystery because manufacturing and construction jobs pay higher wages. Is that because there are still 5.6 million part time workers that would rather work fulltime? They earn less, so that may be what is holding down wage growth.

But real (inflation adjusted) Disposable Income is rising again after going negative in 2016.  Disposable income measures income from rents and the self-employed, as well as wages, which may give a boost to employees’ wages. It is the major reason consumer spending rose 3.3 percent in second quarter’s GDP report, and probably will boost third quarter growth as well. Wages and salaries have now risen 0.5 percent for two consecutive months.

The combination of good unemployment and rising incomes are boosting consumer confidence. The Conference Board reported on Tuesday that its consumer confidence index is now at 122.9, which is its highest value since December 2000.

“Consumer confidence increased in August following a moderate improvement in July,” said Lynn Franco, Director of Economic Indicators at The Conference Board. “Consumers’ more buoyant assessment of present-day conditions was the primary driver of the boost in confidence, with the Present Situation Index continuing to hover at a 16-year high (July 2001, 151.3). Consumers’ short-term expectations were relatively flat, though still optimistic, suggesting that they do not anticipate an acceleration in the pace of economic activity in the months ahead.”

Manufacturing payrolls are surging in part because factory orders are rising again. Factory orders fell in July 3.3 percent because of a drop in aircraft orders, but there was a 6 tenths upward revision to core capital goods orders (nondefense ex-air) to a 1.0 percent gain and a 2 tenths upward revision to core shipments, now at 1.2 percent. These numbers point to accelerating strength for third-quarter business investment, which along with consumer spending are the main drivers of GDP growth.

Another boost to Q3 growth will be the recovery efforts for Hurricane Harvey. Damage estimates range up to $100 billion, and governments (as well as insurance) companies will be spending most of that money.  This is what governments need to do, even if the U.S. congress can’t pass a substantial infrastructure bill this year.

And what about the estimated 6 million damaged autos that will be replaced? That give’s another boost to the manufacturing sector, and Q3 economic growth!

Harlan Green © 2017

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen