This just in...D&S reads the news (#8)

by Dollars and Sense

The eighth in a series of blog entries by D&S collective member Larry Peterson.

First of all, I'd like to wish everyone a happy May Day. Keep struggling out there, comrades!

Speaking of May Day, the most recently released economic indicators are starting to bring to mind—despite the astronomical differences in living standards, efficiency and respect for basic freedoms—the old saying from Brezhnev's Soviet Union: "They pretend to pay us, and we pretend to work." In short, virtually all of them point to slowdowns and backlogs—except corporate profits, comsumer-level inflation (which disregards volatile items like fuel and food), and, to a much lesser extent, wages. How can this be? Basically, the economy is distributing very ample rewards, in the form of stock appreciation and dividend payouts, ordinary wages (this after a long period in which wages lagged very much behind productivity gains) and employment opportunities. True, the housing bubble's bursting still looks set to destroy a significant part of that weath; but the fact remains that, throughout the economy, relatively large payouts are being made while productivity levels are falling rapidly. Since productivity levels are, according to economic theory, the most important contributor to rising living standards, this suggests that the current conjucture is either highly unusual, in a fundamental sense, indicative of a deeper malaise in the economy, or both.

Now it is certainly the case that the astosnishingly high levels of productivity characteristic of the first half of the decade were able to coexist with stagnation in wage levels for a number of reasons: interest rates were unprecedentedly low (given the business cycle stage) for a period of some years, and, as we all know, the wealth effect from rising housing prices acted together to make people feel richer despite the wage lag. This is all the more true because credit was so easily available and relatively cheap, and because the opening of key markets allowed cheaper imports to substitute for—or simply maintain pressure on the prices of—domestic production (and then there were the Bush tax cuts...). Accordingly, inflation was tame despite the low interest rates and high growth. GDP during this period was quite good by developed-country standards; some would even call it exceptional.

The problem now concerns the fact that the set of unusually benign— particularly from the point of capital—influences is beginning to turn into a far more unruly one. For while the various wealth-effects of the earlier part of the decade were able to offset each other (for much of the mmiddle and all of the upper classes, anyway), in the sense that none of them were allowed to stand in the way of growth, growth is now threatened by inflation pressures and deflationary ones simultaneously; and offsetting the two is becoming extremely difficult, while the stakes grow higher every day. And this while our savings rate continues negative and, part and parcel with that, the dollar continues its slide versus the Yen, Euro, Pound and Yuan.

So: to return to the original question...What could possible account for this situation? Well, I can hardly provide much by way of an answer, but I would point in the direction of the financial secctor. Financial institutions have comprised a completely disproportionate share of firms reporting earnings surprises for several quarters now, no doubt due to their fee collections from mergers and acquisitions (some among mega firms in their own sector, such as the Royal Bank of Scotland/ABN AMRO merger proposed last week). Stock prices have been buoyed to a great extent by these mergers and by share buybacks that tend to deter predatory takeover attempts. That earnings continue to surprise on the upside, even beyond the financial sector—which, remember is significantly exposed to the travails of the housing market—and that, in a period characterized by higher interest rates (banks, traditionally—for what that's worth anymore—struggle as interest rates go up: loan demand tends to fall and deposit costs to rise), is unusual, though it does have an underpinning.

That leaves the recent wage rise to explain: why now? Well, much of the wage rise in the earlier part of the year consisted of humungous bonus payouts to filthy rich stockbrokers and the like. But it does appear as if more recent rises are filtering through to the rest of us, which is to be expected, given the rising inflation rate (not to mention the fact that wages have been so slow in following productivity's rise). But nonwage costs (especially health insurance) continues to outpace even inflation, so many workers, even with higher pay packets, aren't bringing home as much as they did even last year. So, for all practical purposes, labor is still being bled. The combination of these two factors, and certain other odd factors (US companies make far more on foreign investments than foreign firms do here), may go a long way in explaing the resilience of profits in the face of inflation and even the uptick in wages. But can profits continue to stay on par, which they are expected to do by demanding (and incresingly debt-laden) investors, especially in a higher interest rate environment, one with an undertermined overhang from the housing slowdown? Maybe here is where the fiction of Brezhnev's Soviet Union will finally meet that of fictitious capital.

Hang on to your hats, comrades. 

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5/01/2007 01:00:00 PM