Sunday, September 03, 2006

a not so happy Labor Day

It boggles the mind that the US economy has remained strong despite deficits, energy costs, natural disasters, unfavorable global imbalances, and all ... and all. The driving force behind this freak of nature is probably the strength of the US consumer culture. And why do we buy? Well, prices are low for many consumer goods and, interest rates also being pretty low, Americans can buy a lot without reaching the point where they can't meet the minimum payments on their credit cards.

Prices are low, of course, because (a) so many consumer goods can be produced cheaply abroad (mainly in Asia) and (b) Wal-Mart and the other big box stores make sure that cheap foreign production yeilds up low retail prices. Another way of expressing these two points is to say that global competition makes for low-cost shopping.

This Labor Day Weekend, The New York Times and Washington Post are calling attention to the downside of the enthusiastic US emersion in the vibrant global economy.

Harold Meyerson in the Post draws attention to an article on Wal-Mart in the July issue of Harper's. He says 20 percent of all retail transactions in the United States take place at Wal-Marts and explains that Wal-Mart exploits the power this gives them. As is well known, they keep wages and benefits low for their own employees, but, less well known, they're also able to force this cost-cutting on their suppliers and, in effect, "drive down wages and benefits all across the economy. ... [With the result that] "of Wal-Mart's 10 top suppliers in 1994, four have filed bankruptcies."

The Wal-Mart trend has been enabled in part, Meyerson says, by a long-term transition from an economy based on heavy manufacture (in which union organization has been strong) to one based on the Silicon-Valley type of manufacture and on services (where it has not been so strong). He says since 1973 there has been a "decoupling of increased corporate revenue from employees' paychecks [as] productivity gains have outpaced median family income by 3 to 1."

The piece in the Times, by Steven Greenhouse and David Leonhardt, gives more recent data:
The median hourly wage for American workers has declined 2 percent since 2003, after factoring in inflation. The drop has been especially notable, economists say, because productivity — the amount that an average worker produces in an hour and the basic wellspring of a nation's living standards — has risen steadily over the same period.

As a result, wages and salaries now make up the lowest share of the nation's gross domestic product since the government began recording the data in 1947, while corporate profits have climbed to their highest share since the 1960's. UBS, the investment bank, recently described the current period as "the golden era of profitability."

Worker productivity rose 16.6 percent from 2000 to 2005, while total compensation for the median worker rose 7.2 percent, according to Labor Department statistics analyzed by the Economic Policy Institute, a liberal research group. Benefits accounted for most of the increase.

"If I had to sum it up," said Jared Bernstein, a senior economist at the institute, "it comes down to bargaining power and the lack of ability of many in the work force to claim their fair share of growth."
Some current Census reports show what's happening. Between 2004 and 2005, although the overall median household income rose by 1.1 percent in the US, the real median earnings of both men and women who worked full-time, year-round declined. Median household income rose because households at the top end of the spectrum saw huge increases in income, much of it coming from sources other than wages and salaries. The Times article quotes Charles Cook, who publishes a nonpartisan political newsletter:
"There are two economies out there," Mr. Cook, the political analyst, said. "One has been just white hot, going great guns. Those are the people who have benefited from globalization, technology, greater productivity and higher corporate earnings.

"And then there's the working stiffs," he added, "who just don't feel like they're getting ahead despite the fact that they're working very hard. And there are a lot more people in that group than the other group."
The Census report provides a measure of the distance between the two economies. It's the Gini index, a widely-accepted measure of income inequality. Says the report: "Over the past 10 years, the Gini index has increased 4.2 percent (from 0.450 to 0.469)." This index has remained fairly constant in the last couple of years. The Wikipedia article on the index puts this data in context. As the chart reproduced below shows, income inequality in the US is greater than in other industrialized nations and even some emerging economies.
{Click to enlarge. Source.}

The Times article says that Fed Chairman Ben Bernanke sees a risk in this inequality. In a speech given last week he warned that the political fallout could produce an increase in economic protectionism. He's quoted as saying that recent economic changes "threaten the livelihoods of some workers and the profits of some firms," and thus the govenment must try "to ensure that the benefits of global economic integration are sufficiently widely shared."

Where does this set of facts and opinions leave us?

It appears the short-term outlook is good; long-term bad. Here's one of many expressions of confidence about the former. It comes from a blog called Between the Hedges by the manager of a hedge fund. He's talking about the stock market but the scenario applies more widely.
Over the coming months, an end to the Fed rate hikes, lower commodity prices, seasonal strength, the November election, decelerating inflation readings, lower long-term rates, increased consumer/investor confidence, rising demand for US stocks and the realization that economic growth is only slowing to around average levels should provide the catalysts for another substantial push higher in the major averages through year-end as p/e multiples begin to expand.

Longer-term, the US is still at risk for slipping into a recession. The country's deficits restrict the ability of the Fed to manage change. The end of the housing bubble puts a huge number of Americans in financial peril since they have borrowed against the value of their homes to help pay current expenses (such as managing their consumer debt of course). This plus the high cost of fuel and an expected continuation of the slow-down in business activity could produce a substantial decline in the consumer spending that's driving not only the US economy, but much of the global one as well.

Another long-term risk is a financial crisis in China, source of so many of the cheap goods Americans buy. Chinese banks have been lending far too much money to marginally-productive and unproductive businesses (many of them state-owned). Recently Bernanke said the Chinese are expected to correct this problem, but the task is difficult and they may not succeed. (See Can't rule out China hard landing: Bernanke in Yahoo News.)

And finally, there's been no progress in stemming US deficits or dealing with the problems of unfunded mandates (future shortfalls in Social Security and Medicare being the main ones). There's been no progress in stimulating consumption in Europe, Japan, and other wealthy countries to help reduce dependence on US consumption as force behind worldwide economic expansion. There's been no progress in correcting the overvaluation of the Japanese and Chinese currencies against the American dollar. No increase in investment in emerging economies by countries that hold large surpluses. Etc.

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