January 8, 2007
WAGES TAKE WING
There are an infinite number of trends for Mr. Market to consider, and here's one more: wages are rising at a pace considerably faster than inflation. In fact, the trend has been around for a while. The question: what does it mean?
But first, the numbers. The Labor Department last week reported that average weekly earnings rose 4.5% in December on a seasonally adjusted basis--more than twice the inflation rate of 2.0% over the past year, as reported in November.
The rate of increase in wages is hardly new. Courtesy of number-crunching from NoSpinForecast.com, it's clear that the 12-month rate of change in earnings has been moving skyward for some time. Indeed, the last time that wages were growing a more than 4% annually was in the late-1990s.
With wages growing materially faster than inflation, now's a good time ask (again) is wages contribute to inflation? Economic theory in recent decades suggests the answer is "no." Inflation is a monetary phenomenon and so the buck stops (figuratively and literally) at the desk of the central banks. If inflation finds a head of steam, it is only because the Federal Reserve (and its counterparts around the world) was asleep at the switch.
In theory, rising wages won't increase inflation because an attentive central bank will nip the pricing pressure in the bud. Perhaps more importantly is the market's perception of the Fed's inflation-fighting credentials. If investors believe the Fed will do whatever's necessary to stop inflation, the threat will be contained. In a world where currency is backed by faith rather than gold, perceptions count for much.
By that standard, the bond market remains optimistic that the Fed will keep inflation contained. The fear premium that bond traders demanded in early 2006 when Ben Bernanke took over from Greenspan has retreated. The 10-year Treasury yield is only marginally higher now than when the maestro gave his last performance in January 2006.
Wages, as Bloomberg columnist Caroline wrote today, is a price reflecting the value of labor. Sometimes it rises, sometimes it falls, just as it does for any other commodity or service. Higher wages "can be a symptom of inflation, rising along with the prices of goods and services. But in terms of a driver of inflation, prices lead wages, not the other way around."
What, then, are we to conclude from the rise in wages? The labor market is tightening. Supply and demand has spoken. But while wages may not drive inflation, wage pressures may still influence the Fed's thinking on what constitutes an appropriate price for money.
If wages continue rising at a rate that's faster than inflation, can the Fed continue to keep interest rates steady? We know what economsts would say. How about the FOMC at the Fed? What do they think and, more importantly, how might it influence (informed or not) monetary decisions in 2007 given a labor market that seems inclined to tighten, thereby driving wages higher?
As a potential clue of what the monetary mavens are thinking, we'll quote from the Fed minutes for December 12: "...the possibility that the tightness of the labor market could lead to sustained upward pressure on nominal labor costs was viewed as an upside risk to the expected moderation in inflation."
So, we know that the Fed is keeping an eye on wage trends. One question investors might consider is whether the bond market is pricing in that publicly observed fact.
Posted by jp at January 8, 2007 9:43 AM
You are correct in that rising productivity can offset inflation's corrosive effects. Unfortunately, productivity appears to be slowing, at least if you consider it on a quarterly basis.
Looking at numbers from the Dept of Labor, the output per hour in the nonfarm business sector rose by just 0.2% (relative to the previous quarter at an annual rate) in the third quarter. That's one of the lowest readings in recent years. In this year' first quarter, for instance, output rose by 4.4% and 1.2% in the second quarter. Perhaps the trend will turn up again. But for now, one might want to be cautious on expecting produtivity to save us from inflation.
Posted by: Jim Picerno at January 9, 2007 1:02 PM
No where in your post do you mention the word "productivity". Yet that's the key: with productivity rising, wage growth can exceed inflation without generating inflationary pressures. That's why many analysts focus on unit labor costs, that is, productivity adjusted wages. Granted, there are measurement problems with the most prominent estimate of unit labor costs, but you can always roll your own and get a more reliable series. For example, the emplyment cost index increased 3.3 % over the last 4 quarters, and productivity in nonfarm business rose 1.4 %. Thus an alternate measure of unit labor cost rose 1.9 %, which is line with core inflation.
Posted by: Lowsmoke at January 9, 2007 9:44 AM
We agree with your thoughts on inflation. In fact we now disregard any government figures in this area and do our own rough calculations.
We would put inflation at between 7% and 9% at the moment based on our own crude shopping basket.
It is the specter of higher inflation that compels us to invest in the precious metals arena.
Posted by: Bob at January 9, 2007 6:09 AM