Tag Archives: inflation

Conflated Issues Inflated Fears

Inflation chart cause

There’s fear, right here in the outback, that raising the minimum wage will drive up inflation.  The Humboldt Sun (Sept. 18, 2015 p3)  includes a long LTE titled, “$15 minimum wage would stimulate inflation.”   The author writes:

“The government requires businesses to pay employees more by passing minimum wage legislation. This increase is not because workers are more productive, so it costs more to produce goods and services. Businesses might lay off workers to bring down labor costs, but that results in less output. Ultimately, they must raise the cost of consumer goods.”

Conflation

There are several macro-economic concepts mashed into this, but let’s assume that the writer is speaking of the form of inflation diagrammed in Chart 2 above, “Cost-Push Inflation,”  defined as follows:

Cost-push inflation … occurs when prices of production process inputs increase. Rapid wage increases or rising raw material prices are common causes of this type of inflation. The sharp rise in the price of imported oil during the 1970s provides a typical example of cost-push inflation (illustrated in Chart 2). Rising energy prices caused the cost of producing and transporting goods to rise. Higher production costs led to a decrease in aggregate supply (from S0 to S1) and an increase in the overall price level because the equilibrium point moved from point Z to point Y. [SFFRB]

Cost-Push inflation might be presented as the Inflation Monster, IF it were the only kind of inflation possible – it isn’t.  There’s also Demand-Pull.  And we return to the San Francisco Federal Reserve for its basic definition:

“Demand-pull inflation occurs when aggregate demand for goods and services in an economy rises more rapidly than an economy’s productive capacity. One potential shock to aggregate demand might come from a central bank that rapidly increases the supply of money. See Chart 1 for an illustration of what will likely happen as a result of this shock. The increase in money in the economy will increase demand for goods and services from D0 to D1. In the short run, businesses cannot significantly increase production and supply (S) remains constant. The economy’s equilibrium moves from point A to point B and prices will tend to rise, resulting in inflation. [SFFRB]

And how does a central bank increase the supply of money? Monetary policy.  The textbook way, prior to September 2008, was that if the opportunity costs for holding noninterest-bearing bank reserves was the nominal short-term interest rate (federal funds rate), then we’d have a situation in which if the funds rate were low the quantity of reserves banks would want to hold would increase. [SFFed]  Note: the banks have an interest in putting reserves to work by lending them.  If a bank found itself with “excess” reserves the obvious thing to do would be to find borrowers and earn a return on the money. Thus the situation wherein the cost to the banks of borrowing money is essentially zero, in a post 2007-08 effort to support the financial markets and kick-start the economy.  Now what?

Why hasn’t there been some awesome Demand-Pull Inflation?  Monetary Policy. The situation has changed, although few outside the financial commentators have paid much notice.

“The change is that the Fed now pays interest on reserves. The opportunity cost of holding reserves is now the difference between the federal funds rate and the interest rate on reserves. The Fed will likely raise the interest rate on reserves as it raises the target federal funds rate (see Board of Governors 2011). Therefore, for banks, reserves at the Fed are close substitutes for Treasury bills in terms of return and safety. A Fed exchange of bank reserves that pay interest for a T-bill that carries a very similar interest rate has virtually no effect on the economy. Instead, what matters for the economy is the level of interest rates, which are affected by monetary policy.” [SFFed]

If Demand-Pull inflation is corralled by monetary policy which is based on the Federal Reserve now paying interest on reserves, doesn’t this argue against raising wages which will increase unit costs of production and hence raise consumer prices?  Not necessarily.

The author of the LTE maintains: “The Federal Reserve has held interest rates at near 0 percent for several years. Some claimed cheap loans would stimulate the economy. The problem is that banks have been fiscally conservative, with few loans and little interest rate to savers.”

A crucial part of this puzzle is the press release from October 6, 2008 from the Federal Reserve stating:

“The Federal Reserve Board on Monday announced that it will begin to pay interest on depository institutions’ required and excess reserve balances. The payment of interest on excess reserve balances will give the Federal Reserve greater scope to use its lending programs to address conditions in credit markets while also maintaining the federal funds rate close to the target established by the Federal Open Market Committee.”

Yes, the interest rate remained low, but the banks with excess reserves on hand had less incentive to loan out those reserves if they could simply leave them on the books and earn interest.  The Financial Services Regulatory Relief Act of 2006 allowing this situation  [S 2856 109th] was quite generous to the bankers, such as section 201 which “(1) authorize payment of interest on funds maintained by a depository institution at a Federal Reserve bank; and (2) authorize the Federal Reserve Board to reduce to 0% the reserves required to be maintained by a depository institution against its transaction accounts. (The current requirement ranges from 3% to 14%.)” [GovTrack]

While the Federal Reserve makes a nice scapegoat for those who believe in broader extensions of consumer credit, it really doesn’t do to belabor its role (or lack thereof) in stimulating the consumer end of the economy when Congress provided the vehicle by which the wall between brokers and bankers was breached (Title 1, Section 101) and compounded the issue by enacting authorization for banks to sit on reserves in order to earn interest (Title 2, Section 202).

And, here’s where the LTE author swims in shark territory – a monetary policy which encourages broader consumer lending would also be a factor in the creation of Demand-Push inflationary pressures.  A person really can’t have it both ways.

How much is too much?

There are, in both fact and theory TWO forms of inflation.  Nor can we assume that inflation is always a bad thing.  Most economists like an inflation rate of just under 3%. [Investopedia]  Why? Because the alternative – deflation —  is even worse.  During deflationary periods workers get laid off, consumers spend less, people hold off major purchases believing prices will fall further, and the spiral continues – downward.

Consumer Price Index 2005 to 2015 The blue line includes items like energy/food which are inherently more volatile, the line for all others shows a fairly consistent rate of inflation right around the 2.5% mark – remember 3% is the economist’s ideal. It’s also useful to note that the wide variances occur between January 2008 and January 2010 – when the U.S. economy was trembling before and  in the wake of the financial crash.

Consumer Price Index chart If fact, before we become too alarmed by inflationary trends we might want to take a look at the column highlighted above from the Bureau of Labor Statistics, and note that we are well below that 3% threshold.  In other words, it’s time to stop worrying excessively about inflation – both forms – and start being concerned with why wages and salaries have tended to stagnate over the past thirty years?  [Pew]

“…after adjusting for inflation, today’s average hourly wage has just about the same purchasing power as it did in 1979, following a long slide in the 1980s and early 1990s and bumpy, inconsistent growth since then. In fact, in real terms the average wage peaked more than 40 years ago: The $4.03-an-hour rate recorded in January 1973 has the same purchasing power as $22.41 would today.” [Pew] see also: [EPI]

Our local author is still alarmed, “Recent price spikes are more noticeable than the usual gradual increases.  That naturally leads to call for a minimum wage increase. But if granted, the inflation cycle will begin again.”  To which we’d have to ask:

  • What recent price spikes? The annual inflation rate as calculated by the BLS Consumer Price Index, the figures the economists use, has been less than 2.5% since 2006.  Further, the prices of gasoline has dropped from about $4.11 in July 2008 to $2.73 as of August 2015. [EIA]
  • If not those phantom price spikes, then what else could raise the call for an increase in the minimum wage?  The trends in stagnant wages and salaries?
  • What inflation cycle?  The annual increase in inflation hasn’t risen above 2.5% since 2006 and 3% is the threshold used by most economists to determine a “significant” increase.  During five of the last ten years we’ve experienced inflation of less than 2%.
  • However, let’s not assume that the author is referring to the here and now but to the ubiquitous “awfulness to come somewhere down the road about which we should be terribly alarmed.”  Is there anything in the statistical tables indicating that an increase in the federal minimum wage would yield inflation rates in excess of traditionally  held economic standards?  Given that the federal minimum wage has been raised 22 times since first authorized in 1938, has there been any drop in the real GDP per capita in the last 75 years? (Hint: no)

If it’s not consumer spending driving an inflation cycle in the modern economic environment – what is?  There is something about which we ought to be worried, but it’s not your father’s inflation cycle – it’s the climate created by the financialists:

“Both gross and net business debt have continued to rise since 2007, but the proceeds have been almost entirely recycled into financial engineering—including more than $2 trillion of stock buybacks and many trillions more of basically pointless M&A deals.

This diversion of the $2 trillion gain in business debt outstanding since 2007 to financial engineering is owing to the near zero after-tax cost of corporate debt. The latter has caused the enslavement of the C-suite to the instant gratification of rising share prices and stock options value in the Fed’s Wall Street casino.” [ZeroHedge]

Not to put too fine a point to it, but the brakes will be applied to any inflationary pressure by the bursting of the next financial bubble.

References and Sources: Federal Reserve Bank of San Francisco, “What are some of the factors that contribute to a rise in inflation?’ October 2002.  John C. Williams, “Economic Research: Monetary Policy, Money, and Inflation,” Federal Reserve Bank of San Francisco, Economic Letters, July 9, 2012.  Bernard Shull, “The impact of financial reform on Federal Reserve Autonomy,” Levy Economics Institute of Bard College, working paper 735, November 2012. (pdf)  Douglas Rice, “Inflation: It’s a Good Thing,” Investopedia, May 22, 2009.  Bureau of Labor Statistics: Consumer Price Index, 12 month percentage change. (2015) “For most workers wages have barely budged for decades,” Pew Research Center, October 9, 2014.  EPI, wage stagnation in nine charts, January 6, 2015.  CBPP, “A guide to statistics on historical trends in Income Inequality,” revised July 15, 2015.  L.E. Hoglund, “Gasoline prices: cyclical trends and market developments,” Beyond the Numbers, BLS, May 2015. (pdf) EIA, “Petroleum and Other Liquids: Retail Prices all grades and formulations, August 2015.  Department of Labor, “Minimum Wage Mythbusters.”  CNN, “Minimum wage since 1938,” interactive graphic.  “Meet the New Recession Cycle,” Zero Hedge, April 4, 2015.

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Filed under Economy, financial regulation, income inequality, Minimum Wage, Nevada politics, Politics

Profits Without Prosperity

If there’s just one item which ought to be remembered from Vice President Biden’s recent  speech in Las Vegas it’s this – If the minimum wage were to be raised to $10.10 per hour this would add $19 billion into the national economy.  For 256,000 minimum income earners in Nevada that would pay for 19 months of groceries and three months worth of rent.  [LA-AP] So, if we really are “pro-business” then this information should be well received?

Once yet again to the point of unmentionable redundancy, here’s how we measure the growth in our national economy:

GDP formula

Consumer spending + business spending + government spending + the difference between imports and exports = the GDP.  So, why all the gnashing of teeth and tearing of hair over spending?  Why not promote that which will increase consumer spending? And why the inordinate attention to national spending?   Because the tail is wagging the dog.

The titans of finance – the banking sector – are wary of inflation.  That which puts more money into the hands of middle and working class families may cause inflation – the banker’s big bug-bear.  However, they’ve not mentioned the other side of the ledger; if income levels are dropping or if they remain stagnant those same bankers might be looking at deflation.  “The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression. Central banks attempt to stop severe deflation, along with severe inflation, in an attempt to keep the excessive drop in prices to a minimum.”

In other words, for average families the income will be spent.  Increasing the minimum wage would put more money into local businesses – furniture, appliances, groceries, clothing, entertainment, food service, hardware and home improvement, and so on.  However, for the top .01% whose income is primarily derived from investment earnings, increasing the minimum wage is of relatively little interest.  They are more interested in The Market (read Stock Market) than in the grocery market, the furniture market, the home improvement market, or the clothing market.

Not sure how this works?  Witness the plans for Hewlett-Packard to split up:

A close follower of the company’s stock price, Ms. Whitman may have also decided that the two separate companies would be worth more on Wall Street. Since Ms. Whitman became chief in September 2011, HP shares have risen about 50 percent. [NYT

HP also confirmed the split will result in the loss of another 5,000 jobs, in addition to the 45,000-50,000 layoffs announced with the company’s second quarterly earnings report for 2014 back in May. HP plans to invest the money saved in research and development, and projects full year non-GAAP (Generally accepted accounting principles) earnings of $3.83-$4.03 per share in 2015, not including one-time tax costs of the split. The companies will each have more than $57 billion in annual revenue.” [SDTimes]

There are structural reasons for the split, but the bottom line is that investors have decided the corporation would be more profitable split into at least two entities. And those 5,000 jobs lost?  The layoffs announced in May 2014?  The Market won’t be bothered by those at all; the value of the stock will increase whether or not the former employees are able to find new jobs, or have money to spend on housing, food, clothing, entertainment, furniture, etc.   The value of the stock is the pinnacle of success in the “Shareholder Value” construct of modern American capitalism.  There’s really nothing dramatically new about this – when share value for the sake of share value becomes the primary force in management then other considerations are necessarily secondary.

Hewlett-Packard’s focus on shareholder value isn’t unique either. Remember how the old Trickle Down Hoax was supposed to work? Corporations were supposed to have more revenue to invest on research and development, more to spend on expansion and hiring, more to spend on marketing and product sales?  Not. So. Much.

“Instead of investing in new plants, equipment and products, instead of paying their taxes and giving a long-overdue raise to their employees, big corporations are spending their record profits — plus gobs of newly borrowed money — to buy back their own shares and those of other companies.” [WaPo May 2014]

And we’re not speaking of just a few corporations, and the arithmetic is fairly simple:

“Meanwhile, the corporations of the Standard & Poor’s 500-stock index spent $477 billion last year (2013)  buying back their own shares, a 29 percent increase over 2012 and the most since the peak year of 2007. The idea behind buybacks is that they are a tax-advantaged way to return profits to shareholders by boosting the market price of their shares. Since the stock market tends to value companies by multiplying the profits per share times the number of shares, reducing the number of outstanding shares has the arithmetic effect of boosting the stock price. [WaPo May 2014]

During 2013 this “tax advantaged way to return profits to shareholders” was applied by 80% of the companies on the S&P 500.  This is precisely how Wall Street and the Corner Offices can see profits without prosperity. What we need to observe is the interplay between value creation and value extraction.  The Harvard Business Review explains:

“For three decades I’ve been studying how the resource allocation decisions of major U.S. corporations influence the relationship between value creation and value extraction, and how that relationship affects the U.S. economy. From the end of World War II until the late 1970s, a retain-and-reinvest approach to resource allocation prevailed at major U.S. corporations. They retained earnings and reinvested them in increasing their capabilities, first and foremost in the employees who helped make firms more competitive. They provided workers with higher incomes and greater job security, thus contributing to equitable, stable economic growth—what I call “sustainable prosperity.”

This pattern began to break down in the late 1970s, giving way to a downsize-and-distribute regime of reducing costs and then distributing the freed-up cash to financial interests, particularly shareholders. By favoring value extraction over value creation, this approach has contributed to employment instability and income inequality.”

Does that last sentence sound familiar?  So, we know that stock buybacks were popular as of 2013, how about 2014 – it’s now reported (Bloomberg) that 95% of the S&P 500 have engaged in the activity – of value extraction rather than value creation.   The Economist chimes in on the subject:

“Over the past 12 months American firms have bought more than $500 billion of their own shares, close to a record amount. From Apple to Walmart, the most profitable and prominent companies have big buy-back schemes (see article). IBM spends twice as much on share repurchases as on research and development. Exxon has spent over $200 billion buying back its shares, enough to buy its arch-rival BP. The phenomenon is less extreme in other countries, but is becoming popular even in conservative corporate cultures. Led by firms such as Toyota and Mitsubishi, Japanese companies are buying back record amounts of their own shares.”

Yes, stock buybacks can artificially elevate share prices, and give quick bucks to the short term investors.    Someone needs to flash on a yellow caution light.

“In 2013, 38% of firms paid more in buy-backs than their cashflows could support, an unsustainable position. Some American multinationals with apparently healthy global balance sheets are, in fact, dangerously lopsided. They are borrowing heavily at home to pay for buy-backs while keeping cash abroad to avoid America’s high corporate tax rate.” [Economist]

Yet when we have a corporate compensation system which rewards share value why would the CEO of Hewlett-Packard, or IBM, or any other major corporation NOT focus on share prices? Even if they are in peril of having lopsided ledgers. Even if they are extracting more value than they are creating?  Even while they are avoiding America’s corporate taxes? The GAO calculates the actual tax rate paid by these corporations at 12.6%. [CNN]

So, instead of creating value (building new plants, new equipment, new products, paying taxes, or raising wages and salaries) the companies are busy trying to extract value at the risk of making themselves uncompetitive. The financialists, focused as they are, on short term investments, in debt incrusted corporations, are far more interested in value extraction than in value creation, and that’s how we get profitability without prosperity.

Capitalism requires value creation, a balance of consumers and producers, and the accumulation of assets. Financialism is focused on value extraction, feeds on the notion that one firm’s debt is another M&A firm’s asset, and demands that “costs” whether for plant upgrades, employee wages, or research and development not impinge on the “tax advantaged ways to return profits to shareholders.”   The Economist closes the argument: “shareholder capitalism is about growth and creation, not just dividing the spoils.”

The creation of value means investing in more products, better products, more goods, better goods, more services, better services – and now we’re back to the point at which we need to restart the conversation about how to increase aggregate demand for these goods and services – by increasing the minimum wage.

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Filed under Economy, financial regulation

Nevada’s Job Trap and the Minimum Wage

The Nevada employment report was encouraging last round. [DETR] Remember when the press release read:

“Total employment in Nevada’s economy is projected to grow by about 61,000 jobs through 2015 to reach an average of 1,218,700; this represents a 5.3 percent increase. Specifically, growth rates of 2.5 percent for 2014 and 2.7 percent for 2015 are expected. Some of the fastest projected growth will occur in accommodation and food services, construction, and retail trade.  Together these three industries are expected to account for over 55 percent nearly 34,000 of all new jobs during this period, Anderson noted.”

This almost mirrors the latest commentary from the Bureau of Labor Statistics on the jobs report.

Total nonfarm payroll employment rose by 288,000, and the unemployment rate fell by 0.4 percentage point to 6.3 percent in April, the U.S. Bureau of Labor  Statistics reported today. Employment gains were widespread, led by job growth in professional and business services, retail trade, food services and drinking places, and construction.

If we are projected to see jobs increase in (1) accommodation and food service, (2) construction, and (3) retail trade, then what does the current debate about raising the federal minimum wage tell us about the capacity for economic growth in Nevada.

Specifically, the median annual income for a person working in a retail clothing store in Nevada is $21,660.  An employee in a grocery store can expect $23,560 median annual earnings.   A worker in a sporting goods store?  He or she can expect median annual earnings of $21,420. [DETR]    The  median annual earnings number for wait staff in the accommodation/food service category is $19,310. [DETR]  The median hourly wages for construction workers? About $16.40 per hour.

Not to put too fine a point to it — BUT when 55% of the employment growth in the state is projected to occur in jobs which don’t often pay a living wage, then the state is asking for trouble.  Either the wages have to improve, or the state has to pick up more of the slack to insure people aren’t falling into unsustainable poverty conditions in which they can’t afford housing, adequate food, and basic utilities.

One of the sputtering arguments against raising the minimum wage is the Inflation Argument.  Gee, if we raise wages then things will just cost more and if they do then the increase won’t be meaningful and “won’t solve the problem.”   What problem?

The Inflation Argument is the essential position of the banking sector.  No inflation is good inflation.   The old saw said debtors liked inflation, while bankers (creditors) preferred stability or deflation.  If our “problem” is that we don’t have enough economic growth (read: more aggregated demand for goods and services) then there are some ideas which need more examination, beyond the recitation of old truisms.

What happens, for example, when the level of deflation is such that it actually increases the burden of the debt and reduces the cash flow necessary to service that debt?  The obvious answer is that the debt becomes uncollectable.  People declare bankruptcy. People down-size their living arrangements; people avoid major expenditures in housing, goods, and services.  That’s not a way to grow an economy — at the state or federal level.

Another notion which hasn’t been explored very often is that during periods of stagnation it makes some sense for enterprises to sit on their cash.   If, however, an industrial or commercial business believes that there is some likelihood of moderate inflation, then the decision to spend money now as opposed to waiting until “things” get more expensive kicks in.

Would we come closer to solving our “employment problem” if commercial and industrial businesses expected that a moderate level of inflation would mean they could get more for their expansion or upgrading money now, as opposed to waiting?

The second sputter often sounds something like — but, but, but do we want the government determining the value of a worker’s labor? Shouldn’t the “market” do that?  This is lovely at the ideological and theoretical level, but doesn’t exactly provide a road map for Nevada business enterprises.

If our sporting goods store employee can expect $21,420 annually, but there is no ‘floor’ under that median, then if there is no minimum standard how do we prevent a race to the bottom, a race in which the big box stores reduce wages to the lowest possible common level?  If there is competition based on who can reduce prices by reducing wages, then where does this stop?  A related question is: At what point does the sustenance provided by the state for the protection of general living conditions become a subsidy for the corporate employers?  Barry Ritholtz’s article for Bloomberg News, “How McDonalds and Wal-Mart Became Welfare Queens,” illuminates this issue.

If there is a state in this union which could benefit from an increase in the minimum wage it’s Nevada, with its projection of most employment rising in retail, accommodation/food service, and construction.  Further, if the inflation argument is demonstrated to be informed by economic feedback from inflationary pressures, and in the real world there are benefits to be gained from moderate inflationary pressures, and if we do not want to create a situation in which major employers are subsidized by taxpayers, then it’s time to support setting the minimum wage to at least $9.80/hour, or $10.10 — or what about $15.00?

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Filed under Economy, Nevada economy, Nevada politics, Politics