View From a Height
Commentary from the Mile High City
Tuesday, September 28, 2004

Good Economic News? 

Rocketman notes the latest Commerce Department report on personal incomes. The fact that incomes are up everywhere, and accelerating in 2/3 of the country is good news. But it may have only limited economic value, and may end up being bad news of a sort.

One of the persistent qualities of this recovery has been low inflation coupled with rising commodity prices, from oil to steel to timber to rubber. Companies haven't been able to raise prices, though, because of a lack of what's called "pricing power." This means either there's too much competition keeping prices down, or too little free money lying around for businesses to charge more.

The net result has been low inflation, but also lowered expectations for corporate earnings, slower-than-desired hiring, along with slower GDP growth, higher gas prices (and soon, coming to a homestead near you, higher heating oil prices), and recently declining consumer spending. This has also put pressure on corporate earnings estimates, and thus on stock prices.

Hold that thought.

The other funny thing, that seems to be confusing everyone now, but will no doubt be crystal clear after the fact and when it's too late to help anyone, is the bond market. Foreign appetite for US government and corporate bonds has kept money flowing into the economy at levels higher than necessary to feed our trade deficit. This has kept down long-term interest rates, based on supply and demand, and allowed the Fed to raise short-term rates at a leisurely pace.

It's also meant that corporations have had the capital on hand to raise capital investment. We may be seeing some of that start to trickle down to employees and workers.

If this increase in wages is eaten up by rising consumer prices, we'll see a couple of bad effects. First, bonds at current interest rates will be less attractive, forcing down prices and forcing long-term interest rates up. Alternately, businesses may just do without that foreign investment, and cut back on CapEx. The Fed may also believe it has to increase the pace of its rate raises, both to bolster the dollar and to try to kill inflation. This risks cutting off the recovery just as it's starting to gather steam.

There's no reason to think that we're headed for another round of late '70s stagflation. For one thing, there's nothing in the money supply that would allow us to start spiraling upwards. The more likely effect is that any slack that we do see will just be eaten up before it gets a chance to do much good.

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