"Transsexual Economics"
Kudlow to Fed: Tread Lightly
by Lawrence Kudlow
Chief Economist, CNBC.com
CNBC.com Chief Economist Lawrence Kudlow debunks the "scarce labor
resources" paranoia, arguing that wages and prices aren't rising out of control.
Stock prices roared after the release of the 315,000-jobs-increase report last
Friday, despite the chorus of economic sopranos that predicts rapid-fire Fed
moves to raise the key fed funds policy rate by 75 to 100 basis points. How can
this be?
In the Internet economy, rising productivity and profits are more important than
the Fed.
Inside the jobs report was another modest 3.7 percent yearly rise in average
hourly earnings. By inferring strong profits, this triggered the stock rally. Well
before Monday morning's announcement that AOL is taking over Time Warner.
If the latest Fed theory about "scarce labor resources" were really true, then
wages should be soaring. After all, if the supply of something is less than its
demand, then prices will rise. Basic micro-economics, or price theory.
But the price of labor is not soaring. This is because its supply is still adequate
in relation to its demand. Fed officials who doubt this are forgetting about the
roughly 10 million who are still unemployed -- nearly four years' worth of
workers.
---CHART----
Source is Schroder & Co.
Also, immigrants and college graduates continue to refill the labor pool. In fact,
most job-takers are better educated than job-leavers. Better educated also
means more productive. And where education is lacking, American companies
both large and small have instituted significant job training programs.
That's why it's a great country.
This whole "scarce labor resources" argument is nothing more than the Phillips
curve in drag. It's transsexual economics. Everything is upside down. Meaning
no disrespect, but it doesn't work for most people.
Growth doesn't cause inflation. Neither do too many people working, producing
or prospering. Last quarter growth was nearly 6 percent. But inflation was just
above 1 percent.
Actually, rapid growth is the key to understanding why inflation is virtually
non-existent. The availability of more goods and services absorbs the existing
money supply. More money chasing even more goods.
That is why King Dollar still reigns and the gold price is still low. Both are
signaling price stability. There is no excess money.
One of the lesser understood spillover benefits of the Internet economy is the
high rate of investment return that increases the economy's capacity to grow.
Therefore, it reduces the economy's inflationary potential. More goods are
counter-inflationary.
Productivity of course is central to this story. Overall non-farm productivity is
trending around 3 percent. For the non-financial corporate sector the trend is
nearly 4 percent. In manufacturing, the trend is over 5 percent.
So, less than 4 percent wage growth leaves unit labor costs, or
productivity-adjusted wage costs, at just about zero. For old economy
smokestack, manufacturing and basic materials labor costs are actually falling.
Rock-bottom costs from moderate wages and rising productivity are the key to
rising profits. S&P earnings-per-share will probably rise close to 20 percent in
1999 and only slightly less in 2000. This is more important than a few interest
rate nicks from the Fed.
If actual core inflation reports this week come in way above expectations, then
the Fed should tighten policy in early February. I have no problem with that.
Really, in that scenario, they ought to tighten immediately that very day.
But I have a hard time envisioning this outcome because commodity price
indicators have flattened. Even oil is showing weakness. Once the Y2K-related
repos run-off, then monetary base growth (true money supply) will be about
equal to MZM and M2 growth (true money demand).
Message to Fed: leave well enough alone. Go slow. Wait and see. Remember,
enough interest rate increases and the economy will slow markedly.
That's the real risk. Too few goods chasing too much money. History shows
that maximum inflation risk occurs with minimum economic growth. A
slowdown in goods will bring on a speed-up in prices. It is this scenario that is
manifestly to be avoided.
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