Doug Noland, with a WHOPPER of a credit bubble bulletin in tonight's "Prudent Bear", discusses rampant wage inflation and its implications for the bubble in general:
prudentbear.com
Not even a holiday shortened week could temper wild stock
market volatility. The Semiconductors, for example, jumped 4%
on Monday, dropped 9% on Wednesday, only to bounce back
with 4% gains both yesterday and today. Today, indicative of
unusual trading and despite all the talk of an economic
slowdown, the S&P Retail Stores index surged 8%. For the
week, the AMEX Biotech index surged 10%, increasing its
year-to-date gain to 85%. Also for the week, the Dow and
S&P500 gained about 1%. The Transports added 3% and the
Utilities 2%, while the Morgan Stanley Consumer and Morgan
Stanley Cyclical indices had slight advances. The small cap
Russell 2000 added about 1%. The NASDAQ100 increased 1%,
although the Morgan Stanley High Tech index had a slight
decline. The Semiconductors dropped about 2%, while The
Street.com Internet index sank 5%. The financial stocks rallied
strongly, with the S&P Bank and Bloomberg Wall Street indices
jumping 4%.
The gold stocks dropped 4% as gold sunk about $7. Crude oil
declined $2.22, leading to a significant decline in the commodity
indices. The CRB index dropped 2%, and the Goldman Sachs
Commodity index declined 4%. The credit market rally
continues, with 2 to 10-year yields falling between 7 and 8 basis
points. The key 10-year yield declined 3 basis points. With
spreads continuing to narrow, the implied yield on the agency
futures contract sank 10 basis points. For the week, the
benchmark 10-year dollar swap narrowed 7 basis points, while
mortgage spreads narrowed about 5. The yield on the
benchmark Fannie Mae mortgage-back dropped 7 basis points
to 7.82%.
“The wavelike movement affecting the economic system, the
recurrence of periods of boom which are followed by periods of
depression, is the unavoidable outcome of the attempts,
repeated again and again, to lower the gross market rate of
interest by means of credit expansion. There is no means of
avoiding the final collapse of a boom brought about by credit
expansion. The alternative is only whether the crisis should
come sooner as the result of a voluntary abandonment of further
credit expansions, or later as a final and total catastrophe of the
currency system involved.” Ludwig von Mises, Human Action
“What matters is that there is an inflow of newly created credit. If
the banks grant more credits to the farmers, the farmers are in a
position to repay loans received from other sources and to pay
cash for their purchases. If they grant more credit to business
as circulating capital, they free funds which were previously tied
up for this use. In any case they create an abundance of
disposable money for which its owners try to find the most
profitable investment. Very promptly these funds find outlets in
the stock exchange or in fixed investment. The notion that it is
possible to pursue a credit expansion without making stock
prices rise and fixed investment expand is absurd.” Ludwig von
Mises, Human Action
Second quarter leveraged bank loan syndication numbers are in
from Security Data Corp. Bank of America jumped into first
place, arranging 228 loans totaling $42.9 billion. Chase
Manhattan, the perennial leader in high-risk credits, dropped to
second place with 122 loans totaling $37.2 billion. Due to a
slowdown in mergers, total leveraged lending declined about
4% to $177.7 billion during the first half; not much of a pullback.
Meanwhile, with liquidity returning to the credit market, the junk
bond sector is once again getting geared up to sell paper.
Apparently, the amount of junk deals in the pipeline has surged
to about $40 billion, nearly double the low established in March.
At the same time, the most recent Bloomberg listing of bank loan
syndications are certainly indicative of a return to aggressive
lending, with $34 billion new offerings posted last week.
And while our view certainly flies in the face of conventional
analysis, we believe that the recent sharp decline in interest
rates is strong evidence of the continued failure of Federal
Reserve policy. Despite spots of tempering demand, global
growth is accelerating and the US economy remains desperately
overheated. As such, our analysis sees heightened inflationary
pressures that require both higher market interest-rates, as well
as a significant reduction in credit availability; only this
combination will engender the curtailment of demand necessary
to ward off escalating inflationary imbalances.
However, the Greenspan Fed founders as it “fights the last
war.” After the tightening cycle in 1994 – with a near debacle in
the credit market/leverage speculating community – the Fed has
found it preferable to ensure heightened system liquidity while
moving to raise the cost of short-term borrowings only
marginally. Apparently, the timid Fed sees it expedient to
pamper Wall Street and the markets. And, likely, it views this
strategy as its best hope for orchestrating the coveted
soft-landing. Instead, this policy only guarantees a greater
debacle down the road. And while the overheated economy
cries out for a dramatic tightening of credit conditions, Fed
policy is not a monetary tightening at all. By accommodating
heightened liquidity, while cautiously managing rates, this only
provides the green light for perpetuating systemic financial and
economic excess. Unbelievably, and much to the satisfaction of
the over zealous and drunken financial sector, the Fed keeps the
party going with a full (somewhat less potent?) punchbowl.
Last week we highlighted the historic real estate bubble that
runs out of control in California. Indeed, we see the Golden
State as a bastion of inflationary pressures. And like other
trends from this most-influential state, inflationary pressures will
continue to fan out throughout the rest of the country. For years
the US labor force has been rightfully praised for its
extraordinary mobility. Now we will see how this mobility can
also be a disadvantage for the economy, as it fosters the rapid
transmission of wage pressures around the country. In many
respects, we don’t think one can overstate the role of the Golden
State in the present U.S. bubble. Indeed, from the most recent
available GNP data, California would have ranked as the 8th
largest country, just below China but above Brazil, Canada, and
Korea. Almost 1 in 5 dollars of Fannie Mae’s mortgage exposure
to real estate in California, and the financial sectors total
exposure to California credits is truly massive. Furthermore,
California has also traditionally led the country in political trends.
With this in mind, it is worth noting that last week California
governor Gray Davis signed the states $95 billion budget for
next year. This budget, reportedly, calls for a stunning 18%
increase in spending over the current budget. According to
local papers, the budget is “packed with pork.” From the SF
Chronicle, quoting an assemblyman, “It’s completely out of
control. The governor has become Santa Claus for every
legislator with visions of boondoggles dancing in their heads.”
Outside of what we would consider “pork,” the budget includes
a 16% increase in rates paid to doctors caring for the poor.
According to the San Francisco Chronicle, the new budget
includes “more than $2.4 billion in incentives for teachers,
students and school administrators, including higher starting
pay and better benefits for educators…the state is trying to
attract and keep quality teachers to meet its demand for 300,00
more teachers over the next decade…” It is not that we have an
issue with how California is spending its huge current revenue
windfall, but we do view as significant the trend of aggressive
spending programs developed in state capitals from
Sacramento to Albany, as well as Washington D.C., both for
fueling a continued economic bubble, and with increasingly
problematic inflation.
The new California budget provides wage increases throughout,
including 12.5% pay increases for Superior Court judges. And
since Los Angeles City and County council salaries are tied to
judges’ pay, this 12.5% increase will be added to the 6.5% pay
increase these public servants received less than one year ago.
Throughout California and the nation, strong revenues allow
municipalities to increase wages for its employees. Even
Orange County, bouncing back from bankruptcy, recently
passed a budget with “sweeping pay raises” for its 4,200
employees, “including hefty increases of up to 19%” for top
officials, according to the LA Times. Reorganization at the Los
Angeles Unified School District is “significantly raising the
salaries of top executives, with the new superintendent and top
department heads seeing salary increases of between 30% and
40%.” Last month the sheriff, public defender and Orange
County counsel received salary boosts of $20,000. In Anaheim,
firefighters recently won a 15% pay increase in arbitration. We
could go on and on.
At the University of California, clerical workers are demanding an
11% raise. In Oakland, teachers just agreed to a new pay
package that provides an immediate 4.8% pay increase, with an
additional 13% this fall, and 5% more next year. Teachers from
the San Francisco Unified School district are currently asking for
a 30% pay increase. San Francisco has already agreed to build
new subsidized housing for teachers that have been priced out
of the housing market. Striking examples of wage inflation are
certainly not limited to California. Recent reports have Long
Island policemen receiving 20% increases, as police forces
across the country fight to fill vacant positions. New York City,
in particular, is struggling to retain policeman, teachers,
administrators and government employees generally. There is
overwhelming evidence that municipalities and businesses
throughout the country are finding it increasingly difficult to
retain necessary manpower. We sense that current wage
pressures are the strongest in many years, and if this
environment continues to be accommodated by money and
credit excess there will be an inflation shock.
What began as wage inflation for CEOs and corporate
executives, technology employees, Wall Street professionals,
pro athletes and entertainers, has made its way to nannies, fast
food servers and janitors. From San Francisco, Seattle, New
York and Boston, wage pressures have made their way to
Baltimore, Cleveland, Milwaukee, Wichita and Buffalo. All the
same, today we had another “weaker than expected” report from
the Labor Department. And despite the bulls’ wishful contention
that this is more solid evidence of an imminent “soft-landing,”
the June report did show businesses adding 260,000 jobs after
May’s mysterious decline of 165,000. The available labor pool
declined to 9.8 million, a 30-year low. Hourly earnings increased
.4% and aggregate hours .3%. Incredibly, government data
continue to put annual wage inflation at only the 3.5% range.
Recently, the Financial Times ran a story, “Law Wars in San
Francisco Dotcom Start-Ups – Law Firms Have Been Forced to
Double Salaries to Stop Attorneys Quitting.” The article began
by highlighting the fortunes of a recent law school graduate who
saw his starting salary increase by $30,000 to $125,000 even
before graduation. His “unsolicited raise is part of what is now
commonly known in the US legal profession as the ‘Gunderson
effect.’” This is a particularly interesting example, unmistakably
demonstrating how wages (among other things) are an
inflationary tinderbox waiting for a spark.
“It began when Gunderson Dettmer Stough Villenueve Franklin
& Hachigian, a small Silicon Valley firm that had lost 10
associates to internet start-ups in 1999, announced in December
it was raising salaries across the board by 45% to prevent
mid-level associates from going to dotcoms. Within a month, a
national salary war ensued among law firms in San Francisco as
well as ones in New York, Washington and Chicago.”
From a Boston Globe article during this period: “This week’s
news that starting salaries for associates at some local law firms
will range from $125,000 to $150,000 this year has shocked
Boston’s legal community…What began Monday as a rumor
turned into fact when Testa, Hurwitz & Thibeault announced it
had raised first-year associates pay to $140,000 per year, a 40%
increase over 1999 rates. A day later, Hale &Dorr said it had
increased new associates salaries from $100,000 to $125,000,
with a maximum bonus of $30,000. Soon enough Skadden Arps
Slate Meagher & Flom noted that it, too, had raised starting
salaries from $107,000 to $140,000, excluding bonuses. In a
state where the median annual income for lawyers was $62,000
in 1998, the initial buzz over the soaring salaries has grown to a
roar…Much of the furor began several weeks ago when
California firms raised their base salaries to $125,000 to retain
young talent.”
Last month, from the Pittsburgh Post-Gazette, “When Michael
Zanic began his law career at Kirkpatrick & Lockhart in 1989 he
earned $54,000 in his first year. Now, as a hiring partner, he’s
promising lawyers $100,000…Area law firms can thank Silicon
Valley for the soaring level…” An Associated Press story began,
“For his job as the nation’s top-ranking federal judge, Chief
Justice William H. Rehnquist earns $181,400. Yet his own law
clerks could beat that salary next year simply by joining a major
law firm…Federal judges are not amused.” This situation is
noted as an example one of a myriad of distortions popping up
in our distressingly imbalanced economy.
And while the spark my have been ignited by the Internet and
Silicon Valley bubble, it now spreads like wildfire from law
school graduates to undergraduate English majors. Today, the
National Association of Colleges and Employers (NACE)
released the results of their latest national survey of starting
salaries. “We’re seeing substantial increases in starting salary
offers for all types of students,” says Camille Luckenbaugh,
NACE employment information manager. “Not only are
engineering and computer science grads getting big offers, but
students in the business disciplines are doing exceptionally
well, and liberal arts graduates are also seeing significant jumps
in their average offers.” According to the NACE national survey,
information system graduates are seeing starting salary
increases of almost 11% above 1999; computer science 10%;
computer engineering grads almost 10%; electronic engineers
8%; and industrial engineers 6%. Beginning pay for business
administration grads has jumped almost 7%, accounting 7%,
and marketing 5%. “Although media attention has focused on
the job market for graduates with technical degrees, the current
economy has also been good to liberal arts grads. For example,
the average offer to English language and literature graduates is
up a whopping 10.5%…political science/government graduates
are also getting extraordinary increases: Their average offer has
leaped 11.8%…Consulting firms, one of the top employers of
new college graduates, have helped push up the average offer
to history graduates by 9.5%…”
Moreover, it should be recognized that this is not a one-year
phenomenon, as can be gleaned with a look back to the NACE
report from 1999. “The class of ’99 enjoyed a good year, thanks
to the economy and tight labor market…overall, recruitment
activity was strong and steady, and starting salaries for many
graduated increased substantially. However, this year wasn’t
marked by the frenetic pace we saw a year ago, when starting
salary offers were spiraling into the double digits in some
cases.”
More corroboration of the extraordinary tight labor market came
today from placement firm Challenger, Gray and Christmas,
complements of Market News International.
“While some interpret government labor data as showing signs
of loosening, they apparently failed to talk with desperate human
resource executives who spend their days scouring the nation
for skilled workers. The labor shortage may in fact be worse
than it was even a few months ago. “ According to Challenger,
Gray and Christmas, layoffs during the month of June fell to a
17,241, a decline of 73% from a year ago, to a 36-month low.
Year-to-date, layoffs have dropped 42% from last year.
And while the unrelenting spin from the “New Paradigm” crowd
will somehow be that obvious wage pressures will not lead to
higher general inflation, there is increasing evidence quite to the
contrary. Numerous anecdotes of rising prices are now
supported by a lengthening list of surveys and indices
indicating rising inflation. Yesterday’s Wall Street Journal
“Business Bulletin” column ran the headline, “Going Up? More
companies expected to raise prices in the months ahead.” This
data should be quite alarming to both the Fed and the financial
markets. According to a survey of 221 companies by the
Financial Executives Institute and Duke University’s Fuqua
School of Business, “Nearly 75% of corporations plan to raise
prices an average 4.7% in the next 12 months…” Recent polling
demonstrated “a progressive willingness to raise prices.” For
comparison, last year’s survey had 60% of firms expecting to
raise prices by 1.3%. Six months ago, 71% planned to increase
prices by 3.1%. No matter what the spin, pricing power is back,
and inflation psychology is festering. Also today, the Economic
Cycle Research Institute reported that its June report on inflation
increased from May and remains only slightly below the 11-year
high established in April. Quickened job growth was sighted as
adding to expected rising inflation.
Admittedly, with the financial sector expanding credit
aggressively, liquidity has returned to the credit system, at least
for now. Capital markets are once again increasingly
accommodating security issuance, extraordinary bank lending
growth runs unabated, and the GSEs are apparently back in the
credit excess game. And, of course, the bulls will celebrate and
dream of soft landings. The truth of the matter is, unfortunately,
that the present course is headed squarely toward the
worst-case scenario. Extraordinary pricing disturbances,
previously isolated to stock prices and Internet companies, for
example, are being accommodated by reckless money and
credit excess. In what is truly a charade of price stability, we are
at the stage of a long period of excess where money and credit
growth will now feed directly to higher prices, severe economic
distortions and continued disastrous trade deficits – evidence of
which is in great abundance already! And, as has always been
the case, inflation begets only higher inflation. The longer the
Fed allows this unhealthy boom to endure, the more devastating
the impact. Repeating the great words of wisdom from Mises,
“There is no means of avoiding the final collapse of a boom
brought about by credit expansion. The alternative is only
whether the crisis should come sooner as the result of a
voluntary abandonment of further credit expansions, or later as
a final and total catastrophe of the currency system involved.” |
