SHI Update 4/12/17: Chickens and Eggs

SHI Update 4/5/17: Consumer Spending
April 5, 2017
SHI Update 4/18/17: Floating in Debt
April 19, 2017

Have no fear …

… we’re not converting our Steak House Index into the “Breakfast Cafe” Index.   Nor is this week’s post an homage to Easter.
No, I felt this allusion was appropriate in light of the growing conundrum around “full” employment and wage inflation.   Which came first?   Full employment and then wage inflation?   Does full employment cause wage inflation?  Or is wage inflation the result of something other than full employment?
Last Friday the US unemployment rate fell to 4.5% for the first time in almost 10 years.   Measured against historic numbers, this is an extremely low national unemployment rate, a rate historically associated with, and believed by many to be the cause of, significant increases in wages.  And at 4.5%, the official unemployment rate is now below the “full” or natural rate of employment.
Yet, wages are not rising – at least not by much.
Why?   
Welcome to this week’s Steak House Index update.
As always, if you need a refresher on the SHI, or its objective and methodology, I suggest you open and read the original BLOG: https://terryliebman.wordpress.com/2016/03/02/move-over-big-mac-index-here-comes-the-steak-house-index/)

Why You Should Care: The US economy and US dollar are the bedrock of global economics.  This has been true for decades…and notwithstanding plenty of predictions to the contrary, it will continue to play this role for years to come.   Fear not.

Nominal global GDP is about $76 trillion.   US GDP is almost $19 trillion.  Is it growing or shrinking?  If it’s growing … how rapidly?   How might this information impact our daily financial and business decisions?
The objective of the SHI is simple: To predict the GDP direction ahead of official economic releases.  While the objective is simple, the task is not.  BEA publishes GDP figures the instant they’re available.  Unfortunately, the data is old, old news; it’s a lagging indicator.
‘Personal consumption expenditures,’ or PCE, is the single largest component of the GDP. In fact, the majority of all US GDP increases (or declines) usually result from (increases or decreases in) consumer spending.  Thus, this is clearly an important metric to track.
I intend the SHI is to be predictive, anticipating where the economy is going – not where it’s been. Thereby giving us the ability to take action early.  Not when it’s too late.

Taking action: Keep up with this weekly BLOG update. If the SHI index moves appreciably – either showing massive improvement or significant declines – indicating expanding economic strength or a potential recession, we’ll discuss possible actions at that time.

The BLOG:    Based on the small number of folks in the theater, I think I’m one of the few people who paid good money to see the recently-released film, “Ghost in the Shell.”  The movie is set in the near future (per the Producer) which, if this is an accurate depiction of the near future, should concern us all.  Because there are tons of working robots in this movie.  Robots that do the jobs of humans.   Of course, we even see ‘sinister’ robots that can – and do – hack into the human brain.  Terrorist robots.   All in all, this future didn’t look too appealing.  But maybe that’s just me.
Last Friday the BLS and BEA released their latest ‘Employment Situation’ report.  The US unemployment rate fell to 4.5% for the first time in almost a decade.   Even my preferred U-6 metric fell:  It is now only 8.9%.   Of course, they mentioned nothing about robots.  🙂
At 4.5%, the unemployment rate is now below the rate where economists feel wage inflation should have been triggered.   Called the “natural rate of unemployment” or the “nonaccelerating inflation rate of unemployment” (NAIRU), many economists feel once the unemployment level falls below this, significant wage inflation begins.   The FED and others feel this rate is about 4.7%.
Each month, the US Bureau of Labor Statistics (BLS) surveys about 147,000 businesses and government agencies to keep precise tabs on this figure.  And now that we have pierced the NAIRU floor, one would expect to see a significant increase in weekly earnings.  Wage growth should now be accelerating rapidly.

Yet it is not.  Why?

In a nutshell, current facts simply do not support the theory:   Since 2007, “average weekly earnings of production and nonsupervisory employees” have increased between 1.58% to 2.94% per year.   In the first quarter of 2017, this number increased at an even slower pace – earnings are up only 0.16%.
In my opinion, the concept of NAIRU is antiquated.  Why?  I suspect there are two foundational causes.
The first is this:   Economic theory around wages and inflation is simply wrong:
  • Historically, economists have believed the size of the labor pool is quantifiable, relatively static.   And while this may have been true in decades past, today the size of the US labor pool is quite fluid.  Not necessarily within the US borders, but far beyond.  Labor activity that was once uniquely American has moved elsewhere in the world.  And in each of these locations, the pool of available labor is very malleable, flexible, and often very reasonably priced.
  • There has been a long-held belief that when the unemployment rate falls below NEIRU, employers struggle to find workers, competition for those workers begins, and a labor auction process begins.  Pitting employer against employer, thus benefiting the worker by putting upward pressure on his or her wages.  However, this theory was formed and tested during times of strong annual GDP growth (3% plus).  Employers had ‘pricing power’ – the ability to pass on price increases to the consumer.  In today’s world, this is no longer the case.  Price increases can no longer be easily passed onto the consumer.  Once again, global forces have created an environment of fierce price competition.  Not only is the American consumer more savvy and informed – thank the internet – but the competition for goods and services has been disrupted and is also going thru a transformation.
  • Finally, today we see a mismatch between job skills and labor itself.  Sure, pretty much anyone can serve a pizza to a table of hungry teenagers. But a growing number of higher-paying jobs require a basic skill set; or even worse, a very unique employee skill set that many employers today have trouble locating.  This may be a greater comment on the changing nature of labor itself more than a comment on unskilled or untrained workers.  Low paying jobs, requiring rote behavior, are smaller in number than at any time since the beginning of the Industrial Age.   And many of them – today and in the near future – are or will be performed by robotics.
You are probably familiar with the economic theory of ‘Substitution.’  Automation is ubiquitous and has now deeply permeated the US economic system. This didn’t happened overnight…but over many years and this trend is now accelerating.  Automation has replaced many human workers.  Automated labor is not counted in the BIS or BEA surveys.   Automation is the new excess labor pool.
Think of it this way.  Suppose the US has 160 million working folks, called our ‘civilian labor pool.’  For simplicity, let’s call this 160 units. And for the moment, lets suppose those 160 units are interchangeable – meaning any one can do any job. There is no labor/skill mismatch.
So, the US has 160 units of available labor. This is the supply of labor.  And right now, suppose we had 160 units of demand. Then, in theory, the labor market is in balance – in equilibrium.  Now, suppose, we introduced an additional labor source. One without limitation, one that is also interchangeable, highly skilled, and once acquired by the business, offers the employer labor at almost no cost. (The only cost for this labor is programming, depreciation and maintenance.)
Once introduced, the system is no longer in equilibrium. Suppose an economic expansion caused the demand for labor to grow beyond 160 units, although there are only 160 units of human labor available, an almost unlimited supply of machine labor is now competing for many of those jobs. Whether using robotics, artificial intelligence, augmented reality, or a host of other developments, machine labor is a readily available substitute – for human labor.  A substitute that is often better trained, is willing to work 24 hours a day and at least 6 days a week, and has an hourly wage of zero.
(It’s worth noting that the newly proposed “border tax” proposal floating around congress would permit a business a 100% deduction for the acquisition cost of automation, most likely accelerating the use of automation and job losses. FYI.)
All right, it’s time to head to the steakhouse.   For a good, old, human-made Filet!  How is our SHI faring this week?   Is the demand for high-priced steaks sizzling yet?
Nope.   This week the SHI is a barely simmering negative (-16).   But once again, this reading is very much on par with this same date last year.   Take a look:

 

It is interesting to note, once again, that Mastros Ocean Club is almost fully booked … while our other three opulent eateries are almost fully available.   Here’s a look at the long-term trend:

 

Wage inflation is created by corporate pricing power.   Not the other way around.   Perhaps Mastro’s has pricing power – but if they do, they are unique in today’s US economy.    (It probably has to do with the fact that you can’t import a 500 degree sizzling filet from China.  It has to be manufactured locally.)   🙂  
And since our economy is merely chugging along – a condition the SHI reinforces once again – it’s unlikely we’ll see much corporate pricing power in the near future.
Like the US economy as a whole, I’m sorry to report salaries and wages are unlikely to make a large surge any time soon.    I doubt we’ll see even 2% growth this year in either GDP or wages.
  • Terry Liebman

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