SATURDAY, JUNE 11, 2011
The Threat of 'Screwflation'
By DOUGLAS A. KASS
The economic beating that the middle class has taken over the past 30 years, combined with the threat of inflation, is adding to the nation's miseries.
In the 1970s, when growth was stagnant and inflation was high, economists spoke of "stagflation." Four decades later, there's another threat to a sustainable trajectory of economic and corporate profit growth. It's "screwflation," which combines inflation with the screwing of the struggling middle class. Like stagflation, screwflation also threatens the general health and valuation of the U.S. stock market.
While the U.S. economy, in real terms, has more than doubled in the past 30 years and corporate profits will soon attain a new peak, median real wages have made little recent progress, and surging food and energy prices (among other cost pressures) now eat up middle-class incomes. Moreover, the lost decade of flat stock prices and an unprecedented four years of declining home prices have further weakened the confidence and purchasing power of the middle-class screwees.
The structural weakness in the labor market also makes this cycle unusual, and far worse for many, long-term, than the downturns of the 1970s. Unemployment has exacerbated screwflation's impact on all but the wealthiest Americans.
THREE MEGATRENDS–THE INTEGRATION and globalization of the worlds' economies, broad advances in technology and the rising role of temporary hiring as a permanent feature in the workplace—are prominent causes of screwflation. And because there are few areas of the domestic economy that can replace the prerecession strength in real estate, a recovery in jobs will be more difficult than in previous cycles. Work related to real estate accounted for nearly 40% of U.S. job growth in 2001-06–almost all of it middle-class.
Tim Foley for Barron's
Back in 1980, the richest 1% of Americans captured 9% of national income. Today, the richest 1% receive about a quarter of national income.
On the expense side, there has been an acceleration in the rate of increase in commodity prices over the past several years. This rise falls more heavily on low- and middle-income families, who spend most of their money on the necessities of life. Add rising health care, education and other costs to commodity prices, and the result is a poor foundation for growth.
Although the 1970s were hardly a good time for consumers and workers, the inflation of that period at least included a rise in nominal wages. Back then, unit labor costs rose at a 6.5% annualized rate. If we start from 1973 instead of 1970, the rate of wage growth was nearly 8% per year. In contrast, unit labor costs have dropped in five of the past seven quarters, and in eight of the past 15 since January 2007. Meanwhile, the Commodity Research Board index rose 65% from 2009-11.
Say what we will about the misery of the 1970s, it's clear that incomes came closer to keeping up with inflation in the 1970s than in the past few years. And with the rise in general prices now accelerating—in line with the Federal Reserve's stated goal—wage growth still remains challenged, and middle-class incomes are being compressed.
The consequences of screwflation are all too easy to forecast: Retail sales might reverse and go lower in the months ahead, threatening the self-sustaining economic recovery, in turn threatening the advance in the stock market, in turn threatening consumer confidence—and so on. If some of the recent strength in personal consumption was "recession fatigue," and not a sign of a durable spending cycle, a negative trend might turn out to be self-sustaining instead.
Although the housing market will not be marked by inflation, it will add to the screwing of the middle class. There's a massive overhang of inventory (far more than 10 million homes that need to be sold), comprising foreclosed, abandoned or heavily delinquent as well as other properties.
In the fullness of time, corporations (whose profit margins have been enriched by the absence of wage growth) will no longer be insulated from screwflation. They, too, might get hurt by the weakening foundation of the middle class. Retailers, in particular, shouldn't feel confident.
MORE SCREWING AND MORE INFLATION may lie ahead, particularly in light of the difficult fiscal decisions that must be made this summer in Washington. The needs to accelerate job growth and to control the federal deficit seem unreconcilable.
A shallow and fragile domestic economic recovery may be exposed to and be vulnerable to the need to cut spending–but drastic spending cuts will jeopardize the shallow recovery in jobs. Not moving on deficit reduction holds its own risks, of U.S. dollar weakness, soaring interest rates and higher unemployment.
Partisanship already makes a real solution less likely. Both parties are inclined to fight for their own issues—until the voters decide in 2012. And, unlike it was in the stagflationary late 1970s, the Federal Reserve isn't led by a strong-willed banker like Paul Volcker, who made the hard decisions about monetary policy.
The economic recovery and the U.S. stock-market rebound ring hollow in a screwflating economy. The U.S. must address both parts of the problem with policies that increase income for the middle class and fight commodity-price inflation.
Policies that could help quickly include: extending the payroll-tax cut initiated by the Obama administration; reducing income taxes for the middle class; providing federal funds for infrastructure spending; creating incentives for businesses to make new capital investments; allowing tax-free repatriation of U.S. corporate earnings made abroad, if they are earmarked for the creation of American jobs; the launch of an energy plan that taps domestic resources; and the use of federal-housing financing to slow foreclosures and distressed sales.
DOUGLAS A. KASS is president of Seabreeze Partners Management, which runs a long/short hedge fund in Palm Beach, Fla.
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