Donald Trump creates chaos with his tariffs trade war

The question remains whether other countries should box back in retaliation

Martin Wolf

The leader of the world’s most powerful country is a dangerous ignoramus. So how should the rest of the world respond? What makes this so difficult to answer is that Donald Trump has created chaos. It is so difficult to negotiate with him because nobody knows what he and his team want. This is just not normal.

The administration’s trade actions and announced intentions are, in this context, important in themselves and indicative of the wider dysfunction. The US has imposed tariffs on imports of solar panels, washing machines, steel and aluminium. If one adds two rounds of tariffs on China under Section 301 of the US Trade Act of 1974, the affected trade comes to about 7 per cent of US imports.

If one allows for the threat of retaliation against retaliation, which could affect an additional $400bn of imports from China, as well as the possibility of tariffs on $275bn of imports of cars and parts, total affected imports reaches $800bn, or about a third of US imports of goods. The US actions have already caused retaliation (see charts).

The administration has justified the actions already in effect on steel and aluminium by reference to national security. The same rationale is being used in an investigation of US imports of cars, launched in May. Fears over such abuse of the security exceptions are why the World Trade Organization’s rules are restrictive. Such exceptions are enumerated as relating to “fissionable materials”, or “the traffic in arms, ammunition and implements of war and to such traffic in other goods and materials as is carried on directly or indirectly for the purpose of supplying a military establishment”, or “taken in time of war or other emergency in international relations”.

US actions on steel, aluminium and, even more absurd, cars clearly violate the WTO rules. But if Canada is a threat, which country is not? If cars are a security concern, what is not? “Protection will lead to great prosperity and strength,” Mr Trump said in his inaugural address. He meant it, alas.

The rationale for the Section 301 action against China is more obscure. Sometimes, the action seems intended to force China to eliminate its bilateral surpluses with the US. Sometimes its aim seems to be to halt its “Made in China 2025” programme. Sometimes it seems intended to remedy coerced technology transfer. The first aim is ridiculous; the second is non-negotiable; the third is reasonable, but hard to achieve.

As if this were not confusion enough, Larry Kudlow, ostensibly Mr Trump’s principal economic adviser, has suggested the president is a free-trader and that the aim is really to eliminate tariffs. In fact, like a two-year-old, Mr Trump is a “disrupter” without clear objectives. If he had wanted to rebalance the relationship with China, he would not have withdrawn from the Trans-Pacific Partnership and he would not have assaulted his own allies. He would instead have confronted China with a powerful global coalition. Instead, he has started fights with everybody.

Protection also tends to spread because users of protected inputs will call for it, because unprotected sectors will demand it and because trade will be diverted from protected markets. China’s exports, for example, will shift from US to EU markets. The EU might feel forced to act against imports, too.

So where might all this end? Paul Krugman, one of the world’s leading trade economists, argues that if this were to become a generalised trade war of all against all, world trade might shrink by 70 per cent.

Yet, surprisingly, world output might not fall by more than 3 per cent. Such numbers rest on the assumptions of “computable general equilibrium” models, which ignore the disruption and uncertainty, as the structure of the world economy is reconfigured. They also fail to account for the lost dynamism, as global competition is reduced. Last but not least, they miss the increase in ill will such a protectionist war would cause. Global co-operation would surely be shattered.

Yet Mr Trump has insisted that “trade wars are good and easy to win”. The argument that a deficit country will “win” in a trade war is not absurd. Ultimately, in any retaliation war, the other side will run out of trade ammunition sooner, simply because their imports are smaller.

But retaliation could go beyond trade, to investment for example. Once retaliation is taken into account, and the impact of higher tariffs on exchange rates, the benefit for aggregate domestic output is likely to be very small even for a country with huge deficits. Every economist knows that the effective way to reduce a trade deficit in a country near full employment is a recession. That is presumably not the US objective, but it could be the result of the uncertainty created by its policies.

Perhaps the biggest question is how other players should respond to the aggression from the White House. Mr Trump likes conflict. He might not respond to retaliation as a normal person would. He might even welcome the rise in protection that a spiral of retaliation would deliver.

At the same time, only retaliation might persuade him to change course. Furthermore, the gathering clouds of a trade war just might shock US business into effective action. The judgment of how far to pursue the cycle of retaliation, then, is no easy one.

Personally, I would retaliate, more because the alternative looks weak than in the belief that it would work. Another thing the rest of the world should do is to strengthen their co-operation. But the most exciting — and risky — thing other high-income countries could do is to take up Mr Trump’s offer of tariff-free trade. Why not at least call his bluff? Who knows? It might even work.

Home Sales Extend Slump Despite Economic Strength

Existing-home sales slipped 0.6% in June from the previous month

By Laura Kusisto and Sharon Nunn

A ‘sale pending’ sign is posted outside a home in East Derry, N.H., in June. Photo: Charles Krupa/Associated Press        
Home sales slumped in the second quarter despite what was likely the strongest period for U.S. growth in years, the latest sign that the economic expansion faces headwinds.

Existing-home sales slipped 0.6% in June from the previous month to a seasonally adjusted annual rate of 5.38 million, the National Association of Realtors said Monday. Compared with a year earlier, sales in June declined 2.2%.

Home sales have now declined on an annual basis in five of the first six months this year, a worrying trend since housing is considered a crucial indicator of overall economic health, economists say.
By a number of measures, the economy looks to be accelerating after a long stretch of subpar growth. Economists are forecasting U.S. growth to exceed 4% for the second quarter when numbers are released on Friday. Jobless claims are falling, and corporate profit growth continues to looks strong.

But weakness in the housing market could muddy the picture. Housing contributes about 15% to 18% of gross domestic product. Existing-home sales help drive other sectors of the economy. Consumer confidence and home-improvement spending, construction and mortgage lending tend to suffer when home sales slump.

“The housing market led the general economy out of the recovery and now it’s leading” it toward a slowdown, said Zillow Senior Economist Aaron Terrazas.
Mortgage-application volume decreased 2.5% in the week ending July 13, compared with a week earlier, including a 5% decline in purchase applications, according to an index put out by the Mortgage Bankers Association last week.

New home construction, which is the major driver of housing-related employment, has also struggled lately. Housing starts declined 12.3% in June from the prior month, according to the Commerce Department. That was the largest monthly percentage drop in about a year and a half, driven by construction declines in all regions of the U.S. for almost all types of housing.

Realtors say some buyers have grown weary of the run-up in prices, especially after mortgage rates increased. Brook Hogan, a real-estate agent in Portland, Ore., said she has seen signs that consumers are growing more cautious, especially at the higher end of the market. “It’s definitely slowing. Buyer confidence is a big deal,” she said.

Jessica Aebersold, a 30-year-old who works at a company that rents photo booths, said she and her husband took three weeks to sell their Seattle-area home—in a town where multiple offers in a single weekend had been more the norm.
Ms. Aebersold said she, too, expected the home to sell in the first weekend, but the day the house was listed, four others went up in the neighborhood. It took three weekends before they received a cash offer $30,000 below the asking price.

“I don’t know if people are getting scared,” she said. “I was just very surprised that we didn’t sell right away.”
Weakness in the housing market is the latest sign that a nine-year-old economic expansion faces challenges, such as the new tariffs that have increased the prospect of a trade war between the U.S. and China or Europe.

The pace of growth and fears that trade tension could bring inflation have also raised expectations that the Federal Reserve will be more aggressive in raising interest rates. Traders in the federal-funds futures market now believe there is a near certainty that the Fed will raise short-term rates at least once more this year, and a better than 60% chance of two or more rate increases, according to CME Group.

Any interest-rate increases could further depress home sales. “One of, if not the most, rate-sensitive sectors in the economy is housing,” said Torsten Slok, chief international economist at Deutsche Bank Securities.

The average interest rate on a 30-year fixed-rate mortgage already has risen to 4.57% in June from 4.03% in January, according to Freddie Mac.

By increasing the monthly cost of owning a home, higher mortgage rates force some buyers to seek out less expensive properties. They can push those at the bottom out of the market altogether.

More notably, they may act as a disincentive for current owners, who enjoy historically low mortgage rates, to sell and lose that rate.

While rising mortgage rates typically help slow price growth, the lack of inventory has meant that prices have continued growing much faster than wages and inflation, compounding affordability concerns. The median sale price for an existing home in June hit a new all-time high of $276,900, up 5.2% from a year earlier, according to NAR.
The slowdown in sales was concentrated at the bottom end of the market, indicating that affordability concerns are a major contributor to the slow spring selling season. Sales of homes priced at $100,000 to $250,000 fell 7.1% in June, compared with a year earlier, while sales of homes between $750,000 and $1 million grew 6%, according to NAR.

Strong price growth also indicates that there is still robust demand for homes, and that if inventory continues to increase, the market could regain momentum in the latter half of the year.

Still, some 40% of home sales each year take place in the critical spring selling period of March through June. Even if sales pick up later in the year, they are unlikely to fully make up the lost ground.

“I don’t think the housing-market sky is falling,” said Ralph McLaughlin, chief economist at Veritas Urbis Economics. “The fact that the price growth remains strong leads me to believe this isn’t a cyclical issue, at least just yet.”

After a long stretch where economists have blamed a lack of inventory for this year’s lackluster housing-market performance, there are recent indications that the trend is beginning to reverse. But that suggests demand may be waning as buyers take longer to purchase, leaving properties on the market longer.

There were 1.95 million existing homes available for sale last month, up 4.3% from the prior month and 0.5% from a year ago. That is the first yearly inventory increase since the middle of 2015, according to Lawrence Yun, the trade group’s chief economist.

Interview with Mikhail Khodorkovsky

'I Believe Putin Is Capable of Change'

Interview Conducted by Christian Esch and Britta Sandberg

In an interview with DER SPIEGEL, former Russian oligarch and regime critic Mikhail Khodorkovsky talks about the importance of the World Cup for Moscow's reputation and of a possible end to the Putin era.

Photo Gallery: Mikhail Khodorkovsky's Vision of Russian Democracy

Mikhail Khodorkovsky, 55, is Vladimir Putin's most prominent opponent in exile. The government arrested the billionaire in 2003 after he sparred publicly with Russian President Vladimir Putin and he spent 10 years in prison. Since receiving a pardon, he has sought to promote democracy in his home country through the Open Russia movement. He lives in London.

DER SPIEGEL: Mr. Khodorkovsky, the World Cup is currently being held in Russia. At the same time, the Kremlin has been the subject of criticism for its actions in Ukraine and Syria and for human rights violations in its own country. Should Western politicians attend the matches?

Khodorkovsky: The World Cup is important for the Kremlin. Vladimir Putin wants to show the Russians and the world that they are respected and not isolated. But it is also important for millions of Russians who love football. That's why it is very good that there has not been any boycott. However: The fans coming to the World Cup are guests of the Russians. But the politicians are guests of Putin. And I think it is immoral and politically dangerous for Western politicians to express their respect for the clique in the Kremlin in this way. We don't know what Putin will do next.

DER SPIEGEL: Western politicians could use their visits to help secure the release of political prisoners like Ukrainian filmmaker Oleg Sentsov, who began a hunger strike in mid-May.

Khodorkovsky: If Putin promised to release hostages in exchange, then, of course -- you'd have to go there and ignore everything else.

DER SPIEGEL: What if politicians were to use the visit exclusively to address the issue?

Khodorkovsky: That's the risk they take. If hostages were to be released after such a trip, then it wil have been justified. If not, it would not have been. But it's not up to me to give advice.

DER SPIEGEL: Putin released you in 2013 before the Olympic Games in Sochi. Sentsov is also a political prisoner, convicted of "terrorism" as an opponent of the annexation of Crimea. Why didn't Putin release him before the World Cup?

Khodorkovsky: Putin has been pursuaded by the people close to him that Sentsov is a terrorist. And Putin has positioned himself as someone who fights terrorism. He considers the intelligence reports that he relies on to be absolutely trustworthy. But that doesn't mean that he can't change his mind. That's evident from my case.

DER SPIEGEL: Has he ever regretted your release?

Khodorkovsky: Whatever the case may be, he has approved the opening of new criminal proceedings against me. He has noticed that, even though I don't pose a threat to him outside prison, I can still make him uncomfortable.

DER SPIEGEL: As a prisoner, you also went on several hunger strikes yourself. Is Sentsov's life in danger?

Khodorkovsky: Feeding tubes are a very dangerous thing. Soviet experience showed that no one can survive it for more than a year. Sentsov is also serving his sentence above the Arctic Circle, in Labytnangi. Only those born there or who are able to adapt to the climate can survive 20 years in the far north. Sentsov is too old for that.

DER SPIEGEL: Your Open Russia movement has been championing his cause. What exactly have you been doing?

Khodorkovsky: We actively supported the rallies in Moscow for Sentsov. For the opening of the World Cup, our people hung a large picture of him next to Moscow's Luzhniki Stadium, but it was immediately torn down again.

DER SPIEGEL: You were once considered Russia's richest man and you know many Russian billionaires who have been personally affected by Western sanctions. Are the sanctions hitting the right people?

Khodorkovsky: I wouldn't presume to say whether the right people are being hit from the perspective of Western countries. I don't even know why these people were targeted -- the reasons weren't made public. I think that is a mistake.

DER SPIEGEL: What effect do the sanctions have on Russia's wealthy?

Khodorkovsky: Take a man like Gennady Timchenko, who has a house in Geneva, or Igor Sechin, who has an 80-meter (262-foot) yacht in the Mediterranean. Of course, it's a loss if they are no longer able to use these things. But when Putin is no longer in power, they will lose everything. What is more important to them? Nobody will seek to topple Putin just because they are no longer allowed to travel to the Bavarian Alps.

DER SPIEGEL: You're trying to influence Russian political developments through a foundation. Which young politicians do you consider to be especially promising?

Khodorkovsky: The best-known are, in descending order: Alexei Navalny, the left-wing politician Sergei Udaltsov, Yevgeny Roizman, the former mayor of Yekaterinburg, ex-Duma deputy Dmitry Gudkov...

DER SPIEGEL: ... and Ksenia Sobchak, the society reporter who was permitted to run in the last election as Putin's challenger? Many view her as being a puppet of the Kremlin.

Khodorkovsky: Sobchak plays the game the Kremlin allows her to play in politics. But that also applies to all politicians in Russia. Anyone who crosses the lines set for them will wind up in prison. Ksenia Sobchak asked for my support before the election. I asked her: Can you guarantee that you will not abandon your political involvement afterward? That you will devote all your time to politics? She said: No, I can't. That's why I didn't give her my vote when I cast my ballot.

DER SPIEGEL: But did then wind up supporting Sobchak. Activists with your Open Russia movement organized Sobchak's election campaign in the regions.

Khodorkovsky: The goal of our movement is the introduction of a parliamentary democracy. To achieve that goal, we support independent politicians. And there was a split among them: About half of the activists founded Nawalny's regional offices, while the other half set up Sobchak's. It was a conflict that I had to mediate. I said: We can support someone if they have a future in a parliamentary democracy. But those who say, "this politician is the only one who embodies our future," they need to look for a different movement.

DER SPIEGEL: Navalny, in particular, has been accused of not tolerating any competition.

Khodorkovsky: Navalny's model is that of the leader. I know that is consistent with the mentality in today's Russia. He promises to ensure a more democratic form of government if he gets elected. But I think it would end in a new authoritarianism. I have also said that to Navalny. I support him as one of the politicians that a future Russia needs, but not as the sole savior who leads us to democracy. We don't need a benevolent czar, no matter what his name may be.

DER SPIEGEL: Are you satisfied with the results delivered by your political movement?

Khodorkovsky: It's hard to be totally satisfied. If we look at Russia today, there are two independent movements within the democratic spectrum. One is that of Navalny's people, and the other is Open Russia. Everyone else is in decline, even the left-liberal Yabloko Party. It is important for a democratic Russia that there is not just one opposition structure, but two. But only when there are three, or better yet four, will I be confident that we we won't end up in a new authoritarianism after a regime change.

DER SPIEGEL: You aren't the first rich Russian to have confronted Putin and fought from abroad for a change in government. The late oligarch Boris Berezovsky did the same. What differentiates you from him?

Khodorkovsky: Berezovsky saw himself as the man who had brought Putin to power and was then betrayed by Putin. He wanted to create trouble for Putin, not to democratize Russia. My aim is not the overthrow of the president, but the establishment of parliamentary democracy. If Putin is prepared tomorrow to democratize the country himself, then I'm all for it.

DER SPIEGEL: Do you expect changes in the next few years, even before the end of Putin's term of office in 2024?

Khodorkovsky: Realistically speaking, little is likely to change. But I do believe Putin is capable of change, even if the odds are slim.

DER SPIEGEL: What do you think of former German Chancellor Gerhard Schröder's involvement in Russia? He's also now on the supervisory board of Rosneft, the oil company of Putin's confidant Igor Sechin.

Khodorkovsky: I do not approve of Schröder's behavior, but I do understand it. Putin helped him adopt two children, so he feels a deep sense of personal gratitude. The result being that he convinces himself that Putin is not as bad as everyone says. Putin has done a good job at this -- he's a professional when it comes to recruiting. Today, Schröder is a person who has no influence on Putin, but through him, Putin can influence a segment of German society.

DER SPIEGEL: What influence does Vladimir Putin have on Donald Trump? Do you think the Kremlin actually has any compromising material against him?

Khodorkovsky: I don't believe there is material of importance in Moscow. Trump is not the kind of man you could put in jeopardy with stories about women. And as far as financial ties with Russia are concerned, they would have to be at such a high level that the FBI would have noticed.

DER SPIEGEL: Maybe Putin and Trump are just soul mates ...

Khodorkovsky: I don't believe that either. To me, Trump is an extravagant businessman who wants to transfer his experience from the business world to the system of government. When inappropriate methods are transferred to a new object, a conflict arises -- and this is similar to the conflict that arises in Putin's system, where a mafioso group is trying to lead a country. Essentially, they are quite different. The similarities are purely on the surface.

DER SPIEGEL: Russia is in a difficult situation. In contrast to those imposed by the European Union, the U.S. Congress has ensured that American sanctions against Russia are very difficult to lift. What would you do if you were in government?

Khodorkovsky: I would say, I don't care about sanctions in the first place. I can export oil and gas anyway, and the West will not be able to do without them, so these revenues will still be mine. I would also take a calm view toward the ban on importing certain technologies. Russia is so economically ineffective that it is unable to use cutting-edge technology anyway. The slightly older models that we are still able to get suffice for our purposes. What would worry me is the lack of human potential. The most productive people are leaving the country and foreign experts are no longer coming. It's also a question of reputation.

DER SPIEGEL: Can the World Cup bring about change on that front?

Khodorkovsky: In this respect, the World Cup is important, even if it alone does not go far enough. I would also reform the institutions. The people I want to attract can have no impact unless there are independent courts and a parliament that does its work professionally. Reputation and the institutional environment are crucial. Sanctions are of secondary importance.

DER SPIEGEL: You had high hopes for Ukraine when the Euromaidan revolution prevailed there. Are you disappointed today in the face of sluggish reforms?

Khodorkovsky: I had hoped that Ukraine would become a model for Russian society. Unfortunately, Putin has succeeded in preventing this. And, unfortunately, some people in Ukraine helped him to do so -- out of greed. Other than that, though, I'm not disappointed. Ukraine is a large country, and no rapid changes could be expected. If the Ukrainians prevent a relapse into authoritarianism, the country will become a normal democracy after one or two changes of government. The economy will also recover.

DER SPIEGEL: Why do you assume that so much will change once Putin has left office? The system he created could outlast him.

Khodorkovsky: Only for a short time. Putin will push the country to the limits of its resilience. A poll showed that 20 percent of Muscovites want to go abroad. That sends a dangerous message. If we are not talking about Putin himself, but about Putin's regime, then I do not believe it will live to see its 30th anniversary. They'll ruin the country sooner.

DER SPIEGEL: You've lived in London since 2016. Are you watching the World Cup on TV there?

Khodorkovsky: I used to play football, but I have never really become a fan. If the Russian team reaches the quarterfinals, though, I'll watch. Emotionally, I'm still Russian.

DER SPIEGEL: Mr. Khodorkovsky, we thank you for this interview.

The European Union’s Dublin Conundrum

Daniel Gros

BRUSSELS – Tensions over immigration continue to dominate European politics. In Italy, Interior Minister Matteo Salvini, a populist firebrand, is monopolizing the public’s attention with almost daily outbursts against immigrants. Likewise, Salvini’s German counterpart, Horst Seehofer, created a crisis in the governing coalition in order to secure new measures against asylum seekers trying to enter Germany from Austria. With their countries having been left to fight illegal immigration on their own, Salvini and Seehofer claim, they must focus on national, not European, solutions. They are wrong.

The truth is that the European Union has been instrumental in reducing the flows of irregular arrivals, which have declined considerably since the massive influx of Syrian refugees, via Greece and Hungary, in 2015. Thanks to the agreement that the EU reached with Turkey in March 2016, very few people are now crossing into Greece. Likewise, the number of arrivals in Italy is a mere fraction of the total just last year. Overall, illegal crossings into the EU have been reduced to about 100,000 annually, compared to the estimated more than one million who arrived in 2015.

Given the EU’s population of over 500 million, that number is eminently manageable. Nonetheless, politicians continue to exploit the migration issue, with some highly visible arrivals – in particular, the large number of migrants who have been rescued off the coast of Libya – keeping the issue in the news.

The real issue that needs to be resolved, however, is which country should be responsible for those who have already entered EU territory. The EU’s failure to answer this question in a way that satisfies all sides is now threatening the survival of the Schengen Area of border-free travel.

On paper, the EU has clear rules on the matter: under the so-called Dublin Regulation, the first EU country that asylum seekers enter is responsible for examining their applications. But countries with external borders, such as Greece and Italy, naturally complain that this puts an unfair burden on them.

Asylum seekers themselves also resist this rule. Given unfavorable labor-market conditions in southern border countries, many make a beeline for northern Europe to apply for asylum. That is why Germany, which has no external border, receives more asylum applications than Italy.

Many such cases have already been registered on the EU asylum database EURODAC.

According to the Dublin Regulation, Germany has the right to ask other member states to “take charge” (the legal term) of these cases. But there are many exceptions to the first-country-of-arrival rule. For example, if an asylum seeker already has family in a different country (in this case, Germany), that country may be responsible for processing the application. Or if an asylum seeker manages to leave the country of arrival for three months, the initial application can be withdrawn and a new one submitted in a different EU member state.

These exceptions give asylum seekers ample room to contest Dublin transfers in court.

Moreover, national authorities have a strong incentive to object to incoming transfer requests on formal or substantive grounds, while trying to send abroad as many as possible. About 160,000 “take charge” requests were lodged in 2017, though only about 20,000 were actually implemented. These factors, together with discrepancies among EU member states’ legal systems and administrative procedures, have largely nullified the Dublin Regulation.

It was this reality that lay at the root of recent tensions within Germany’s coalition government. Of more than 60,000 take-charge requests lodged by German authorities in 2017 under the Dublin Regulation, fewer than 15% were actually implemented, resulting in just 7,100 transfers to other member states.

Yet in 2016, Germany implemented close to 30% of the 27,000 incoming requests it received, meaning that it took charge of about 8,700 people. Germany has thus become a net recipient of Dublin transfers, despite lacking an external border.

Given this, Seehofer wants to prevent asylum seekers who have been registered elsewhere on EURODAC from ever entering Germany. But he is far from alone in his frustration: the upshot of the gulf between legal principles and reality is that no member state is satisfied with the current system. While border countries continue to insist that the Dublin Regulation is unfair to them, northern countries complain that it is not being implemented properly.

An asylum system in which more than a dozen national bureaucracies try to pass applicants around like hot potatoes cannot work. The European Asylum Support Office (EASO) should be made responsible for interpreting the rules for assigning refugees – deciding, for example, which country is responsible when member states disagree in individual cases. Providing financial incentives for accepting refugees – say, a lump sum for each one – would also help.

These two measures will not satisfy the populists. Opposition to refugees and migrants – and even demonization of them and their supporters – is their political bread and butter. But strengthening EASO and boosting financial support should go some way toward alleviating today’s tensions, at least until a radical reform of Europe’s asylum system can be contemplated.

Daniel Gros is Director of the Brussels-based Center for European Policy Studies. He has worked for the International Monetary Fund, and served as an economic adviser to the European Commission, the European Parliament, and the French prime minister and finance minister. He is the editor of Economie Internationale and International Finance.

 Rising Wages = Shrinking Corporate Profit Margins … And Falling Stock Prices? 

Today’s Wall Street Journal contains a couple of charts that illustrate a relationship that’s not getting much media attention these days: The fact that tightening labor markets are forcing companies to raise wages, in the process squeezing their own profit margins.
Historically this margin compression has been either a cause of or contributor to cyclical turning points — in other words it coincides with recessions and equity bear markets.

The first chart shows wages rising after an unusually long period in which they didn’t rise much at all. They’ve still yet to achieve the velocity of previous recoveries, but anecdotal evidence of desperate employers raising wages and lowering standards (see here, here and here) is now so widespread that continued wage gains are pretty much baked into the cake.

wage growth profit margins

What has this meant for corporate profit margins in the past? Big drops, as higher wages combined with an inability to raise prices commensurately left corporations with less money at the end of the day.

S&P 500 earnings profit margins

Since a share of stock is simply a claim on a portion of a public company’s earnings, falling profits obviously lead to falling share prices:

S&P 500 profit margins

Here’s an excerpt from the WSJ article:
Rising wages are beginning to eat into the profits of some U.S. companies. 

Businesses from dollar stores to hotel operators to fast-food chains have warned in recent months that higher labor costs have been a drag on their profits—a potential headwind for the nine-year stock-market rally as it struggles for momentum ahead of the second-quarter earnings season. 
Average hourly earnings increased 2.7% in June from a year earlier, according to the Labor Department’s monthly jobs data released Friday. Although that is below the 2.8% economists expected, wages have risen at least 2.5% for 16 of the past 17 months, a faster pace than recorded earlier in the economic expansión. 
That is good news for U.S. workers who have seen tepid wage increases over the past few years and may benefit some businesses as consumers become more willing to open their wallets for discretionary purchases. 
But the higher costs pose a threat to some U.S. companies that are already facing trade-related tensions and a limited ability to raise prices to keep up with inflation. Fears about rising wages sparked concerns back in February and sent stocks tumbling as investors worried the tightening labor market may finally trigger higher inflation. 
Economists at Goldman Sachs predict that every percentage-point increase in labor-cost inflation will drag down earnings of companies in the S&P 500 by 0.8%. In total, the bank estimates labor costs equate to 13% of revenue for companies in the S&P 500. 
“At the end of the day, I haven’t heard this many CEOs talk about shortages in skilled labor and wage increases to attract talent in a long time—in at least a decade,” said Will Muggia, president and chief executive at Westfield Capital Management in Boston. 
In a traditional economic cycle, companies would attempt to pass along the increasing cost of labor to customers, but that doesn’t appear to be happening this time.