Economic Casablanca: I am Shocked! Shocked!
Wednesday, April 20th, 2011
On Monday the stocks and bonds markets where rattled by the announcement by Standard & Poors that US debt still had a AAA rating, but they had lowered their outlook for those obligations to “negative.” It reminded me of the casino scene in Casablanca (listen here).
An angry murmur starts among the crowd. People get up and begin to leave. Rick comes quickly up to Renault.
Rick: How can you close me up? On what grounds?
Renault: I am shocked, shocked to find that gambling is going on in here!
The display of nerve leaves Rick at a loss. The croupier comes out of the gambling room and up to Renault.
Croupier: Your winnings, sir.
Renault: Oh. Thank you very much… Everybody out at once!
The markets took the supposed news badly at first and then found ways to digest it through the trading day with little change to its trading range for the last few weeks. Cynics wondered what took S&P so long, and noted that it was worse than they said (remember, when GAAP accounting standards are applied, just like businesses use, the Federal debt is more in the $70 trillion range, which is nearly 5x GDP). In the end, everyone knew what S&P admitted, so they moved on. Optimists said that the S&P report would bring a new focus on discipline and urgency to the budget debate. That’s unlikely, as the band-aids of continuing budget resolutions will be used, and short term budgets will drive events until the 2012 Presidential and Congressional campaigns are over.
In the meantime, various economic measures are showing deterioration, especially compared to last year. Here are how our major macroeconomic indicators are running (click on image to enlarge):
GDP is running at rates below post-WWII average, and is below the readings of last year at this time. Productivity is still greater than GDP, which means that employment is sluggish. It’s when GDP exceeds productivity that employment grows. Since we have not had the usual breakout of economic growth that characterizes recoveries (in the +5-8% range), unemployment remains at discouraging levels. Productivity is essential to pay for wage increases that workers deserve, but they’re not getting them.
Real wages are declining; they were rising last year at this time. Where are the dollars from productivity going? To pay for the increased prices of goods and expenses used in manufacturing and delivering services. The three-month annualized trends for inflation are more important than anything S&P could say. The two-digit rises in producer prices (PPI) cannot be passed on fully to the marketplace, and only recently has the consumer price index (CPI) reflected those prices getting into supply chains. But the difference is wide. The PPI is about 2x the size of the CPI, which means that producers are still absorbing their increased costs. At some point it will burst through… or collapse as they did in mid-2008.
This is a time for economic caution. Be sure to keep inflation in mind when judging company performance. The table below shows what to multiply past years financial statements by to make the comparisons.
Note that there is already a 2% difference after the first quarter compared to 2010.
Don’t let the emerging economic situation get you down; business still goes on and clients still have problems for businesses to solve. It’s important to get ahead of costs as they are changing to be sure that our businesses are healthy enough to creatively solve their problems. Don’t let growing cost pressures get in the way of your business mission. Get ahead of them as soon as possible.