There are limits to the costs that can reasonably be passed on to consumers without damaging top-line revenue performance. Thus, simultaneously, businesses worked like beavers to preserve their bottom lines by controlling the costs of goods and services they sold, shifting their management models and budgeting accordingly.
Then they experienced a traumatic shock. Demand imploded. The equity and fixed-income markets seized up. Bank credit evaporated. The growth of the global economy hit a wall. Whereas just over a year ago managers were coping with a pervasive scarcity of inputs and escalating prices, there is now an abundance of almost every input and output and no pricing power. There are too many ships at sea; too many rail cars; too many airplanes and trucks; too many homes; too many hotels and apartments and office buildings; too many retail stores and malls and convenience stores; too much oil, natural gas and corn; and, according to Wall Street Journal reports this week, even too much champagne and bottled water.
And yes, thank you Lord, we have finally come to realize there are too many lawyers.
In almost every sector of the economy—save for nonelective medical services and a few basic commodities being hoarded by the Chinese—the CEOs I survey are struggling to cope with excess capacity and slack.
Businesses trying to sell products and services feel they are pushing on a string and are adjusting their behavior accordingly. To maintain sales volumes and clear inventories in the face of weakened demand, they are cutting prices. Beginning in the fourth quarter of last year, we began to see an upward shift in the number of items falling, rather than rising, in price. In the July data just released, almost 50 percent of the items in the PCE basket—weighted either by simple count or expenditure—were falling in price. Small wonder that headline inflation was negative over the year ended in June: This is the first time since 1955 that we have seen deflation.
Evaluating the Numbers
The new numbers tell me two things. First, for the immediate future, the risk to price stability is a deflationary risk, not an inflationary one. And second, given they are operating in the shadow of the absence of pricing power and the pervasive difficulty of expanding top-line revenues in the face of weak demand, businesses will continue to run tight budgets as they try to preserve profit margins. They will continue to focus on cost control, most painfully by shedding workers and driving those who remain on the payroll to higher levels of productivity.
All of which means that we are likely to see a prolonged period of sluggish economic performance and uncomfortably high unemployment as businesses reallocate capital and labor to fit the new economic landscape.
The needed reallocation of labor and capital has been, and will continue to be, impeded by financial markets. Although substantially improved from last fall—due in significant part, I would argue, to the work of the Federal Reserve—markets are still a long way from having normalized. We know from our own experience and from the experience of other countries that financial headwinds like these take years to abate.
To offset those headwinds, fiscal authorities have stepped forcefully into the breach, putting in place a massive stimulus effort. They have done so with the intent of limiting the damage to disposable income from unprecedented declines in wage and salary income—while trying to goose up capital expenditures on infrastructure.
If you go back to the rudimentary formula taught in high school economics to account for the makeup of GDP—consumption plus investment plus government expenditures plus net exports—the “G,” or government, variable is receiving enormous emphasis, while “C” is flaccid, “I” is hesitant and net “X” is tentative. At the present rate, federal, state and local authorities are expected to spend, net of intragovernmental transfers, $5.4 trillion in 2009—just under 40 percent of expected GDP.
The problem is that government stabilization measures come with a real long-term price tag: higher tax rates, greater national indebtedness and the prospect of higher interest rates driven by the government’s issuance of debt. These long-term costs of a larger government limit the American people’s willingness to rely on the public sector to drive overall economic growth. A fiscal gag reflex ensues, and the public-sector option looks less and less attractive as anything other than a temporary source of growth.
The major challenge facing U.S. fiscal authorities is meeting the need for near-term economic stimulus while pursuing a practicable plan to stabilize the government’s debt-finance obligations. The Secretary of the Treasury is doing his level best to reassure investors—both overseas and here at home—that the programs put in place by the Obama administration will work their magic and then be gradually withdrawn as the economy gets back into stride. But this is no simple task. It is now common knowledge that deficits are growing at $3 million per minute and will accumulate to some $9.1 trillion over the next decade.
And our fiscal predicament is compounded by the embedded unfunded liabilities of Social Security and Medicare. By our calculation at the Federal Reserve Bank of Dallas, the present value of the unfunded debt of these two entitlement programs has reached $104 trillion, with $88.9 trillion of that due to Medicare alone.
No comments:
Post a Comment