Saturday, January 27, 2007

Businessweek Business Outlook - All is Well and No Inflation

If you don't subscribe to Businessweek you should. It's revamped organizational format makes for an easy read. Though I don't pay a great deal of attention to the cover stories which to me are just shock value for media reach, I do regulary enjoy their columnists. The first section I turn to each Friday is the Business Outlook by James C. Cooper. He provides a concise analysis of current economic issues as well as relevant data and enlightening graphs. You can link to his post in the blog link section above if you are a Businessweek subsriber.

This week Mr. Cooper brings to our attention that it is possible to have strong economic growth with stoking the fires of inflation. This is largerly due to corporate cost control and productvity. Read below.

U.S. : A Stronger Economy? Yes. Higher Inflation? No
The rules have changed. Business is focused on cost control, not prices

Ask investors, especially those in the bond market, where they think inflation is headed in 2007, and they will most likely say down. They are probably right, but maybe not for the reasons they think. Many expect the economy to be weak enough to allow core inflation, which excludes prices for energy and food, to fall. The twist is that the economy is already proving stronger than anticipated, but despite that vigor, inflation may well decline anyway.

There is still a sense in the markets that a strong economy means higher inflation, and a weak economy means lower inflation. But over the past decade, the growth/inflation relationship has become a lot fuzzier, because the processes that influence inflation have changed drastically. A lot of market folks still haven't caught on, which can lead to misguided expectations about Federal Reserve policy and interest rates....

...In the past, labor costs have been a central factor pushing companies to lift prices, but this time the pressures may not be as intense. For example, although job markets were tightening last year at the same time energy costs were soaring, pricing power made only limited gains. Still, profit margins widened to record levels...

....The latest industry survey by the National Association for Business Economics shows margins continued to make steady improvement heading into 2007....

....One of the biggest problems in assessing the inflation outlook is knowing which measure of labor cost tells the true story. Right now, the most worrisome-looking gauges are the least credible..... Take the gains in average hourly pay for production workers.... that measure is not adjusted for the changing mix of jobs surveyed, which in recent years has favored higher-paying industries, such as business services and health care, thus lifting the average.

The Labor Dept.'s employment cost index, a more comprehensive measure of hourly wages, is not affected by changes in composition. It shows annual growth of only 2.5% in 2005 and 3.1% through the third quarter of 2006.

Another case is unit labor costs, or compensation adjusted for productivity. The Labor Dept. offers two versions: one for the nonfarm business sector and one for the nonfinancial corporate sector. The former shows unit costs through the third quarter up 2.9% from the year before, while the latter has risen only 0.5%. Many economists, even some at the Fed, believe the tamer-looking cost measures are closer to the truth.....

Excerpts from James C. Cooper Businessweek, Feb 5 , 2007

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