How come we have no Inflation?

11 Jul, 2019 0 comments
Pawel Rzeczkowski Pawel Rzeczkowski

I have just watched Jerome Powell’s Congressional Testimony and the issue of inflation came up in the questions. How come the FED is going to cut rates when the economy is considered to be strong? Is this not the time to raise rates?

Well, the FED is committed to maintaining inflation at around two percent as measured by the annual change in the price index for personal consumption expenditures, or PCE. Overall economic growth as measured by GDP has been steady, however that is not translating in increases in wages. We are continuing to have employer’s market, where the employer’s have advantage over employee’s.

This answers the question, how come personal consumption expenditures are not rising. However, this begs the question how come it is employer’s market when we are in a record setting eleven year long economic expansion!?!?

This requires a more complex multivariable answare:

  1. Since 2008, general labour participation has declines, meaning we have more capable people out there who are not even looking formwork. The slight uptick in June labour participation from 68.8 to 69% is positive but does not shift the pricing power to the employees. Thus salaries are not rising as on average corporations do not have to compete for labour, labour is competing for open positions.
  2. Number of public corporations is shrinking. This has been happening slowly but steadily over time. In the mid-1990s, there were more than 8,000 of publicly traded firms. By 2016, there were only 3,627, according to data from the Center for Research in Security Prices at the University of Chicago Booth School of Business. A very troubling side effect of this is our understanding of what’s happening in corporate america is declining as a result! Due to regulatory reporting requirements we know considerably more of what’s happening in public vs private companies. The point is fewer companies means fewer jobs, no wonder the “gig” economy is rising, but that is not contributing to increases in personal consumption expenditures. PE owned and private companies have very clear focus on profits as the profits are theirs to keep. Public company exec compensation correlates with the company size thus the incentive is to grow, this has significant implications on aggregate labor force growth, and consequently on the growth of personal consumption expenditures. More private companies is not a good thing for the economy at large.
  3. Structural technology driven change reduces the number of jobs. Just looking from 40K feet, the wining new economy companies ride the wave of structural shift from legacy industrial to networked economy that favors platformization, essentially winer take all economy, google in search amazon in retail, apple in consumer devices, and facebook and google in advertising. Those technology platforms are the new engine of the economy, but they employ considerably fewer workers than did Ford, GM or GE. Those changes will accelerate as essentially anything that is not powered by software and shifting to AI will face market challenges and soon extinction. That has huge implications on jobs and our aggregate growth of our personal consumption expenditures.

Thus here it is, given the overabundance of people available for work, given the shrinking number of public companies and shift in the corporate mix to private profit focused firms, and given the tech driven platformization of the emergent network economy, short of government driven regulatory changes, I do not see risk of more money flowing to the wage earners that could possibly drive up our personal consumption. We have no risk of inflation. Thus the FED is right to worry about deflation. And, that’s why they are considering cutting the rates.

Monetary policy however will NOT solve the lack of inflation issue. We need to ask ourselves collectively, what kid of world do we want to build as we are reimagining our organizations and institutions for the networked age. But that is a bigger and ultimately political and ethical question!

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