Opinion

James Saft

Waiting for labor’s gains

October 4, 2011

James Saft is a Reuters columnist. The opinions expressed are his own.

HUNTSVILLE, Ala. – Right about now, even the most committed capitalist investor ought to be hoping for one thing: that labor soon has the upper hand.

That’s because the whole edifice: the global economy, the consumption-based developed economies and the share prices they power are crumbling because average workers simply haven’t got enough earning and buying power to play their central role.

Wages in the U.S., for example, have been stagnant for the best part of 40 years, during which time the consumption merry-go-round has only been kept spinning through a combination of artificially high asset prices and spending borrowed money.

Consumer incomes actually fell in August for the first time in almost two years, according to new data, and consumer spending only eked out a modest gain due to a sharp fall in the savings rate. Given that people are living longer and have stressed balance sheets, dis-saving is a tactic that will only work for so long.

This state of affairs has allowed corporate profits, as a share of the economy, to hit their highest point in the second quarter since records began in 1947, and on track to hit an annual high since at least 1929. Even the stock market no longer sees that as evidence of rude health, as shown by the steady, grinding decline in prices relative to earnings.

To be sure, this long-term stagnation in wages is in substantial part because of globalization. Some of what labor in the developed world lost has been converted to gains for labor in emerging markets, where income has surged over the past decade. Nonetheless, the system is predicated on consumption in the west and that consumption is crimped by stagnant incomes and high debt loads.

Up to a point this will be self-correcting. Wages in China, for example, have grown strongly, which will eventually lead to domestic consumption there and to a balancing out in the relative costs of production. Sadly, that long-term solution is not going to arrive in time to save this morning’s equity investors, which is perhaps why so many of them are deciding to become this afternoon’s debt investors.

This is the catch for equities; a vibrant economy depends on a rebalancing of negotiating power between labor and capital, but that very process is going to undermine corporate profits, and with them stock prices. The best strategy may well be to remain structurally underweight equities until that rebalancing has happened or until the stock market moves ahead to price it in.

UNSUPPORTIVE POLICY

There has, rightly, been a great focus on debt in the current malaise, with much head-scratching over how to deal with Greek sovereign debt and individual mortgage debt. That’s natural because debts come due and when defaulted upon have a nasty habit of causing a chain of defaults through the economy. Even so, the focus then has been on how to protect debt holders from the consequences of their foolishness and the foolishness of the parties they loaned money to.

“Almost all remedies proposed by global authorities to date have approached the problem from the standpoint of favoring capital as opposed to labor,” bond giant Bill Gross of Pimco wrote in a note to clients.

“If the banks could just be stabilized, if the ‘markets’ could just be elevated back in the direction of peak 401(k) levels, if interest rates could just be lower so that borrowers would inevitably take the bait, then labor — job creation — would inevitably follow. It has not.”

In the case of Greece, that is because austerity only makes it weaker and less able to bear the debt’s burden. In the case of over-indebted mortgage holders it is because most loan modifications leave the borrower with more than they can afford.

All of what we are describing is deflationary, which makes the epic rally in government bonds seem not so much a bubble as a down payment on future gains.

Investors hoping, as they will and as they should, to make profits need to get some things straight in their own minds: who, exactly, is going to buy all of these goods and services and where are they going to get the money?

It is not clear that monetary policy can address this. Its success rate so far is not great. It is far less clear that fiscal policy will even be given a chance.

It is reasonable to expect that eventually western labor will make gains, and that emerging market labor’s new buying power will slowly build and provide a buttress to global demand. That’s not happening any time soon, to judge by the run of events, which is a good reason to remain shy of equities.

At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.

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