Why living standards continue to rise

For the past 25 years, inflation has averaged 1.8% per year, but that disguises the fact that prices of durable goods have been falling by a significant amount. Is that a problem? Hardly, since a big decline in the prices of durable goods has dramatically increased the purchasing power of the average worker.

Chart #1

Chart #1 it shows the three major components of the Personal Consumption Deflator index (a broader and better measure of inflation than the CPI): services (which are largely driven by wages and salaries), durable goods (e.g., equipment, computers, cars, TVs), and nondurable goods (e.g., food, gasoline, clothing). Total inflation over the time period represented here was 55% (an annualized rise of 1.8% per year), but looking deeper we see that wages rose 85% while durable goods prices fell 38%. At the risk of over-generalizing, this means that wages over the past quarter century have gone up 200% relative to the prices of durable goods (1.85/.62). That's equivalent to saying that one hour of the average person's work today buys three times more durable goods than it did 25 years ago. It's no wonder that these days nearly everyone has a smartphone and nearly every house has at least one big-screen flat TV. 

Such a divergence between wages and prices has never happened before, as I first noted in a post over 9 years ago. Prior to 1995, there was never a time in modern history when any major category of prices experienced a sustained decline. Why did this change beginning in 1995? For one, that's about the time when personal computers began to proliferate. But it's also the case that 1995 marked the beginning of China's emergence as a major exporter of durable goods. China's economy has become a powerhouse of productivity as hundreds of millions of Chinese workers have benefited from the introduction of modern equipment and capital. This in turn has raised the productivity of all workers globally, and it has resulted in a significant increase in global economic prosperity. What's good for China has been good for nearly everyone in the world.

Chart #2

Computer deflation is coming to an end, however, as Chart #2 suggests. Note that this series began in 1998; prior to that the BLS didn't consider it important to create a separate price series for personal computers and peripherals. But by then they were already plunging in price. The cost of personal computers fell 36% in 1998, 22% in 2002, 12% in 2006, and 6% in 2010, but prices are down only 1.3% in the year ending last August. Computers and related equipment are not going to become ever-cheaper for much longer. Plus, the Chinese economy is slowing down and tariff wars are like sand in the wheels of commerce. It's been a great ride, but it's slowly coming to an end.

Chart #3

On the bright side, prices of nondurable goods haven't increased at all for the past 8 years (see Chart #1). And as Chart #3 shows, commodity prices in general haven't gone up for more than 10 years. Wages, in short, continue to go up relative to things. That's another way of saying that living standards continue to rise. 

Jobs growth continues to slow, but it's not a problem

For the past several months, I've observed that the growth rate of private sector jobs was slowing. Today's jobs report—which was much weaker than expected (96K vs 150K private sector jobs) only confirmed that. It's not a cause for concern or a precursor of a recession, however. Most likely it just reflects the fact that it's getting harder for employers to find new workers.

Chart #1

Chart #1 tracks the monthly change in private sector jobs. It's pretty clear from this that jobs growth has been decelerating since last January. It's also true that jobs growth has decelerated prior to the last two recession. This time, however, things look very different. Unlike the runup to prior recessions, to date the Fed has not restricted liquidity; real interest rates are very low; credit spreads are very low; and systemic risk is very low. The only other sign of a recession is the inverted yield curve, but as I explained in a prior post, today's inverted yield is a sign of risk aversion, not a sign of an economy struggling under the burden of tight money.

Chart #2 

Chart #2 shows the 6- and 12-month rate of change in private sector jobs. I think this is the only reliable way of judging whether jobs growth is accelerating or not. Monthly numbers are way to volatile—and subject to huge revisions—to come to meaningful conclusions. What we see now is that jobs are growing at something like a 1.3-1.6% annual rate. That's down quite a bit from the 2.0% rate which prevailed around the end of last year. But it doesn't condemn the economy to a recession or even to an uncomfortably slow rate of growth. For the first six months of this year, labor productivity surged to an almost 3% annual rate. Slower growth in jobs has been accompanied by faster growth in the average worker's value added. There's nothing wrong with that, especially since productivity has been rising for the past several years after having been dismally weak for most of the current expansion.

Over the past year, productivity rose by almost 2%. Thus, a relatively weak 1.6% growth in jobs in the past year generated real GDP growth of 2.3%. If productivity continues to pick up (thanks in no small part to Trump's deregulation efforts), then a measly 1.3% growth in jobs could deliver 3% real growth or more.

Chart #3

Chart #3 tracks first-time claims for unemployment, which typically begin to rise in advance of recessions as businesses sense a deterioration in their business outlook and attempt to shed workers and cut back on expenses. That's certainly not the case today! The worst that can be said about claims is that they have been flat for the past 12 months, averaging 217K per week.

Chart #4

Chart #4 divides unemployment claims by total payrolls. By this measure, unemployment claims are much lower than they have ever been before. This is a virtual "jobs nirvana" since it means that the chance of the average worker being fired is lower than ever before. And on top of that, wage growth has been accelerating: average hourly earnings rose 3.2% in the past year, and that's up significantly from the 2.0% pace that prevailed in 2014 and the 2.6% pace of 2016.

Chart #5

Chart #5 compares job openings with the number of persons unemployed but looking for work. There are more jobs available than people looking for jobs, and that's been the cast for over a year.

Slow jobs growth these days is not a sign of a deteriorating economy, it's a sign of a healthy labor market that continues to seek out new hires, only to find it difficult due to a shortage of people willing to work.

Tariffs are really beginning to hurt trade and manufacturing

It should not be surprising to learn that Trump's tariff war with China is having a negative impact on the US economy and global trade. Tariffs inhibit trade, and most of the tariff hikes to date have been directed at manufactured goods. The latest data show just how much this impact has been, and it is not insignificant.

Chart #1

Today's release of the August ISM manufacturing survey data showed a big drop in export orders (see Chart #1). The August reading of 43.3 was the second lowest in history of this data series, worse than the late 1998 reading, which was negatively impacted by the S.E. Asian currency devaluations in early 1998 and the Russia/LTCM implosion in late 1998. Only the Great Recession generated a weaker number, and that, in turn, reflected the worst collapse in global trade since the Depression. (As an aside, the collapse of trade that occurred in late 2008 was largely a function of the inability of exporters to get letters of credit from a global banking system that was in complete disarray.)

Chart #2

The overall ISM manufacturing survey began to weaken in late 2018, and by now, a slump in activity in the manufacturing sector has put considerable downward pressure on US GDP, as Chart #2 suggests. Though it's not likely enough to tip the economy into a recession, it is nevertheless of concern. The bond market has not been blind to this, however, as suggested by the significant decline in real yields since late last year. By my estimates, 0% real yields on TIPS most likely are priced to a slowdown in GDP growth to 2% or possibly less for the foreseeable future.

Chart #3

As Chart #3 shows, the volume of world trade has been declining since its Oct. '18 peak. (The latest datapoint is for June '19; undoubtedly the index has weakened more since then.)

Chart #4

Chart #4 reflects Chinese trade statistics through July of this year. China's exports to the US have not been greatly harmed by the imposition of tariffs, most likely because the yuan has fallen almost 13% since Trump first began slapping tariffs on Chinese imports. Chinese manufacturers effectively have absorbed the brunt of the US tariff costs by accepting a lower dollar price for their goods while receiving more yuan per dollar of sales. The decline in Chinese imports from the US can be attributed not only to China's imposition of retaliatory tariffs on US goods, but also to the fact that the weakness of the yuan has boosted the yuan cost of US imports by over 14%. 

Chinese imports from the US have suffered significantly of late. According to Chinese statistics, July'19 imports were 19% below the level of a year earlier. US statistics confirm this, showing that June '19 exports to China were down 17% from a year earlier.

Chart #5 

Tariff-related trade tensions have plagued the markets for most of the past month. 10-yr Treasury yields have fallen below 1.5%, driven by risk aversion (Treasuries are classic hedges against a weakening economy and they are the ultimate safe-haven asset) and declining growth expectations. Meanwhile, the Vix index has risen as fear and uncertainty drives demand for the risk-reducing properties of options in lieu of outright positions. 

UPDATE (9/5/19): The manufacturing sector is definitely hurting these days, but the much larger service sector—which accounts for over 70% of total private sector payroll employment—is doing just fine.

Chart #6 

Service sector business activity rebounded strongly in August (Chart #6). July's plunge was most likely a reflection of worried sentiment (this is all based on surveys of people's opinions) rather than an actual deterioration in business activity.

Chart #7 

The employment index (hiring intentions) softened a bit in August, but remains at a healthy level (Chart #7).

Chart #8

The Eurozone service sector survey reveals a continuing improvement, albeit modest, from the depressed levels of late last year. (Chart #8)

Chart #9

The service sector New Orders index rebounded in August from depressed July levels. Like Chart #6, this likely reflects improving sentiment (less worried sentiment) rather than any fundamental change in new order activity.

The service sector remains healthy, and that is a nice offset to obvious weakness in the manufacturing sector. The economy as a whole is thus likely to continue growing, albeit at a less-than-impressive pace (~2%).