Business Activity Indicators
Financial Indicators - United States
Selected International Transactions - United States
In the previous issue of the Pulse, we showed that the consumer price index had gone up almost five-fold in the 40 years from 1960 to 2000. We also noted that this was in sharp contrast to the experience from 1870 to the 1930s when the price level was relatively steady except for the World War I period.
This sharp contrast brings up the question of why things changed so much. What happened to the economy to result in such
opposite results? To try to answer these questions, we again quote economist G.L. Bach, writing in 1957:
"Except in war, the prodigious productivity of the American economy has made it hard for inflation to get a toehold.
Though total spending has risen decade after decade, the goods and services poured out into the market have risen apace."
In this statement Bach points out that rising productivity should keep prices in general from rising. Higher productivity means that a larger quantity of goods or services can be produced with the same amount of labor, resulting in a higher return on capital. A good example is Henry Ford's famous introduction of the assembly line for producing automobiles. As a result of this innovation, productivity rose so much that he was able to raise the wages of his workers, increase his own profits, and reduce the price of the automobiles simultan- eously. This could be viewed as the ideal sharing of productivity gains, but it is not the norm, as shown in the following graph:
Source: Bureau of Labor Statistics
Rising productivity did not prevent an increase in the price level; it also did not prevent an accelerating increase in the price level. Of particular note is the divergence after 1970.
Bach estimated that the economy had been growing at about 3 percent per annum at the time he wrote, and this rate rose to 3.5 percent in the 40 years from 1960 to 2000.
Another broad-brush way of measuring productivity growth is shown by the following data:
|Industrial production (1992=100)||36.5||147.5||304.1|
|Manufacturing employment (millions)||16.8||18.5||10.1|
This data shows that production tripled over 40 years with only a 10 percent increase in employees, a very impressive gain
indeed! To again quote Bach (Inflation, pg. 39), "But why inflation at all in the face of this huge increase of goods and services
available to purchase?" He then goes on to list six major trends that he believed would result in continuing low inflation, most of
which now seem dated. Two of his points, however, are worth quoting in our attempt to answer the same question that he was
"(3) The Increasing Political and Economic Strength of Major Socio-economic Groups and the Increasingly
'Administered' Structure of Prices in the Economy.
"The third force increasing the likelihood of inflation is the increasing political and economic strength of major socio-economic groups and the increasingly 'administered' structure of prices in the American economy. There has been a persistent, though not steady, tendency in all democratic countries for trade unions to become stronger. This means an increasingly powerful upward push on wages the major component of costs in the modern economy. But equally important, as economists discovered a quarter century ago, most other prices in the American economy are no longer established impersonally in highly competitive markets. Instead they are 'administered' - set by leading firms, and by bargains between leading buyers and sellers. Often these bargains are closely constrained by the competitive pressure of the market, but administered the prices and wages are, nonetheless. Many services are priced in this way.
"(6) The end of the Gold Standard
"The sixth factor underlying the prospect for inflation is the ending of the gold standard. It is now a quarter century since the late gold standard went to its generally unlamented death. Surely the gold standard had many failings, and I would not want to see it back. But with all its failings, it did provide a monetary 'religion' that brought the government and the public up short when they felt the urge to spend more than they were taking in both through the check it imposed on expansion of the money supply to finance new spending and through the international gold drain if inflation exceeded the rate of other countries. Today the gold standard, fair weather friend that it was, is gone, and we have nothing to put in its place save our own resolution. Perhaps a modern-day equivalent of those gold standard watchdogs, the international bankers, would make us squirm more when we contemplate the inflationary consequences of our policies. But none such looms up on the horizon - nor do we really show signs of wanting one."
In these two points, Bach focuses on the two broad areas that are involved in any inflationary experience. One is the structural factors in the economy propelling prices upward. The other is the monetary practices that make the rising prices sustainable.
To understand how these two factors must interact to produce inflation, let us imagine an economy in which income, consumption, and production are stable and the money supply is constrained by some impersonal factor such as the supply of gold. Now imagine that the price of oil rises substantially and unexpectedly. Since the amount of income does not change, consumers will pay more for energy and will have less to spend on other items. The price of these items will tend to fall since demand for them decreases. The net result is that the price level overall remains stable.
Now let us imagine that after the oil price rise, manufacturers raise their prices due to higher energy costs, workers obtain higher wages because their living costs have risen, and the Federal Reserve enables the banking system to create sufficient additional money to maintain production at the same level even though prices have risen. In this case, the net result is that the price level overall has risen. The difference between the two scenarios is the presence of or absence of an impersonal constraint on the growth of money. (Essentially, this is what happened in the 1970s.)
As noted in the last Pulse, the U.S. experienced little or no inflation through the 19th and first third of the 20th centuries except in war periods, although there was enormous growth. Rising productivity, in Bach's words, made it difficult for inflation to take hold except in war periods. The decentralized nature of the banking system, however, also made it difficult to increase the money supply faster than the increase in production. Periodically there would be money "crunches" that would temporarily bring expansion to a halt, but also helped to maintain a stable price level. In the last two-thirds of the 20th century we still had rapid productivity gains, but we did not have an impersonal limitation on the process of money creation. This appears to be the main factor in creating the inflationary surge that occurred. Our task, then, is to identify the structural changes in the economy that tended to push prices up, and the monetary and banking changes that made it possible for the price increases to persist.
Both the structural and the monetary factors are complex, and "lie deep in our basic democratic political and social processes as well as in our particular economic institutions" in Bach's words, but we will attempt to outline an updated version of each in future issues. The main theme of the current article is to point out that inflation has persisted for decades despite continued productivity gains that should have kept it in check.
|Canada||Germany||Japan||United Kingdom||United States|
|Real GDP (% chg. at annual rate)|
|Industrial Prod. (1992=100)|
|Retail Sales (volume chg. 1 yr.)|
|Consumer prices (1995=100)|
|Interest Rates (3 months)|
|Stock Indices (ending)|
|Current Acc't Bal's ($bn) latest 12 months|
|Foreign Exchange Rates|
|Currency units per U.S. $
UK pound in U.S. $s
U.S.: index of major trading partners : 1973=100
# Euro zone
|Sources: Economist, Economic Indicators, F.R. Bulletin|
World recession is glaringly evident in the GDP figures for the year ended September, 2001. All countries in the table showed growth of less than 1.0 percent except Britain, where the cycle seems to be behind the other four economies. Industrial production fell from the 2000 level in all countries except Germany. Notably, GDP growth and industrial production in Japan weakened after rises in 2000.
Retail sales growth also fell in all countries except Britain, strongly in Canada, Japan, and the U.S. Consumer prices, however, advanced near the 2000 rate except in Japan where they are virtually at the 1995 level. With this background, unemployment rose in Canada, Japan and the U.S.
In an attempt to combat economic weakness central banks have been lowering short term interest rates, led by the U.S. where rates are about 2 percent lower than in 2000. In the year to October, broad money growth was 13 percent in the U.S., its fastest since 1981; it was 8.1 percent in Britain. Stock indices reflect the economic weakness with sharp declines in all five indexes, averaging around 25 percent. The U.S. average rose in the fourth quarter but still ended lower than where it started the year - the second consecutive yearly decline.
Canada's current account balance surplus almost doubled in the year to September, thanks to a positive trade balance of $44.46 billion. Japan's surplus during the same period shrank to less than $100 billion, which will exacerbate its problems. The U.S. deficit shrank slightly as the negative balance on goods declined while the positive balance on services increased.
The exchange rate of all five of the countries in the table fell versus the U.S. dollar. Presumably U.S. markets seemed more promising to foreigners than those at home, but these swings made little sense economically. For example, Canada had a current account surplus of $23.9 billion whereas the U.S. had a deficit of $-430.7 billion, yet the Canadian dollar declined versus the U.S. dollar.
|Business Activity Indicators - United States|
|Industrial Production (1992=100)||139.4||147.5||141.4 *|
|Manufacturers' New Orders (billions of $s)||338.5||362.5||335.2 #|
|New Construction Expenditures (billions of $s)||763.8||815.4||861.9 *|
|Real Gross Priv. Dom. Invest. (chained$s)||1,660.1||1,772.9||1,668.9|
|Business Sales - Mfg. & Trade (billions of $s)||787.1||843.3||833.2 #|
|Business Inventories (ending) (billions of $s)||1,138.6||1,204.5||1,173.3|
|Retail Sales (billions of $s)||238.6||256.9||263.3 #|
|Retail Inventories (ending) (billions of $s)||391.8||417.9||414.7|
|Per Cap. Personal Consump. Expend.'s (chained  $s)||21,381||22,152||22,495 *|
|Nonagricultural Employment (millions)||128.9||131.8||132.5 #|
|* Annual Rate
# Monthly average
|Source: Economic Indicators|
GDP, the Growth God (see Pulse #01-2), weakened further in 2001. This weakness first appeared in the third quarter of 2000 when growth fell to 2.2% from 5.6%. It then fell to 1.0% in the fourth quarter, 1.3% in the first quarter of 2001, 0.3% in the second, and -1.1% in the third. The fourth quarter also appears to have been negative, putting the U.S. technically in a recession, the first since 1991.
Industrial production declined from 2000 but remained above 1999. From February through October, production was below the year-ago month, and durable goods declined more than non durable. The capacity utilization rate fell relatively more than output, reaching its lowest level since 1983. This indicates over-capacity, which could impede any quick rebound in business investment spending, the source of the present economic weakness. Manufacturers' new orders were below the 1999 level.
New construction expenditures remained quite strong through the first three quarters of 2001 but did stop rising after April. The contracts value index rose to a new high while the vacancy rate for rental housing was rising.
As noted, the present weakness is centered in gross private domestic investment, which has been falling since the second quarter of 2000. Investment in non residential structures, equipment and software, and inventories declined while residential investment rose.
Business sales for the first nine months ran a bit below 2000 but well above 1999. Retail sales continued to advance. Business and retail inventories trended lower. These changes occurred despite an advance in per capita personal consumption expenditures to a new record $22,495 (a.r.), though the growth rate slowed.
Employment is the most politically sensitive of these indicators, and here the peak was reached in March at 132.65 million from which it fell to 131.43 million in October, a decline of 1.22 million. This net decline was almost entirely in goods production, but services employment also fell after August, while government employment tended to rise. These declines continued in October and November.
|Financial Indicators - United States|
|National Income (billions of $s)||7,462.3||7,980.8||8,189.0 *|
|Per Cap. Disp. Personal Income (chained $s)||22,641||23,148||23,725 *|
|Avg. Real Gross Wkly Earnings (1982=100)||271.25||272.16||272.30|
|Gross Saving "||1,707.6||1,785.6||1,752.6 *|
|Commodity Price Index (1995=100)||73.5||72.7||67.7|
|Producer Price Index (1982=100)||133.0||138.0||141.6|
|Corp. Profits (with i.v.a.&c.c.a.) (billions of $s)||825.3||876.4||748.8 *|
|Interest Rates - 10 year Treas.||5.65||6.03||5.10|
|Money Supply - M3 (ending) "||6,531.0||7,114.3||7,839.7|
|Fed. Res. Open Mkt. Operations @ thru Aug "||135.8||-63.9||16.0 @|
|Federal Gov't. Current Surplus or Deficit (NIPA) "||119.2||218.6||127.3|
|Commercial Bank Credit (ending) "||4,770.4||5,215.6||5,400.2|
|Consumer Credit (ending) "||1,413.6||1,557.9||1,621.6|
|Credit Market Debt (ending) "||25,737.7||27,524.7||27,874.3|
|* Annual Rate
@ Net purchases/sales
|Sources: Economist, Economic Indicators, F.R. Bulletin, F.R. Flow of Funds|
National income continued to grow in the first three quarters of 2001, but the pace slowed in the third quarter. The most pronounced weakness was in corporate profits, which peaked in the third quarter of 2000 and fell by almost one-fourth (a.r.) by the third quarter of 2001. As indicated by the percent change, the gain in 2001 is likely to be about half that of 2000.
Per capita personal income received a considerable pop in the third quarter from federal tax rebates, resulting in a 4.6 percent (a.r.) gain for the period compared with a 2.2 percent rise in 2000. Real weekly earnings advanced slightly.
Gross saving fell moderately at an annual rate due primarily to a drop in government saving. Personal saving rose as many individuals held on to their tax rebates rather than spend them.
The weakness in the world economy is reflected in the commodity price index, with all sectors below 70 percent of their 1995 level. Producer prices for finished goods, however, rose in 2001 but less than in 2000. Curiously, there is less divergence among various categories (such as capital equipment and consumer goods) than at any time in the last decade - all are around the 140 level.
We have already noted the decline in corporate profits in discussing national income. This decline is likely to discourage an increase in business investment, the weakest sector of the economy.
The yield on the 10 year Treasury bond reached its lowest level in over a decade during the fourth quarter of 2001, 4.30 percent, but is likely to rise again as the federal budget surplus is replaced with a deficit.
Rapid growth of the money supply is not usually a characteristic of recessions, but it is of the current one. M-3 money growth during the nine months was the second highest in two decades although debt growth was comparable with recent years. Federal Reserve open market operations through August have been moderately stimulative, while the federal government incurred a current deficit in the third quarter of 2001 for the first time since 1997.
An examination of the data for bank credit shows that credit expanded at a slower rate in 2001 than in 2000 despite repeated reductions in the federal funds rate designed to stimulate it. This is the phenomenon described as "pushing on a string". Creating additional money to lend does not assure that it will be lent - that depends on the prospect of being able to use the money profitably and thus being able to repay the loan. This same slowing trend is apparent in the consumer credit data.
Credit market debt expanded near the 2000 rate, but some of the details are of interest. In the nine months, non financial debt expanded 4.5 percent while financial debt grew 8.1 percent; household debt grew 6.5 percent while business debt grew 4.6 percent. Significantly, foreign held U.S. debt fell 6.4 percent ($56.7 billion), its first decline since 1994.
|Selected International Transactions - United States|
|Trade Balance on Goods & Services ($bns)||-261.8||-375.7||-263.2|
|US Owned Assets Abroad, net [inc/capital outflow(-)] "||-437.1||-581.0||-330.7|
|Foreign Owned Assets in US, net [inc/capital inflow(+)] "||813.7||1,024.2||625.4|
|Net change in Foreign Owned U.S. Securities|
|Sources: Economic Indicators, Survey of Current Business|
U.S. exports began to decline in the fourth quarter of 2000, and imports followed in the first quarter of 2001. The negative balance on goods declined in each quarter of 2001, while the positive balance on services jumped $11.1 bn in the third quarter, presumably related to the receipt of insurance payments in connection with the 9/11 attack.
Capital flows also fell through 2001 to a level approximating that in 1999 rather than 2000. Foreign entities continued to divest their holdings of U.S. Treasury securities while increasing their holdings of other U.S. securities, both at lower rates than in 2000.
Copyright © Andrew Caughey, 2002
The Pulse of Capitalism is published quarterly. Comments may be sent to Pulse Publication, P.O. Box 140, Gibsonia, PA 15044. Telephone: (724) 443-2396
Material may be reprinted with acknowledgement of the source. Economic statistics are revised routinely and may, therefore, differ from one report to another.
Published 17 January 2002