Friday, September 10, 2010

Falling Incomes & Prices Stoke Delation Fears

The Commerce Department reports that incomes fell in 49 of the country's 52 biggest metropolitan areas last year. The only areas that saw incomes rise were Washington, DC, San Antonio, Texas and Virginia Beach, Va. All three cities have a strong presence by the federal government or the military.

The decline in wages is a worrisome development. It coincides with a drop in prices; the Consumer Price Index has fallen three months in a row.

Both data points stoke fears of deflation.

Excluding oil, prices are climbing at a very slow 1.2 percent pace, much slower than the Federal Reserve would like. The Fed likes to keep interest rates below the inflation rate. But with the Federal Funds rate near zero, there is little wiggle room should prices continue to fall.

While falling prices might not seem like such a bad thing to the average consumer, falling wages are another thing altogether. Falling wages make debt repayment all the more difficult. And considering the size of consumer debt in America right now ($13.5 trillion), that would be a very bad thing.

The Labor Department announced that business productivity declined nearly one percent in the second quarter, and yet labor costs hardly rose. It was the first time that productivity declined in a year-and-a-half. The bad news for workers is that they are working more and barely being compensated for it.

After all the trillions the Fed has pumped into the economy and banking system over the past two years, the greater concern should be price inflation. But that is nowhere in sight.

To fend off signs of deflation, the Fed may continue to print money, and lots of it. And it will continue buying Treasuries as well — lots of them. Through its purchases of more government debt, the Fed hopes to keep money from draining out of the financial system.

But after lowering rates to nearly zero, pumping money into the Big Banks, and buying enough mortgage-backed bonds to drop the mortgage rate to record-low levels, the question is, What more can the Fed do?

Even if money is cheap and readily available, no one can force people to borrow. People with huge debts, falling wages, no jobs, or the fear of losing their jobs, will not be persuaded to borrow.

And therein lies the problem: our entire economy is based on borrowing and lending for economic growth to occur. Money is created through borrowing. Without borrowing, there is less money and no growth. Absent growth there are no jobs. And without jobs there is no recovery.

The fear of so many economists is that the US might follow Japan's path into a "lost decade" of our own.

And that is a disturbing and worrisome possibility at the moment.

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