Leaving wet footprints on the carpet of an inn, we slumped there in relief. We slipped, slid, sloshed and cursed our way down that stream until we saw a light at the end of this confounded tunnel of trees. Chancing upon a stream, with bleak logic, my mate and I reasoned that the stream had to lead to a river that had to lead to civilisation. It was raining steadily, and we had nowhere to stay. It was dusk in an ominously quiet forest somewhere – I’m still not quite sure where – in mid Wales, more than 30 years ago. NOW WATCH: 4.It’s been an awfully long time since I asked myself that question without the means to answer it straight away. Remember, this is called an "impossible trinity" for a reason: someone loses.
Which, depending on how you see it, is either good or bad.
Namely, corporate profits.Īnd it is these profits have buoyed financial markets, which to an extent have allowed the economy to come as far as it has in the seven years since the recession. On both the right (Donald Trump) and left (Bernie Sanders), presidential candidates have rallied around this idea and seen success.īut any pickup in these wages would have to come from somewhere. The current political cycle in the US has seen the decline of middle-class working wages get significant play as something that must be addressed. Current levels of the stock market do not suggest that equity investors are prepared for profit margins halving in the next 3-4 years. The historical relationship with corporate profit margins would suggest that in this scenario, profit margins would fall by nearly 1.3 percentage point a year from their current levels of 10 per cent. In some ways, recent signs from the Federal Reserve that it is willing to let the economy ‘run hot’ for a while, that is, tolerate inflation above its two per cent target might signal this is the central bank’s preferred outcome.Ĭonversely, if the Fed chooses to enforce its two per cent inflation target religiously, the labour share of output would grow at 1.5 per cent per annum. This implies inflation has to rise to 3.5 per cent and would decimate many fixed income investors given current inflation expectations for the next five years are barely over one per cent currently. Firstly, the labour share of output, and therefore corporate profit margins, remain constant at current levels. The problem is that this sort of looks like it can go two ways and there are losers in multiple directions.Ĭonsider two possible scenarios in this situation. (Or: will aggregate US economic output decline?) Right now, the US corporate economy is in a profit recession - a year-on-year decline in profits - and the question has become whether or not this will tip the broader economy into recession, too. But the Fed also wants investors to be happy - the "third mandate" of the Fed is financial stability, which has come to be taken as stocks not tanking and bond yields not ripping higher - which would potentially be jeopardized by a prolonged and sustained decrease in profits. Investors, meanwhile, want more profits and earnings. Īnd so it is the tension between these forces that really gets at the heart of why markets seem so stalled out right now.Īgain, the Fed explicitly wants inflation to move higher and wages to increase, and DB argues that Fed officials continually citing less-than-stellar wages increases as evidence of slack remaining in the labor market make this a de facto official reason for keeping rates low. Or in economist speak, increases in nominal wages must equal the sum of productivity improvements, price rises and changes to labour’s share of output (which is the flip-side of profit margins). They can either pass on the extra costs to customers, thereby leading to higher overall prices and rising inflation, or they can absorb the extra costs resulting in lower profit margins. If workers’ wages rise faster than their productivity, the companies paying those higher wages face two choices. The theory behind this new ‘impossible trinity’ is intuitively simple. Slightly more comprehensibly, this formula accounts for how much output a business gets per hour worked by its employees, how much the business gets paid for that output, and then how much of that pay is transferred to employees. Wages, as DB outlines, are the sum of labor productivity, prices, and labor's share of output. But so the new trinity facing the US economy is that policymakers - read: the Federal Reserve - want inflation to run closer to its 2% target and wages to increase, while investors attribute much of the success of the post-crisis stock rally has been underpinned by high levels of corporate profitability (and, as a result, higher earnings).
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