Bernanke vs Sticky Wages


New Market Update Video from Slipstream Trader Murray Dawes

Murray Dawes has released a new video analysing the markets for his YouTube Channel. This week he again looks at the Aussie Dollar/Japanese Yen currency pair, along with the FTSE 100, the ASX/200 and the S&P 500. Click on the image below to watch the video.

Market Update video

Click the image above to see the video

Once again, we turn to dishing out praise to those who don’t deserve it and need it most. The delusional and the mistaken. Can you guess who? The title probably gave it away.

First, let’s look at Bernanke’s opponent in the struggle for economic prosperity: sticky wages. Keynes coined the term ‘sticky wages’, or at least it was coined in his name. It describes the fact that wages don’t tend to fall in the same way that other factors of production do during a depression (now known as a recession).

When 2008 hit, oil, steel, copper, land and factory prices fell off a cliff. Wages remained comparatively high. And it’s this stickyness that causes unemployment. As any supply-and-demand graph will show, an artificially high price of something will cause less of that something to be used. In more human terms, the unwillingness of the employed to lower their wages is what creates the unemployment. Instead of everyone receiving less pay, some receive none. That’s what makes unreasonable unions so inhumane. They benefit members at the expense of the unemployed.

If wages were not sticky, the price of labour would fall as with other production costs and there would be far less unemployment. This is what happened in depressions for many years. And this explains their short duration.

The first time wages were ‘stickified’ was, coincidentally, the Great Depression. Keynes, despite pointing out the effect of sticky wages on unemployment, approved the policy of then President Hoover to maintain wage rates. Hoover even managed to increase them for a short time! It ended in a terrible and extended depression.

Since then, wages have only grown stickier, implying worse depressions in terms of duration and unemployment. But this is where Bernanke and his forebears come in. Instead of allowing wages to fall with other prices, the central planners have come up with the idea of increasing all other prices, thereby lowering wages in relative terms. The central planners created central banks to do so. And, contrary to common knowledge, the Federal Reserve did attempt to inflate the money supply during the Great Depression. It was the first time the Fed was used to fight a depression. (Again, coincidentally coinciding with the worst depression to date.)

But back in the 1930s, the population had a way of outwitting the inflationist policies of their central bank. They could go to the banks and demand the gold that their banknotes represented. Of course, when they did this, the banks had to reduce the currency in circulation. If they didn’t, too many depositors might turn up at their door and demand gold the bank didn’t have.

So you had the Fed inflating and the banks and depositors deflating the money supply. The two just about cancelled each other out – a fact that fools modern economists into thinking the Fed did nothing in that period. Keen to rob the citizens of this inflation escape mechanism, central banking has evolved into a fiat system. Now inflation is much more difficult to counter. At least for the general population. Still, gold is catching on slowly. Bankers are doing exactly the same thing they did during the Great Depression – parking all that new cash in excess reserves right where it came from. The Fed.

But it seems the Fed’s new fiat system is winning out over the banks and people’s deflationary preferences. The world’s CPIs are up.

As for the central banker’s mandate to maintain ‘stable prices’, don’t let that fool you. If the central bank maintains stable prices when those prices would be falling without central bank intervention, that is still an inflationary achievement. And it still counters the artificially high level of wages, as the prices of other factors don’t fall.

Don’t let the seeming inaction of central banks fool you either. All it requires for massive inflation to take place is for their targeted cash rate to be below where the free market would place it. Here is why: if the demand for funds goes up because of a bubble, the free market would increase interest rates to counteract the demand. But with a central bank targeting a specific interest rate, it subsidises that bubble by printing money to keep the interest rate from rising. In other words, the central bank encourages the bubble, even though rates haven’t changed.

Even increasing rates, if done too slowly, can stimulate the economy. As investment legend Marc Faber often points out, this is what took place in the mid 2000s. Despite rate increases, there was no tightening.

If the lack of tightening is realised too late by the Chairman or Governor of the central bank, then subsequent rate increases have to be dramatic to have a tightening effect. This is what America experienced under Chairman Paul Volcker. That’s why there is so much concern for America’s fiscal situation now. Its interest on debt is currently low, but could jump higher quickly if the Fed responds to inflation.

A final point on Bernanke’s efforts to battle sticky wages: why wouldn’t wages rise with other prices during a central banker’s inflationary effort?

Bernanke’s testimony, as paraphrased by John Mauldin, recently answered the question: ‘… wage inflation is unlikely in a period of high unemployment.’ The idea is that unemployment keeps wages low. People bid down employment opportunities.

So the theory sounds plausible. Because wages can’t fall, increase all other prices until the economy is back in equilibrium, but at a higher price level.

So, to sum up the ideal world of central banking: the central banker is curing the effects of sticky wages by greasing all other prices. Quite an undertaking!

And here the wishful thinking ends, because central bankers don’t understand the more insidious effects of inflation. Namely the misallocation of capital and its role in priming the next crisis. But even before we get to that, it seems Bernanke isn’t even winning the war against sticky wages. He has created inflation in the wrong parts of the economy. At least the less preferable when it comes to combating sticky wages.

As we have discussed previously, producer price inflation is running higher than consumer price inflation all around the world. This will decrease profits and discourage employment. Inflation in consumer prices above inflation in consumer prices would do the opposite. But it’s all inflation in the end.

And this is where the Austrian Business Cycle theory comes into its own. It explains why the inflationist quick fix causes the very imbalances it tries to fix. In the face of central bank policy, the relevance of the ABC theory today is genuinely astonishing.

The inflation that is intended to offset the inability of wages to fall causes a misallocation of capital. It attracts investment into areas that would not have been invested in without the inflation. The last cycle of this kind can be explained as follows: to battle the recession following the tech boom, the Fed kept rates low, providing masses of funding to the finance sector. That money flowed into a housing boom, a misallocation of capital. Then the cycle repeats. Bust, inflation, boom, bust.

The housing boom was fuelled with massive inflation, but the inflation is even more intense this time around. That implies a worse cycle next time. Where the bubble is forming is a tough question.

Some point to commodities. That could imply the bubble has quite some way to go. Another bubble contender is sovereign debt, which implies the bubble is popping now. Then there is China.

The important thing to note is that the bubble needn’t be in the sector of the economy that is experiencing higher prices. It is in the economy that is experiencing higher prices relative to where they would be without inflation.

So where is Australia in the Austrian Business Cycle timeline? Heading towards the bust, it seems. But with some intriguing variations.

Firstly, we didn’t get into as much trouble as other nations in 2008. Apart from the stock market, not much blew up. This implies the malinvestments that need correcting are still waiting for that correction. Not a pleasant thought.

What are those malinvestments? Resources and housing come to mind. When the resource boom turns to dust, will all those 100k+ wages remain sticky? They have little to cling to out in the outback. And Australia’s housing bubble, which seems to be punctured but not popped, is one of very few global housing markets to escape impressive declines. (Click here for an apt metaphor for the Australian Housing bubble’s gradual decline.)

But if things get bad we can look to Glenn Stevens to cut rates (and the Aussie dollar to plunge), stimulating economic activity and dampening any distress. The precedent for remarkably low interest rates has been set and the policy is now widely accepted. No central banker wants to be known for being too tight this decade around!

Remember though that such stimulus is what brings on the next bubble.

Putting the Australian bubbles topic into a global perspective leads to the big investment question of today: where will the cracked dam breach? In the USofA, or in the ROW (Rest of the World)? If ROW falls apart first, say the China bubble pops, as Dan Denning expects, then the flight to the dollar could still be on. It would be back to 2008 and more QE.

But what if America’s fiscal situation is suddenly perceived for what it is? What if the flight to safety can’t be to the dollar and treasuries because they don’t represent safety, they represent the problem? What if Peter Schiff is right again and ‘the only thing worse than holding dollars is holding a promise to be paid dollars in ten or thirty years time.’ Then, Daily Reckoning reader, we’re in trouble.

Vice President Joe Biden, the man charged with bringing together congressmen for Obama’s deficit reduction plans, fell asleep during Obama’s speech on the matter. And the recent $38 billion budget cut turned out to be made up of less than a billion in cuts.

Trouble it is!

From ETS to Carbon Tax to …

We have an extrapolation of how this carbon tax rubbish will end. Sound Money Sound Investments editor Greg Canavan spurred the thought in Thursday’s Daily Reckoning:

“The political imperative is already getting in the way of carrying out the intended reform. The result will be some half-arsed policy that has massive unintended consequences and fails to achieve its goals.’

This is an inherent part of government intervention, aided by the inherent nature of politics. A compromise leads to losses on both ends. Anyway, our extrapolation, not prediction, for the carbon tax is as follows:

We went from the Emissions Trading Scheme to the Carbon Pollution Reductions Scheme, to The Carbon Tax and next up is simply regulation of pollution. Probably administered by an existing agency.

Why is this likely? Well, it’s pretty much how the debate went in the US. And it’s logical. The environmentalists will get what they can by bidding gradually lower until they are successful. If the carbon tax fails, it will be watered down. It already has.

The key point is there will be a policy to combat climate change. But by the time the political process of bidding lower and lower is complete, we will be left with the policy that Greg Canavan describes above. It will not reduce carbon emissions. It will make a mess of everything else.

And don’t accuse us of being climate change deniers or science ignoramuses. We merely extrapolated the data, just like those climate change scientists do. And besides, Greg suggested a real solution to climate change.

Nick Hubble
For Daily Reckoning Australia

Nick Hubble
Nick Hubble is a feature editor of The Daily Reckoning and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about The Daily Reckoning, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.


  1. “the unwillingness of the employed to lower their wages is what creates the unemployment. Instead of everyone receiving less pay, some receive none. That’s what makes unreasonable unions so inhumane. They benefit members at the expense of the unemployed”.

    Hmm. And how many Directors, Executives and CEO’s have taken a pay cut during the recession.

    Typical capitalists, everyone but me, attitude Nick, you really need to be a little more open minded with respect to your idiology.


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