Several of my recent columns that included discussions of the economy and the Fed have elicited queries concerning whether they indicate that my position on the macro trajectory for the economy and monetary policy has changed.
The short answer is that my position has not changed. However, the fact that there have been so many similar inquires implies that I've done a poor job of relating the concerns I have about the immediate economic environment and Fed policy, so I'll address the issues here.
To reiterate my medium to longer-term view of monetary policy, economic activity and long-end bond yields, I continue to believe that the Fed will need to implement more stimulus measures, which will be required due to a lack of aggregate demand, consumption and inflation, and that the 10- and 30-year U.S. Treasury yields will decline to below 1% and 2%, respectively.
For the purposes of this column, I'll leave those observations at that.
My immediate concern about economic activity and monetary policy is that issues are unfolding that are not supposed to be, the Fed is not acknowledging them directly, and capital market participants are not evidencing an awareness of them.
The first of these issues is the increase in wage growth rates over the last few months, which is occurring coincidentally without an increase in demand and consumption.
According to the dominant operating economic theories, which provide the reference for monetary and fiscal policy decisions, consumption leads wages, wages do not lead consumption.
The fact that wages are now leading consumption is not a minor issue and may be a symptom of a systemic or structural change in the functioning of the economy that has implications for monetary policy and capital markets.
One reason this issue is not receiving attention is that it's counterintuitive. Wages leading consumption is the way most people think about consuming -- i.e., I'll buy a new car after I get a raise. Because of the way data is collected, though, that's not the way it's evidenced in economic reports.
This structural change most probably is the result of the increase in technological unemployment that is leading to the bifurcated economy, which I discussed in the column, "The Fed's Dual Mandate Tug of War."
The Fed leadership is surely aware of this situation even though they've not commented on it publicly. If the trend continues, the Fed will not have the option of ignoring the issue and investors need to be aware of that beforehand.
The prevailing hope right now appears to be that this is a temporary situation that will correct itself as those with rising incomes increase their consumption and in so doing create the possibility of income opportunities for the unemployed.
That logically would be an extension of the wealth effect the Fed has been hoping would occur because of rising asset prices afforded by low interest rates. That is, that rising asset prices cause consumer confidence among asset owners to increase, leading to an increase in consumption by them, which trickles down into the rest of the economy, producing similar results.
The problem is that the wealth effect hasn't been borne out over the seven years since the last recession officially ended. Hoping that an "income effect" will succeed in driving consumption is illogical and without precedence.
What is more logical based on the current totality of economic reports is that the bifurcation of the economy into "haves" and "have nots" will continue and accelerate.
This is not an immediate issue for the Fed to deal with, but it is most probably an issue it will need to address at some point within the next year as the rate of increase in wages of the past few months continues.
If wage growth accelerates and aggregate consumption and inflation do not, the Fed will need to grapple with the idea that the tools it has are not only incapable of producing inflation but also may be promoting deflation.
The mechanism for such an outcome is that if wages continue increasing and unemployment declines further, the cost of labor will increase and the financial benefits of allocating resources into technology in lieu of human labor will also increase. In that environment, the countercyclical stimulus provided by low interest rates intended to produce an increase in consumption and inflation actually becomes a pro-cyclical deflationary-pushing mechanism.
An even bigger issue for monetary policy, though, is that reversing course and raising interest rates in that environment does not result in the opposite effect. It, too, is deflationary.
None of what I've outlined here is fringe thinking. It is the logical outcome of the continuation of current economic events and the trajectory they imply.