A recent remark made at the opening of the convention of the United Auto Workers portrays the current state of the union as “in need of structural changes”. And although the union is faced with accepting concessions from here on, the influence that can be welded by its membership is much wider than it gives itself credit. (Many of them voted for the current business friendly administration without regard to how those policies would affect them.)

Unions have often consoled themselves with a pendulum hypothesis for their ebbs and flows in membership and strength. Long chided and secretly envied by a non-union workforce, those who do not have the protection afforded these organized groups of workers often see the union workforce as the enemy rather than the barometer of workplace health.

If the average American worker was given the choice between financial stability with the accompanying right to a fair and safe workplace and the alternative: upward mobility, the free market availability to migrate between workplaces, and the constant positioning of oneself to gain the best economic advantage over your fellow workers, I’m inclined to believe that many would choose the former rather than the later.

Even among college educated workers, the ability to increase one’s economic opportunities at a steady pace, hand in hand with the profits generated by the company they are employed by has its supporters.

But this isn’t about the waning union membership or the fact the U.A.W. (and other unions forced to negotiate contracts for their membership) has significant problems facing it in the near future. It is about wages in general and the fact that so much Fed-speak of late is peppered with concerns about controlling those wages.

Two myths need to be discussed at the onset before we talk about the three main players. First of which is the strength of this economic expansion measured by GDP and the other is productivity. There is good reason to celebrate the expansion as measured by Gross Domestic Product. Business has become much better at controlling costs, reining in inventories and developing markets overseas. Trouble is the largely intellectual nature of those products.

While we lead the world our innovation, the actual completion of our production is increasingly done overseas. We design the idea here and export it to be made. Doing this allows many corporations to pat themselves on the backs with increased pay packages and options, dated correctly or not. GDP is mostly an illusory measure of health. (Were you aware that Hollywood is our largest exported product?)

Flush with profits and repatriated tax breaks, companies have been buying shares of their own companies back in record numbers. While this is being hailed in many circles, draining liquidity does not show any investor the true picture of a company’s actual worth.

Productivity, a concern of not only the former Fed chief Alan Greenspan but his successor is over-rated as data as well. If companies actually paid attention to such Fed measures, they would see that in order to sustain productivity you need three things in place: inflation of prices at a rate commiserate with raw materials, customers willing to pay for each increase, and a workforce willing to produce at an ever-increasing rate without the award of wages.

Companies will produce their goods or services and will do so at any costs – or fail to exist. Which is why the U.A.W. is so concerned. Automakers are strapped and the union is being blamed. Is that condemnation justified? Hardly. In the current state of manufacturing, controlling wages is not the path to increased success. Better products are.  

The three main players threatening the economy are wage pressure, inflation, and prices. For the first time in modern history, these three things are not related.

Wage pressures, or as Ben Bernanke likes to call it, the wage price spiral are an effect that was once the primary menace in the inflation battle. Here’s how it works: Prices rise and workers would then begin to demand pay increases to stay even with the inflationary pressures they felt. Employees in past years would have been interested in “keeping pace with inflation” as the criterion for their wage negotiations. This would raise the company’s expenses and would force them to raise their prices to compensate.

That is not even on the table these days. Wage increases at best are running about 2% if that. Many industries have offset any pay increases by suggesting that the money be used to pay for health (whose own inflationary pressures have risen year over year as little as 5% to as much as 10%, depending on whom you speak) benefits. While unemployment remains low by most measures, the pay for those employed workers has stagnated and is largely void of any real benefits.

Inflation has become a very real nuisance to the average American. Ask most people and they will point out higher prices for fuel naturally leads to higher prices for goods dependent on fuel for production. This creates a situation that forces many consumers to make economic choices and is keeping Mr. Bernanke awake at nights.

In truth, inflation is not so much about prices but the ability of the consumer to borrow to purchase goods and services. Each price increase lowers the willingness of the consumer to go into debt to make any purchases at all. This strips them of the wealth effect embraced by the low interest environment. And the economy slows

Yet prices continue to increase. And when they do, Mr. Bernanke should fear the embedding of those prices as the new norm, not the result of any shift in the cost of raw materials.

How does this affect the investor? Does the knee jerk reaction by the markets to all of this inflation talk both here at home and abroad show any sort of efficiency?

I was taken to task last week by a reader who called my revisiting of dollar cost averaging as nothing more than an “old cobbler”. He was thankful that I was not investing his money.

“No mention of GOLD” he wrote as the eve of the sell-off in that commodity, a normal hedge for inflation worriers. The long-term bond continues to look as if it believes that inflation is worth worrying about but only in small way. So as stocks sold on the price weighted Dow Jones Industrial Average, folks worried that the Fed had gone too far.

Tools such as indexing and dollar cost averaging are old cobblers. But they offer some comfort when the markets decide that they may have gone too far too fast, are overpriced or are a little of both. Corrections happen and this one is far from over. Inflation however will not be the reason and relying on old cobblers will keep you from panicking.

The Fed chief and his banking cronies believe that they have the power to keep inflation in check. They believe that they can accommodate for the increased prices for commodities used on a global scale by what seems to be an ever-increasing pool of countries in need of raw materials. “Anchoring the publics long-term expectations”, Bernanke said recently would make the Fed the champions of price stability.

While teaching someone to swim while they are drowning seems like an exercise in futility, the Fed thinks it is possible. And it would be if they had not already gone too far and far too slowly. Consumers don’t buy into the notion that the Fed has the ability to control inflation. Recent university of Michigan surveys have pointed to a perception of an inflation rate closer to 4% among the 500 households surveyed than the current 2.4% (excluding food and energy).

If that perception continues, the pullback by consumers, so mightily predicted at the beginning of the year will begin in earnest. They will be forced to. Wages will not support any more expansions.

© 2006 Paul Petillo
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