In the Papers

From The Globe and Mail

The most important sentence in economics last week - written by a futures trader, not an economist – highlights the essential problem for U.S. economic policy; profits are growing at the expense of labour which is creating excess production that heightens deflation risk and squelches growth.

Kevin Ferry is the co-founder of Cronus Futures Management, a frequent guest on CNBC and about as far from a Marxist as it’s possible to be. On his blog Contrarian Corner, Mr. Ferry writes, “Tax law skewed toward capital over labor fosters excess capacity that makes a credibly high inflation expectation target out of reach.”

The American economy currently makes more products, and provides more services, than the American people can afford to buy. This is best illustrated by the Output Gap, which measures current economic activity relative to the maximum possible. In nominal terms, the allegedly bi-partisan Congressional Budget Office estimates that the output gap is currently 2.73 per cent.

Most economists, particularly those on the left, argue that a re-distribution of wealth is necessary to increase demand and close the output gap.

Mr. Ferry, without denying those claims, is arguing from the other side – there’s too much supply rather than not enough demand. I’m extrapolating, but he appears to be inferring that a series of corporate tax cuts combined with efficiency-focused technology and the Fed’s monetary stimulus programs (which allowed corporations to refinance debt at lower rates and boost profitability) allows too many companies to remain in business when, given the lack of aggregate demand, they would have failed under normal circumstances.

In the end, we have an oversupply of goods and services while overall corporate profitability remains, for now, strong. The big economic problem with this is the lack of corporate incentive to invest in expansion. The investment that does occur is to increase efficiency in order to maintain profits despite downward pressure on prices.

Increased efficiency, of course, means that fewer workers are necessary, so they can be fired in order to increase profit margins further. This is the spiral the Americans are in. The Fed may not have been successful in raising inflation expectations, but it has to date prevented deflation.

The current clown show in Washington makes it feel pointless to discuss viable policy U.S. options – a bill to supply bottled water to the chamber might shut down the government at this point, so we’d be fools to expect a comprehensive bi-partisan economic policy.

But when the motivation finally hits, the most helpful policy result will likely affect both sides of the supply/demand equation and investors can expect a tougher corporate environment that reduces overall supply as part of the package.

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