It’s Called DEFLATION Folks

March 4, 2010

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Courtesy of Karl Denninger, The Market Ticker

It’s Called DEFLATION Folks

Never mind the man behind the curtain, who won’t utter the word:

The Labor Department reported Thursday that productivity jumped at an annual rate of 6.9 percent in the fourth quarter, even better than an initial estimate of a 6.2 percent growth rate. Unit labor costs fell at a rate of 5.9 percent, a bigger drop than the 4.4 percent decline initially estimated.

In the real world this means:

Work harder and get more done.
Get paid less.
Suck it up, don’t complain, or you’re fired.

That’s all.

And by the way, reduced pay per unit of work spells DEFLATION.

Now here’s the problem: We have huge public-sector labor unions that are resisting this force. Yet this force is exactly what has to happen in order to bring the economy back into balance.

We have "advanced" promises made to these people – $200,000+ pensions and other similar obscenities – even though doing so is a ponzi scheme that is impossible to maintain. We have continually cow-towed and pandered to these unions, including educators, police and fire and all other manner of public sector employees with wage increases that exceed growth in aggregate output per-person when one counts both salary and benefits.

This, of course, cannot continue. It is yet another example of the expanding gap that opens up between two exponential functions – for those who have forgotten my favorite pair chart (two exponential curves, one with a slightly-higher exponent than the other), here it is again:

I understand that everyone wants to avoid taking the pain. I understand that everyone claims that "its not fair!"

None of this changes the facts. You cannot continually offshore your better-paying labor to China for the purpose of being able to have a $30 DVD player, destroying the $40/hour skilled job base and replacing it with $7/hour burger flippers and espresso-shot-pullers, and maintain the ability to commit compound annual growth rates of 5, 6, 7% or more to public-sector employees. Doing so inevitably destroys the tax base necessary to meet those commitments, and once the destruction has occurred it cannot be un-done.

You cannot falsely-report "growth" that is in fact no such thing, but rather is simply the addition of more debt, thereby creating false demand that never existed on an organic basis, and continue this process forever.

The person who loses their job can continue to spend as if they have not – for a while. They can run up the credit cards – for a while.

They can do so until the credit card company discerns that the ex-employee has no money, and thus will never pay them. Once that happens the credit card is cut off.

States, municipalities and nations are no different than people in this regard. We have played this game for 30 years. We have promised people they could have unlimited health care, unlimited prescription drugs and unlimited, compound increases in salaries and benefits. At the same time we have permitted our corporations to send their labor base overseas, destroying the income base to purchase these products and the tax base required to pay those benefits. All of this has been "facilitated" by a financial system that grew from about 7% of the marketplace to well north of 20% (in 2007) before it all fell apart.

Instead of allowing it to fall apart and return to a 5-7% of the market, which would be sustainable, politicians instead created false final demand of about 9% of GDP (~ $1.2 trillion annual increases in deficits on a $14t GDP) and then added $13 trillion of "guarantees" in the form of funny money to the financial system to prevent it from imploding (roughly equal to the entire financial debt in the system, which currently stands around $16 trillion.) This "prevented" the immediate recognition that the derivatives written by these firms were nothing more or less than a gigantic fraud, as there was no ability to pay – not at origination, not at maturity, not ever.

But none of this game-playing changes the mathematical fact that:

The money to pay these bets never existed, and never will. It was a fraud, but our politicians refuse to direct law enforcement (which reports to them) to enforce the law against fraud, as that would "hurt" their campaign donors (they’d go to jail!)
The offshoring of our production has destroyed both incomes and the tax base. "Replacing" that with more borrowing is exactly identical to an unemployed person using their credit card to maintain their standard of living. It will fail – we are simply arguing over when, not if.
Public sector employees are inherently parasites. It cannot be otherwise. The policeman, fireman and teacher do not directly produce anything. Their employment and the wages and benefits they can collect must therefore inexorably track the actual productive output of the nation.
Finance in all it’s forms, whether banking or insurance – produces nothing either. Every dollar of such "activity" comes about only as a parasitic drain on production. It cannot be otherwise. Further, speculative activity in all of its forms produces losers in exact proportion to winners – if Goldman makes $100 million speculating on oil prices, someone else loses the same $100 million. The net benefit to our nation’s economy? Zero – we merely moved money from one hand to another.

The actual private sector production worker is now being forced to recognize this. He’s being told to work harder and longer for less money (per hour) or lose his job. That’s what the statistics say. This sort of movement in the private labor force is unprecedented – it in fact exceeds that which formerly was accomplished with computerization in the 1980s and 1990s – and this time it’s actual labor, not the introduction of new technology.

The first step to solving problems is admitting to what they truly are.

The recent pronouncements and announcements out of both the new governor of New Jersey but also California, where they have attempted to play "extend, pretend and charge-it-up" more and worse than anywhere else in the nation make clear that the credit line has run out and we either face the facts – like it or not – or we get the clue-by-four upside the face.

As usual, the politicians thought they could extend, pretend and lie until after the election. As in 2008, they’re wrong, and if they don’t cut it out we’ll get a repeat of the 2008 disaster but this time around it will be much worse.