All Aboard the Inflation Express!

The Daily Reckoning PRESENTS: There is a monster under the bed of America that threatens to eat us in our sleep…minimum wage. For ten years he’s been held at bay, but now he’s being tempted to rise up and bring his evil friend inflation along with him. Can anyone stop him? We leave it to our resident monster slayer, The Mogambo Guru…


The Congressional action on raising the minimum wage by 40% over two years is perhaps what prompted the article “For $7.93 an Hour, It’s Worth a Trip Across a State Line” by Timothy Egan. The essence of the story is “In Washington State, the minimum wage is 54 percent higher than in Idaho. Businesses at the dividing line are a real-life laboratory for the effects of an increase.”

After a lot of background information, Mr. Egan concluded, “raising prices to compensate for higher wages does not necessarily lead to losses in jobs and profits.” I admit that that is true, as few things are “necessarily so” in anything, especially economics.

But what I know for Freaking Mogambo Sure (FMS) is that if the businesses do not raise prices to cover their higher labor costs, then they will make less profits. It’s not economics; it’s simple arithmetic. He concludes as much when he admits, “Business owners say they have had to increase prices somewhat to keep up.”

Aha! There! There it is! There is the reason NOT to increase the minimum wage; prices will go up! “Business owners say they have had to increase prices.” He admits it! And if you don’t think, like little Timmy here obviously doesn’t think, that inflation is the thing to be feared above all else, then I know that you are young, or ignorant, or stupid, or else you would know that there is nothing worse than inflation, as it is a killer of economies. It’s THE real killer of economies! And nations, too!

So now get a load of this: The kid even quotes some guy named Fazzari who says, “If you look 10 years down the road, we will probably have no minimum wage jobs on this side of the border, and lots of higher-income jobs.” Hahaha!

What he is saying is that everybody else in the whole wide world is so sublimely stupid, that we will voluntarily stay where we are, working at our dumb, dorky job for a hateful, pinheaded boss, all for less money, instead of moving to the Washington/Idaho border where they pay more! Hahaha!

If not everyone is as stupid as I am, and did move there, then the increasing numbers of job-seekers would drive the cost of labor down to the minimum, by the simple expedient of an oversupply of labor and profit-maximizing employers! Jeez! This stuff seems so obvious to me!

Timmy-boy, obviously not realizing how utterly ridiculous this whole idea is, chimes in with “Job figures from both states tend to support his point.” Hahaha!

He sees the skepticism in my face and contempt in my voice, and retorts, “Several studies have concluded that modest changes in the minimum wage have little effect on employment.” I leap to my feet and exclaim in exasperation, “Again, Mr. Egan, employment is NOT the issue! You already concluded earlier, and I admitted, that rising wages doesn’t necessarily result in job losses! Inflation is the only issue!”

I’m thinking to myself, “The little moron can’t seem to comprehend that inflation has gotten so bad that the minimum wage is practically no income at all, but he blithely ignores the additional inflation that will be caused by raising the minimum wage! He figures it is not even worth talking about, I guess!”

He ignores me completely, and defensively says that some university egghead named David Holland said, “Job loss was minimal when higher wages were forced on all businesses.” Again with the job loss thing! He’s like a broken record! But even so, he admits there WERE job losses! “Minimal” job losses as they may be, we still end up with less jobs and higher prices by raising the minimum wage! My God! I scream anew, “What in the hell is the matter with you people?”

Perhaps at my insane persistence at always bringing inflation into the discussion, he again admits, “business owners have found small ways to raise their prices,” but I guess that is all okay with everybody (as ludicrous as that sounds), as “customers say they have barely noticed.”

To prove it, he quotes a Mr. Singleton, who owns a pizza place, who says, “We used to have a coupon, $3 off on any family-size pizza, and we changed that to $2 off. I haven’t heard a single complaint.”

Memo to Mr. Singleton: the complaining is done in the parking lot and on the way home, where the missus says, “It seems that we used to eat here for $15. Now it’s $16, plus another 20 cents on the tip! That’s, in total, an 8% price hike! And their pizza just doesn’t taste as good as it used to, either, now that I think about it! And I think he is using cheaper ingredients, too, the little illegal-immigrant bastard!

“And now that I think about it, YOU aren’t as good as you used to be, either, buster! And slow down, slow down, slow down, you idiot, or you’ll get a ticket, like that’s just what we need around here! And let me tell you that you ate your pizza like a disgusting gluttonous pig, making these slobbering noises and yammer, yammer, yammer!” And the husband hears this, and thinks to himself, “Well, a higher price means we can’t come here as often, which is good news since I won’t have to listen to her irritating voice as much!”

And it is not just the expense of higher labor costs that will drive prices up and customers away. Other related costs will go up as well, as unemployment compensation insurance and all of that other worker-protection stuff is figured as a percentage of payroll.

Additionally, the employer is responsible for half of the Social Security/Medicare tax on those wages, so another 40% raise in the minimum wage will cost the employer another 16 cents an hour in higher payroll tax alone for each worker, or about $330 a year.

All of this, and more, means that a higher minimum wage will result in higher prices, which is the thing that is bedeviling people in the first place! It doesn’t stop inflation! It merely temporarily (a couple of years) partially compensates less than 1% of workers for the disastrous declines in their living standards due to the ravages of inflation, while making life more expensive for everyone else in the whole freaking country, further absolutely impoverishing those who do not have a wage to increase! What a cruel trade-off!

And everybody else up the line will want more money, especially the guy who used to make 40% more than minimum wage, and who will now, thanks to the increase, make only the minimum wage! Hahaha! Welcome to the hell of inflation!

But this, sadly, is the sorry course that the corrupt, incompetent Congress has decided on, instead of doing the right thing and forcing the Federal Reserve to hold money supply growth (and thus inflation) at a constant of “zero”, which is optimal.

So buckle your seatbelts on the Inflation Express, because it will be a hell of a ride from here on out!

Until next week,

The Mogambo Guru
for The Daily Reckoning
January 22, 2008

**** Mogambo sez: Money is fleeing hither and yon around the world, going here, then going there, making this go up in price when it comes, and that go down in price when it goes.

This is how the whole thing shakes itself apart, and then how everyone belatedly realizes that gold would reign supreme in the end, like it always has, and like it always will, and that a stable money supply that is guaranteed by the gold exchange standard is the only way to keep the government from letting the banks kill all of us again the next time, because it is too late for us this time, and that is why you gotta – you just gotta! – get silver or gold, or both, Right Freaking Now (RFN).

Editor’s Note: Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter – an avocational exercise to heap disrespect on those who desperately deserve it.

“It’s worth remembering that markets were very upbeat in the early summer of 1914,” said former U.S. Treasury Secretary Larry Summers.

Summers was warning the attendees to this year’s upcoming World Economic Forum in Davos, Switzerland, that there are precedents for such bountiful seasons. The trouble is, history shows that such incredibly good times tend to be followed by incredibly bad ones. “Financial history demonstrates that the biggest liquidity problems always follow the moments of greatest confidence,” Summers continued. “Complacency can be a self-denying prophecy,” Summers says.

“A glut of cheap money and the strongest global economic growth in three decades have encouraged banks, private-equity firms and hedge funds to bet that the good times will keep rolling,” says a Bloomberg report.

“It’s too good to be true,” adds Vittorio Corbo, head of Chile’s central bank, who will speak at a seminar in Davos about the dangers of derivatives. “Tomorrow the mood could change. We have to be prepared.”

These voices of warning will soon be echoed by Jean-Claude Trichet, head of the European Central Bank. They will all certainly be dismissed. The crowd will remind itself that it heard similar warnings last year. And lo…nothing bad happened. Last year too, the self-same Summers told Davos attendees to watch out…to be more prudent in their financial affairs and more modest in their projections. Of course, they did just the opposite – which is why the Great Credit Boom continued.

Takeovers last year rose to a record $3.6 trillion, according to the Bloomberg report. Morgan Stanley’s Capital International World Index of stock prices rose to a new record high on January third…and the head of Goldman Sachs, the alpha male of Wall Street, earned a bonus of $53.4 million.

Prices of London’s priciest digs – where the super-rich are roosting these days – grew even more expensive last year. They rose nearly 30% in a single year. And bonuses for Wall Street’s masters of the universe, its five largest investment firms, rose too – by 30%.

Meanwhile, one of those firms – Morgan Stanley – announced another mega-deal in the real estate sector, last week. The company says it bought CNL Hotels & Resorts for $6.6 billion.

What’s a New York investment house doing buying a hotel chain? What does it know about running a hospitality business? Nothing. But gone are the days when the owners of businesses knew the business they were in. Now, the economy has been financialized and the financializers are getting rich.

In the old days, a family might run a hotel chain, trade the stock among themselves – at, say, five times earnings – and put an ambitious nephew, cousin or son at the top post. They would, of course, be careful not to pay him too much…and be sure to put other nephews and cousins in the business too…to give the enterprise more management depth and to keep control in family hands.

But along comes a big investment firm with a buyout offer, backed by debt financing. The offer is too good to refuse. So, a ‘liquidity event’ turns the family into billionaires. The company is placed in the hands of professional managers and goes public at 20 times earnings. The investment firm makes millions on the deal.

And now, the new CEO earns $10 million a year and thinks he is underpaid. Meanwhile, the firm sells millions in bonds, which are then repackaged and resold, with swaps and derivatives all over Wall Street. And the stock – which is now held by millions of people who wouldn’t know a hotel from a gas station – soars.

Before…there was just a family with a family asset, a hotel chain from which it earned a living. But now, millions of people own a stock that has gone up in price. Investment bankers can afford to build a bigger, swankier house in Greenwich, CT. Hedge funds, pension funds and wheelers and dealers all have multi-million dollar positions in the company’s debt. And investment industry pros can earn their own fortunes just by trading the company’s stocks, bonds, and derivatives.

Is this a great system, or what?

‘Or what’…is what we wait to find out. In real terms, there is still a hotel chain, with a certain stream of revenue and profits. But this new financialization has created a whole new industry…and a whole new flood of liquidity. People have ‘wealth’ that didn’t exist before. The only trouble is, the ‘wealth’ is a fiction.

But when you get to the top of a liquidity bubble, who cares?

Debt…debt…debt… nobody seems to worry about it going down. The gap between good debt and bad debt – that is, between emerging market bonds and those of the U.S. Treasury – fell to a record low last week. And hedge funds in the United States are the most leveraged since 1998 – the year that Long-Term Capital Management collapsed – according to Bridgewater Associates.

The European Central Bank at least, still keeps track of its money supply. It reports that last fall, M3 was clocked rising at nearly a 10% rate – its fastest in 16 years. This prompted the ECB to raise its key-lending rate.

“Current risks are ludicrously under priced,” says Willen Buiter a professor at the London School of Economics. “At some point, someone is going to get an extremely nasty surprise.”

So far, the surprise has been that no surprise has come. But the longer it delays…the nastier it is likely to be.

More news:


And more thoughts…

*** Colleague Byron King:

“Household savings are a variety of endangered species, certainly for most working-class Americans. But not to offend the working class, the middle and upper-middle classes are falling into the same category as non-savers. Most U.S. households have no current savings plan. None. Zip. Nada. Most households live paycheck to paycheck, and most households are constantly on the edge of technical insolvency.

“Lost job, illness, divorce, sudden financial hit…. most households will be pushed over the edge. This is as true in the leafy, McMansions of the McSuburbs and ex-urbs, with their well-coifed soccer moms and well-shod hockey-dads, as it is true in the rows of urban and near-suburban tract houses in which dwell the blue-collar workforce of the nation (or what is left of it).

“And of those U.S. households that do ‘save money,’ the vast majority have only nominal savings. Many people who try to save really don’t know what they are doing. They will put $100 in a passbook savings account at 2.2%, but still carry credit card debt at 24%. Nobody has ever explained to them the difference, or advised them how to do it better. Best figures are that close to 50% of U.S. households have negative net-savings (even excluding mortgage debt). With mortgage debt included, something like 70% of U.S. households (homeowners and renters in total) have a negative balance sheet. (OK, so they ‘own’ a house with some equity and a mortgage. If housing prices decline 20%, then they are in negative territory.) One U.S. bankruptcy trustee put it to me this way…’More U.S. citizens are net in-debt, than voted in the last presidential election.’

“Doesn’t say much for either U.S. financial habits or political trends.

“Most households are busy paying daily bills, and past debt. This uses up essentially all income. It is a situation of, as the saying goes, ‘too much month left at the end of the money.’ So it is no wonder that there is so little (or nothing) left over to save.

“Was it Warren Buffet who coined the phrase ‘sharecropper society’?

“We are there.”

*** “Real Estate Will Underperform Inflation for Decades,” writes Dan Forshee.

Most people think that real estate is a safe, reliable place to put your money. But that is just a trick of perspective. Once you have climbed to the top of a mountain, everything appears to be downhill. In fact, there could be many steep hills between you and the bottom…and long periods where you are not going down at all.

From 1915 to 1965, says Forshee, property doubled in price, but rose only about 1.32% per year. But the dollar gave way during this period, too. Housing prices didn’t keep up. So the typical house owner actually lost about a third of his purchasing power.

In real terms, the prices of 1910 went down all the way to the 1990s. Only recently did they begin to go up enough to offset inflationary losses. And only in 2005 did they regain the heights last seen early in the last century. From here, it looks as though they did nothing but rise, but in fact, property prices in the United States mostly went down for the last 100 years.

Another way to look at this is to recall Larry Summers’ warning about 1914. Liquidity and confidence were running at epic highs just before WWI. When they crashed, they crashed hard. Property in the United States did not recover for another 91 years. You can also see the long trends in real property prices simply by opening your eyes, says Forshee. The higher real property prices go, the taller the buildings property developers put up.

“Higher prices of real estate make it profitable to build tall buildings because the higher construction costs are offset by lower land costs. Most major cities in the United States had tall buildings built between 1914 and 1933 during the real estate boom of that time frame. After the tallest building was built, it typically took about 41 years for the real estate prices to return to levels that would justify buildings of similar height.

Forshee then reminds us that the “tall building indicator UNDERSTATES the time to return to a previous peak because of technological improvement in building construction.” As construction techniques improve, the cost of building up goes down. A more accurate measure of the property cycle in the United States – peak to peak – may be “closer to 60 to 120 years.”

*** Oil bounced at the end of last week. Maybe the bottom for oil is in. Gold rose strongly too – up $8.30. The correction in the gold market seems to be over. Could it be that the ‘financialization’ of the economy has other investors worried? Gold is the traditional way to protect against financial surprises. As we explained last week, it is not a perfect way to store wealth; but it is better than any other way ever discovered. Most of the time, you will do yourself no favor holding it. Most of the time, it is as useless as life insurance. But come that day when you need it, nothing is more useful, or more welcome.