It's A Dollar-Based Boom Shortage More Than Anything

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by: Jeffrey Snider

Liquidity preferences are one of the least discussed economic concepts. There are several channels into which monetary instability can hamper the real economy. A "dollar" squeeze doesn't just impact banks, they often pass it along further down the economic chain.

In its most extreme form, we had something like 2009. Some of the best companies all over the world found themselves stranded through nothing they had done. The Great "Recession" was bad, meaning even the best businesses suffered on revenue and profits. But even sure survivors were shut off from cash, abandoned by banks and funding markets at the worst possible time.

I'm talking about companies like McDonald's (NYSE:MCD), which needed (and always needs) to fund working capital regardless of health, ill or not, on its top or bottom lines. Banks withdrew liquidity backstops and credit lines, and then commercial paper became impossible to negotiate on reasonable terms.

Some like McDonald's, Verizon (NYSE:VZ), and Caterpillar (NYSE:CAT) were forced to almost beg. In one of the more absurd aspects of the 2008 panic, there was the global fast food chain knocking at the door of the Federal Reserve getting it to buy commercial paper the market wouldn't on any terms. Big Macs had become Too Big To Fail, too.

What do you do if, as a C-Suite officer, you found yourself in such a situation? The first thing is that you vow never to be so vulnerable again. As a company, you make it a policy, informal or otherwise, to self-insure on liquidity. That means any number of things, up to and including holding large cash balances far greater than you ever would have before August 2007.

It also means managing your cost structure down the tenth of a penny in search of hidden future liquidity risks. Hiring new workers and building new facilities are - in terms of cash - huge, huge commitments beyond today. The standards for undertaking them just added a new chapter.

And if the overall economy is at best lackluster on top of all this?

You can begin to appreciate why so many corporations have said, "Screw it, buy back the stock instead". On the surface it appears to be a Catch-22, but only if you don't see the underlying issue for what it really is. The economy doesn't grow because no one will seriously invest in anything but stock price growth.

According to the BLS, productivity has picked up a little once again. Since the downturn in 2015-16, productivity has increased a bit on average from those lows. This isn't surprising. Instead, it reinforces one of the most insidious aspects of the lack of real economic growth these last eleven years.

This current "boom" is little more than the usual low-grade upswing that always follows each and every "unexpected" downturn. Companies know this in a way Economists never will. Buy back the stock, since even when it's one step forward inside boardrooms, they know what they will never say publicly; the return of "dollar" volatility will mean two steps back. Liquidity risks all over again.

Total hours have picked up since the beginning of 2017, but not nearly as fast as the peaks of the prior two upturns. At an average of 2.2% in Q2 2018, that's substantially less than 3.0% for Q4 2014 and 2.8% in Q1 2012. That's why output, real GDP, in what has been the best quarter since 2014, was materially less than 2014. Even the "best" of times aren't so good anymore.

Companies that are overly attuned to liquidity risks and, therefore, overmanage costs aren't going to be heavily competing for new workers - no matter how many times the Wall Street Journal or Washington Post may come up with some wild story about how one HR department or another is attempting to handle a purportedly shocking, nationwide labor shortage.

The simple and easy answer to any difficulties finding and securing new workers, especially during a true economic boom, is to pay them.

There continues to be, unequivocally, absolutely no evidence whatsoever that there is a labor shortage to even the smallest degree. None. According to yet another labor force data point, Unit Labor Costs, wage pressures for still another quarter/year remain historically subdued.

In fact, since Q3 2017, Unit Labor Costs have been decelerating on a year-over-year basis. In Q2 2018, they rose by less than 2%. It doesn't matter how low the unemployment rate goes, there is no relationship with wages, pay, and therefore, income and economic recovery. None.

In early 2007, when the unemployment rate was last about as low as it has been over the last year, Unit Labor Costs rose by just about 4% - more than twice the pace of the current quarter, in which the unemployment rate is testing the 3s. In 2000, when the unemployment rate had dipped below 4%, Unit Labor Costs gained more than 4.3%. There is just no case for a tight labor market, let alone any shortage.

Companies aren't paying for workers because they don't actually want a lot of new labor. That's way too much commitment without the credible prospects for sustained economic growth. At least with share repurchases, they can use funds for something that will raise the share price (executives get paid) and not risk sending it into a tailspin with future cash commitments they can't easily shed if things go wrong again - which they do every few years. They are not focused at all on growth but on risk.

There is no boom. If there was, productivity would be surging as companies heavily invested in productive capacity and bought loads of new labor at whatever price the market demanded.

This updated employment data is more than consistent with the construction figures. In terms of major potential outlays, those that feature not just demands on current cash but also entangle any business in future sustained liabilities, companies are reluctant to do the very things that the economy needs to grow; the so-called supply side.

Historically, low productivity isn't some myth, call it R* or even a negative neutral interest rate if you want. The problem continues to be the eurodollar. With another "rising dollar" in the works, and thus another potential global downswing becoming more and more visible each passing month, is it more or less likely this is all going to change so that a real boom can happen? In other words, are companies finally about to throw caution to the wind, or are they going to batten down the hatches for a fourth time?

These questions don't just get asked of US businesses, obviously. We have an initial sense of how many globally are facing the dollar already.