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Graph of the week

Graph of the week

11-10-2019 | Insight

Party like it’s 1969?

  • Peter van der Welle
    Peter
    van der Welle
    Strategist

Last week, the US Bureau of Labor Statistics published the job growth figure for September. Although somewhat disappointing (136,000 were created, instead of the expected 145,000), there was still cause for optimism. The number for August was adjusted upwards (to 168,000) and unemployment fell further to 3.5%.

This is the lowest unemployment rate in the past 50 years. The last time unemployment was at 3.5% in the US was the year of the moon landing – Bryan Adams’ ‘Summer of ‘69’.

Appropriate parallel?

In theory, such a low unemployment rate implies that we’ve very nearly arrived at the point in the economic cycle when employees’ bargaining power in the workplace should be at its highest. We have seen some increases in bargaining power. The strike at General Motors last month is a case in point, and marked the first labor walkout in the US industrial sector in the past ten years.

The parallel between the current situation and the summer of ’69 is not entirely appropriate for other reasons, too. At the end of the 1960s, nominal wage growth in the US was above 6.5% – despite a 7% rise in unit product costs at the time. An increase in labor unit costs means that the negotiated wage growth is higher than the underlying productivity growth. If this increase cannot be passed on to the end consumer, the result is a decline in businesses’ production efficiency and a deterioration of the cost-to-income ratio. This is what happened in 1969: US businesses’ profit margins plunged by percentage points within a period of 12 months.

Unit labor costs in the US are currently at just 2.6%, with nominal wage growth at 2.9%. Despite a historically tight labor market and theoretically strong position to negotiate higher wages, wage growth is not far above labor productivity growth at the moment.

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No traditional profit recession in sight

We see that the decline in trade union power, automation and increase in part-time workers are keeping unit labor costs at modest levels. This is good news for the profitability of US companies as a whole, which – as seen at the end of the 1960s – will eventually level off due to the strong dollar.

The graph shows that, historically, a cyclical dip in the unemployment rate often seems to precede a recession. That is why investors suspect the current low level of unemployment must indicate an impending profit recession. But correlation does not imply causation when it comes to the relationship between low unemployment and recession.

The underlying dynamics between labor-market tightness and the price of labor should be the determining factor. As long as we have yet to arrive at a cyclical peak in the unit labor costs (and thus a wage-price spiral), causing central banks to apply the brakes to quell core inflation, a traditional profit recession is less likely.

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