Facing Economic Challenges - Facts Demand Attention

In his December 11, 2024, article "The Big Shining Lie: We're Better Off Now—No, We're Poorer, Much Poorer," Charles Hugh Smith challenges the prevailing narrative that modern Americans enjoy greater prosperity than previous generations. He argues that, despite technological advancements and higher nominal wages, the purchasing power of today's workers has significantly declined compared to 40 years ago.

Erosion of Purchasing Power

Smith emphasizes that the true measure of prosperity is the purchasing power of an hour's labor. He recalls that in 1977, as a 23-year-old apprentice carpenter in Honolulu, he could cover his monthly studio apartment rent with just three days' wages. In stark contrast, he notes that today's workers would need to earn between $60 and $90 per hour to achieve the same, far exceeding the current median wage of approximately $30 per hour.

Rising Costs Across the Board

The article highlights that the cost of living has escalated in various sectors:

Healthcare: In 1985, Smith's individual health insurance premium was $54 per month, equivalent to four hours of work. Today, with average premiums around $350 monthly, a worker would need to earn $87 per hour to match that affordability.
Utilities and Services: Smith points out that in the past, expenses like utility bills and auto repairs required fewer work hours to cover, indicating a lower overall cost of living.

Decline in Product Quality

Smith also addresses the deterioration in product quality over time. He shares a personal anecdote about a dining set purchased by his mother in 1970, which was already 100 years old at the time and remains in use today. In contrast, he observes that many modern products, such as furniture from Ikea, often fail within a year, leading to more frequent replacements and increased expenses for consumers.

Wages' Shrinking Share of the Economy

The article presents data showing that wages' share of the U.S. economy has declined from 51.6% in 1975 to 43% today. Given the current U.S. GDP of $29 trillion, this 8.6% decrease translates to approximately $2.5 trillion less going to wage earners annually. This shift indicates that a smaller portion of economic output benefits the average worker, exacerbating financial strain.

Challenges in Saving

Smith reflects on past advice from friends who recommended saving 40% to 50% of net pay to achieve financial goals—a feasible target decades ago. However, he argues that for most wage earners today, especially without external assistance or exceptionally high incomes, such savings rates are unattainable, underscoring the increased financial pressures on modern workers.

The Inflation Trend: A Persistent Challenge

The Federal Reserve’s decision to reduce its benchmark interest rate for the third consecutive time next week is a response to the persistent inflationary pressures.

The federal funds futures market currently anticipates a 95% probability of a Fed cut at the December meeting of the Federal Open Market Committee (FOMC). A 25 basis point reduction would bring the total rate cuts in the second half of 2024 to 100 basis points, representing a significant easing of monetary policy, despite the robust labor market and stubbornly high inflation rates.

The Department of Labor released its latest consumer price index (CPI) report on Wednesday, indicating that consumer prices rose at an annualized rate of 3.8% in November, a substantial increase from the 3.0% annualized pace observed in October. Core inflation also surged at an annualized rate of 3.8%, up from 3.4% in October.

It is important to note that the monthly-to-month figures are annualized to emphasize the extent to which the most recent data deviate from the Fed’s target. This approach underscores the acceleration of inflationary pressures. Both core and headline inflation experienced a 0.3% monthly increase, matching the previous month’s core figure and surpassing the 0.2% reading for headline inflation.

The Wall Street Journal characterized the November figures as “a sign that the path to bringing down price pressures remains challenging.” However, a more accurate assessment reveals that inflation has not only proven to be “bumpy” but has been on an upward trajectory since its June low. This trend suggests that higher inflationary pressures persist month after month.

This trend is evident in the annualized three-month figures. Headline inflation has risen by 3% on a three-month annualized basis, up from 2.5% through October. Core inflation has also increased by 3.7%, up from 3.6%.

If shelter is excluded from core inflation (which, despite the consensus, many analysts persist in doing), prices have risen by 3.5% on both a one-month and three-month annualized basis. This represents an acceleration compared to the 2.4% and 2.7% inflation rates observed through October.

Core Goods Inflation Resurgence

The prices of core goods—a metric that excludes food and energy—have ceased their decline. New car prices increased by 0.6% in November relative to the previous month, while used car prices surged by 2%, despite a 2.7% increase in October. Household furnishings and supplies also rose by 0.7%, and appliances prices increased by 0.7%.

One of the most prominent components measured in the consumer price index is food. Food prices rose by 0.4% in November, doubling the inflation rate of the previous month. Grocery prices increased by 0.5%, with four of the six major grocery store indexes experiencing a rise. This surge in grocery prices will likely be a source of concern for American consumers.

Despite the inflationary pressures, the Federal Reserve has announced a reduction in interest rates. The Fed maintains that the current monetary policy stance remains restrictive and that the neutral rate—the rate at which policy neither hinders nor stimulates economic growth—is still below the prevailing rate. However, there is limited evidence to support the assertion that policy is restrictive.

Recent survey data consistently indicate that the economy is not signaling a demand for lower interest rates. Consumer sentiment has been on the rise, with small business confidence surging to unprecedented levels. The outlook barometer recorded the largest increase ever observed, and the New York Fed’s measure of consumer confidence showed a significant improvement in year-ahead expectations in November. The share of households anticipating a better financial situation in the coming year reached its highest point since February 2020, indicating a resurgence of consumer confidence to pre-pandemic levels.

While we believe that the policy mix proposed by Donald Trump will stimulate non-inflationary growth by increasing investment in expanding the supply-side, the specifics remain uncertain. Legislation implementing substantial portions of the Trump plan is likely to take several months to pass. There is no immediate imperative for the Federal Reserve to reduce interest rates—and a substantial risk that inflation will continue to rise.

However, the Federal Reserve has demonstrated a profound aversion to disappointing the market adversely. Consequently, it is almost certain to validate the expectation for a rate cut next week. This would constitute a third policy error in as many Federal Open Market Committee (FOMC) meetings.