Thursday, April 23, 2009

The Distance

First, they responded to consumer demand for lower prices by cutting labor costs. They cut labor costs by going to low-wage developing countries. Those producers that chose to stay slashed their labor costs to the barest minimum. While manufacturing was only part of the economy, the cost reductions produced a domino effect because once a factory's employees were out of a job, those employees couldn't pay their house payments, electric bills, food, etc. This phenomenon reverberated throughout the economy many times over. Soon, other manufacturers and cottage industries followed, pulling wages down even further. The consumer wanted lower prices because...their wages were falling. And down the spiral we went. Since 1975, inflation-adjusted wages have remained relatively stagnant. The distance between wages and prices began to widen.

To make up for weak wages, the powers that be had to do something. First, in the recession of 81-82, Reagan and his successor, Bush 41, saw the distance, cut taxes and started the deregulation trend that continued until recently. This helped to bridge the distance to some degree, but only temporarily. Clinton didn't help when he repealed Glass-Steagall. Then, Greenspan, after seeing that the distance had, once again, revealed itself when the dot-com bubble burst, came up with another bubble, the housing bubble. We all know what happened there. Instead of addressing the distance between wages and prices, the powers that be insisted that the rest of the world would catch up to the Americans before we would have to take a cut in our standard of living. This didn't happen because the consumer continued to demand lower prices. The powers that be have now ran out of bubbles to bridge the distance. They must now either raise wages or let deflation cut costs to the point that they are more in line with wages.

The banks are not going to lend like they use to because they don't have anyone to sell that debt to. Lending, if it happens at all, will finally be based on one's ability to pay it back. Deflation must cut costs to the point that the banks feel like the consumer can pay back whatever loans they give.

So this reduces this entire issue to one thing and one thing only. How much of a distance is there between wages and prices? How long will we have to wait until prices are more in line with wages?

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