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Don’t sell your bonds yet: weak wages will keep rates low for a long time

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Another week, another drop in jobless claims. On July 24, the number of people who filed for unemployment benefits for the first time dipped to an 8 ½ year low. The unemployment rate is at 6.1%, lowest since July 2008, and probably heading lower. It’s already way past Bernanke’s 6.5% level that the world once thought was the trigger for higher rates. Additionally, the number of employed persons – as well as job openings – is back to where it was before the financial crisis.

The sum of all American wages (“Compensation of Employees” in Dept. of Commerce parlance) was 16% higher at the end of 2013 than at the end of 2009. This means that all the salaries paid to Americans grew by 4% every year, on average, in the four years since the financial crisis. This is way ahead of inflation, which averaged well below 2% per year in the same period.

But the Fed doesn’t seem to think that any of this is good enough. Its new boss, Janet Yellen, keeps talking about the “slack” in labor markets and the “slow pace of growth” of hourly compensation. Is she blind to the good news on the labor front?

No, she isn’t. And she has good reasons to be concerned about the labor market. Despite the huge improvement of the last five years, the financial crisis hit American wages hard. And that blow came on top of a decades-long worsening trend.

The sum of all employees’ compensation has grown steadily over the years. There is a simple reason for this: every year there are more of us. But wages stumbled as a percentage of GDP after the financial crisis.

Total Employee Compensation as % of GDP

One way of looking at the decreasing importance of wages in the economy is to look at the trends. As the graph below shows, wage trends took a serious hit after the crisis of 2008/2009, on top of a steady deterioration over time. The severe departure from previous (decreasing) trends will be virtually impossible to make up.

Decreasing growth trend in employee compensation

Yet another dismal indicator is the annual growth rate of total employee compensation above inflation. After being positive since records started in 1959, it went negative four times in the last 14 years - during the difficult market periods of 2001/2002 and 2008/2009.

Real growth in employee compensation, annual rate

So Janet Yellen is right: go past the headline employment numbers and a darker picture comes into view. Since she has repeatedly indicated that wages rank among her top concerns, it follows that under her guidance the Fed will keep monetary policy loose for a long time to come.

So far, some argue, the Fed’s easy monetary policy has made little progress towards bringing up wages, but it has surely inflated asset prices. If they are right, Yellen's efforts to improve employee compensation – and therefore reduce “inequality” – are having the opposite effect: those who depend on wage income are seeing little difference, while those who don’t have become better off under an easy-money policy because the value of their financial investments continues to go up.

The American economy has long been compared to a supertanker: it takes a long time to turn around. And the Fed can plausibly argue that its policies need time to take effect, especially because the contractionary fiscal policy of US congress offsets much of what the Fed is trying to do.

Fair enough: Yellen can’t turn the whole ship by herself. But turn it must, so unless the US government starts coordinating its work, don’t blame the Fed for keeping rates lower for longer than most people expect. It’s not yet time to sell those bonds.

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