Wage Inflation Isn’t Coming. It’s Already Here.

George Soros has a great line that we've used a lot in Epsilon Theory notes. When he was asked how he could possibly have predicted what would happen when he famously "broke the Bank of England" in 1992, he replied in that growly Hungarian voice: I'm not predicting. I'm observing.

It's the perfect catchphrase for the modern, narrative-savvy investor. It's the perfect catchphrase for the Three-Body Problem market, where there is no algorithm for predicting markets (no closed-form solution, in the lingo), but only tools for calculating markets. Where there is no Answer for successful investing. But there is a Process.

I'm not predicting. I'm observing.

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  1. The interesting piece here is that in March-May 2020, the case was made (rightly so) that wages bounced because a huge chunk of lower-paid workers got axed in retail, restaurants, travel, entertainment, and other services industries. Thus, the labor force in the spring of last year was left with a bunch of workers in higher-income positions, so the jump in wages that we saw at that point could be explained by showing 30M people out of work in low wage jobs, and so average wages slid up even though it wasn’t like everyone suddenly saw their incomes jump because of COVID. Not at least with how BLS calculates it for this report.

    But if we’re looking at it now, the question for those businesses in those sectors that are trying to reopen and trying to rehire is that this was not a seasonal closing where you go back and find the workers from last year and bump them from $11 and hour to $11.25 an hour. This was the biggest one-year labor disruption in history. A ton of people moved. A ton of people retired. A ton of people changed industries because they saw friends getting paid more in other businesses. A ton of people are still dealing with kids remote learning with no childcare. Businesses aren’t simply hiring back the same employees at a slight raise now.

    They have to compete with the higher wages that some of their workers have gone out and taken in the last year. They have to find new employees to replace the ones who moved. They have to pay enough for parents to be able to afford babysitters to watch their kids remote learning and make sure the house doesn’t blow up.

    So while last spring’s jump in wages at the same time we saw tens of millions of people getting axed can be explained by the type of workers who were laid off en masse and their wages, the labor market has shifted because those workers weren’t simply stagnant waiting to return to the same job they had previously. Those industries are not competing within themselves for workers anymore. They’re competing with the higher wages and stability that exist in the industries that weren’t shuttered.

    Ultimately, it’s a good thing for the American worker to be able to have a chance to see wage gains. I don’t bemoan it, and I think given the trends of the last 40 years, it would be tough to find fault with Americans who are finally seeing the tables turned and taking advantage of a labor market that is in their favor for the first time in a generation. But wage inflation is the sticky kind of inflation. If I cut down an oak tree, it doesn’t care how much its timber gets sold for. It has no pride in the price of its services. But if I pay Sally $15 an hour this year, she’s gonna lose her shit if I tell her to come back next summer at $13 an hour. So unlike the bumps we’re seeing in lumber prices, used car prices, and things without feelings, wage inflation is the piece that likely makes this inflation stick. And it makes it stick in the two of the three sectors that have been the dominant trend in employment growth in America over the past 50 years - restaurants and travel.

    Prepare for takeoff.

  2. I will echo a few of the points that @Canid brought up. Initially average wages went up solely because lower earning employees were laid off. Now with those employees being rehired, average wages should go down. I would have to take a look at the actual employment numbers and hours worked to see if you wage data has captured this properly. I am not disputing your narrative I just want to make certain that you have captured the above mentioned facts.

    Now I will tie in John Hussman (mentioned in the ET Forum). One of Hussman’s favorite valuation measures which he uses to predict 12 year forward earnings in the stock market is what he calls MAPE (Margin Adjusted Price Earnings Ratio). He has long stated that businesses have record high margins partly due to low earnings by workers and that this would change and his MAPE calculations call for no or negative twelve year returns partly as a result of this. So obviously higher wages will result in lower earnings and potentially lower equity prices.

    I am not looking forward to another bout of inflation. Dealing with inflation usually takes ones effort off of more productive endeavors.

  3. All of which suggests a very nice level of heterogeneity may develop in stocks as companies with pricing power (the way we used to invest back in the inflation day) are treated differently over companies with no ability to move prices.

  4. Risking some personal inflation, your observations are worth every penny nickel dime of the subscription price. Not that it solves anything, I just wonder how many people spreading these narratives are complicit and how many are unknowing mouthpieces repeating the spin.

  5. Avatar for olowe olowe says:

    So in terms of Rusty’s Things We Need to Be True, a change in Common Knowledge would take out at least his top3:

    1. We live in a deflationary world.
    2. We live in a flat world.
    3. We live in a world in which the Fed has your back.
    1. By definition
    2. MCD and CMG can't prepare and serve food in local markets over Zoom from India.
    3. To Ben's point about the Fed being trapped in their own narrative, if they admit it's not transitory, they might have to do something about it.
  6. The Fed just reported that it’s balance sheet ballooned another $32 Billion last week. That’s a 23% annualized increase over 3 months and 89% growth rate from 1 year ago.

    Insane rate of increases in an environment already of rising inflation .
    How they can justify printing massive quantities of money is beyond me.

  7. I am trying to better understand Ben’s points above. I get that hourly wage growth is being mathematically depressed by longer working hours. But I assume this is only for those that are actually employed?

    Can we assume that there IS still slack in the US labour force that WILL come back once all the stimulus cheques and other programmes stop or shrink? Can I assume this is the case when I look at the underemployment rate (at 10.4%)?

    I don’t know the answer to this but it’s important to understand this in the context of whether or not this is “transitory”.

  8. The Fed and the government remind me of an alcoholic that is hitting bottom. The lies that they have used to build their house of cards is starting to get wobbly. They must know tell more ridiculous lies to cover for the lies previously told.

  9. Now not know —we need an edit :writing_hand: button.

  10. You should read https://mishtalk.com/economics/the-psychology-of-qe-is-far-more-important-than-the-amount-of-it including the John Hussman article linked inside. The John Hussman article is also linked in the ET Forum article “Hussman Letter”. The Fed balance sheet is not inflationary because the money goes nowhere but sits on the books in banks. It does have an effect on interest rates however. The “helicopter” money (deficit spending) is another matter especially if it doesn’t get paid back. That money goes into people’s pockets for them to spend.

  11. I like the fact that Ben used The Great Wave off Kanagawa as the image for this one. Very appropriate in that it’s a gigantic rogue wave that’s about to crash into us. Terrifying. I don’t know if it’s been coined yet, but “hyper-stagflation” is a phrase that I have not heard a lot about… yet.

  12. The move to $15 an hour sticks, but does it create a trend where Sally demands and gets paid $17 next yet, and $20 the year after? If it stays at $15 you don’t have an inflationary spiral, you have a one off wage increase, so the wage inflation rate (the first derivative) goes back to zero. If it creates an inflationary trend then where Sally gets a series of pay rises then you have wage inflation that is game changing, but I have yet to see convincing arguments for why Sally gets a series of pay rises.

    Maybe demographics might be one driver for a series of pay rises, as ratio of the number of retired people to the number of working people keeps going up.

  13. Some of the money people spend gets taxed when it ends up in someone else’s salary, so some of it goes back to the Federal Government (as well as to local and state governments).

  14. Avatar for bhunt bhunt says:

    With the jobs report today showing 4% year-over-year wage inflation and 0.4% month-over-month wage inflation, it seems like a good day to repost this note. Personally, I’m delighted that wages continue to rise at a rapid clip. But if you think that any of this happens in a vacuum, if you think that employers aren’t preserving their margins by raising prices more than they’re raising wages … you’re living in a fantasy world.

    This is what a wage/price inflation spiral looks like.

  15. Yeah, and you keep showing up and killing my buzz with all this real world data. Leave me to my narrative fantasies you brutal realist!

  16. I think your inflationary spiral might happen elsewhere and not with Sally.
    If I was making $20 when Sally was making $13 and now Sally is making $15, whether I deserve it or not, I’m expecting to make $22 shortly. This thinking applies regardless if you work at the same company as Sally or not. And if my pay doesn’t go up, I’m going elsewhere to get paid my $22. However, I might be placated by my employer to accept $21 this year and $22 the next year. If previous to Sally’s pay bump and my related bumps my employer was only going to pay me $20.25 next year and $20.50 the year after then there’s your inflationary spiral for the next few years.
    This scenario could also potentially explain all those surveys we keep seeing saying 40% of the workforce is thinking about quitting.

  17. Did the Fed finally hit it’s target inflation rate?

    Given a decade or more of under shooting the target rate, is overshooting for a bit just fixing the average?

    If I have a large mortgage, and I never want to move house until they carry my body out in a box, should I be happy with some inflation making it easier to pay off my capital? (Assuming that I personally see some “wage growth?”)

  18. In Austin, TX the help wanted signs all advertise how much MORE than $15 per hour you can start at. $15 is a new base reference that is no longer acceptable to attract new workers at most companies. And this reference is for entry level cashiers or prep personnel at Jimmy John’s Subs, Papa Johns, Starbucks, Target, etc. Wage expectations have already rolled well past $15 per hour, for entry positions.

  19. I understand Ben’s sentiment when he states he is pleased with the boost in wages. However, when he is sure that this means a wage/price inflation spiral it is counterproductive to be happy about the wage boost .
    Inflation hurts the poor and middle class the most.
    In the inflationary 1970s, wages did not, could not keep up with inflation.
    People were upset, average people.
    That led to a political upheaval, sweeping Democrats out of power in 1980.

    I understand totally the general desire to reduce income and wealth disparity, I think that’s where Ben is coming from.
    I happen to believe the Federal Reserve and Congressional capture by big business and plutocrats (Chuck Schumer’s “Carried Interest” tax break for Hedge Funds and Private Equity Billionaires for example) is to blame for a majority of that.

    IMHO, the only way Ben should be happy about wage gains are if they are accompanied by Productivity gains

  20. Capitalism is dynamic. If the labor pool is unavailable at wage rates businesses grew to rely on then a few things will happen. The business will hire fewer workers. The business will alter its model to work around the new cost. The business will raise prices. Some of those are negative for growth. While the lower end workers are watching their living standard fall they will also be able to consume less. As Rusty reminded us in a note on inflation regarding used car prices, inflation is not a monolith. It is a source of risk and uncertainty and gums up the functions that seemed so seamless in its absence. It is less a factor to invest for, than a giant unknown to hedge against.

  21. If Sally went from $13 to $15. I’d expect my $20 to go to $23.07. Assuming Sally got the raise just for existing and not because she added to her skill sets, received additional responsibilities, or brought in a profitable new account.

  22. You should be happy with your mortgage payments becoming easier to make, assuming your income has increased and you are able to buy the goods and services necessary to live.

  23. Haven’t you heard companies are not raising prices. They’re repackaging their products in smaller quantities but the price is the same as the larger quantity. Its called deflationary packaging - and an ESG movement!

  24. Google the term “Great Resignation” and read a few articles. The wage inflation that initially started at the bottom of the ladder ($10/hr moved to $15/hr) has put a lot of upward momentum on mid tiers as pointed out in the “Sally” analogy above. What is only starting to be discussed is the issue of management and executive staff starting to make “lifestyle choices” which are not about money, but really still are about money. What I mean by that is that it’s about net value, more than just a number after a dollar sign.
    Example? That awesome executive making $500,000 total comp is now leaving to spend time with her family and lower her blood pressure by being a yoga instructor on a beach in Costa Rica. Her physician husband making $250,000 seeing 30 patients a day on a treadmill is going to join her on the beach and be a surf instructor. Together they’ve purchased a 20 room hotel for $2M and that’s their retirement.
    Is that inflationary? Hell yes it is. Because you can’t really replace her right now. So you try throwing a higher dollar figure at her and seeing if she’ll bite. She probably will, but that number will have to be one decimal point higher than her previous salary. I don’t mean $500k to $5m, but if she’s made that lifestyle choice then your offer is going to have to be in the low 7 digits instead of mid 6 digits.
    Is that everyone? No. It doesn’t have to be to have an affect. It just has to be a small percentage. The labor market is so constrained right now that the Great Resignation is having an outsized affect. At scale, that’s inflationary.
    Right now it’s mid-upper management and lower level executive levels. Very soon that will trickle up to VP level. Next? C-suite. And wow wait for predictable fireworks from the progressive camp when CEO payscales double.

  25. Avatar for Pat_W Pat_W says:

    This comment is of “human interest”. A consequence fo both wage inflation and Tump’s previous throttling of immigration from Mexico is that low wage jobs go begging. In the past few years I have read several dozen posts by spinal cord injured people on forums I participate in, who say they simply cannot find carers. Those from publicly funded agencies are often terrible at the job, don’t show up, etc. How does a high quad get out of bed and have breakfast if no one comes to help?

    Quads who worked for decades and raised families, paid taxes, and have long lived independently paid their own help. Now they cannot compete. These are folks I have learned from and grown fond of over the years. Some post of their despair and then are never heard of again. i do not doubt some suicide, if they had put aside enough spare meds. i subject you to this sample:

    " Going down fast

    15 Aug 2021, 2:32 PM

    I am down to one intelligence challenged, untrained, non vaccinated caregiver, and a couple kind friends. My care is being compromised in every corner. It is only a matter of time that an infection pulls me under. Never in my 67 post injury years did I think I would go out this way."

    The liberal narrative coalesces around “This is great! People on the bottom need to make a living wage!” Absolutely true. Equally true is that the people I mentioned and nursing home residents need carers.

    As people here know well, narratives paper over real life.

  26. Is it possible that additional barriers to entry are contributing to the difficulties in finding people to employ in those jobs?

  27. I’m still finding it hard to believe that much has really changed. Sure, there are some bottlenecks. And sure, those bottlenecks are leading to some relative price shifts. But I think that’s a lot different to a broad/generalised inflationary dynamic.

    The parts of the it’s here argument that I most struggle are that: there’s been a shift in the perspective of low-wage workers, and that this will lead to increased wage pressure in the future.

    I think the arguments that are put forward about changing perspectives can be summarised as: either they’ve changed their willingness to endure poor working conditions or that their inflation expectations have adjusted upwards.

    Starting with the inflation expectations have shifted bit, I just don’t think we have much evidence. Yes, survey measured inflation expectations are up, but it’s in line with moves in the oil price https://fred.stlouisfed.org/graph/fredgraph.png?g=GhUX , so I’m not sure it’s telling us of some big shift.

    What about if preferences shift? I think that’s interesting, but in order to withhold labour, those selling their labour need to have the income/balance sheet space to allow them to do so. I don’t think there’s much evidence that, when supplementary payments end, there will be a greater number of households with the income/balance sheet space to withhold their labour in favour of better prices and/or conditions. Put simply: I think that inflation is always and everywhere a balance sheet phenomenon. And I don’t see evidence that the number of households who will be able to withhold their labour whilst relying on other forms of income/capital depletion has increased.

  28. I think preferences have shifted. Especially among working poor and working middle class. They spent the last year and a half at home and re-evaluating their lifestyles and came to the conclusion that their second/third job wasn’t worth it. Someone mentioned here or in another thread (I’m sorry I can’t find it at the moment) that they have friends who had second/third jobs who realized that after expenses, childcare etc, they were either breaking even, barely making money or even losing money in some cases. This has been my experience as well with my friends who were working second and third jobs. I think the uber/lyft driver shortage is reflectively of this sentiment.
    As you said, it comes down to balance sheet. Income is an important aspect but it is only one side. If I can switch to one job making the same or a little less than before but my costs decrease accordingly, my balance sheet is fine and the general labor pool is still finite.

  29. Totally. I think the key bit here though is that the households who re-evaluate also have to reduce consumption - e.g by reducing expenses, childcare etc. So net, that looks like demand & supply fall simultaneously?

    In summary: unless there is some other (non-labour) source of purchasing power available, then you can’t make the choice to keep consumption at the same level and pivot labour supply.

    Maybe it’s not clear in the aggregate until the supplementary measures have rolled off.

  30. Thanks for the response. I see what you’re saying now.
    There is an argument to be made that the increased savings rate declining as households now have services and things to purchase again could be that other source of purchasing power.
    But I’m particularly fond of this argument:

    Interest payments declined significantly during the pandemic as households paid off their credit card and other debts. A smaller amount of household income going to debt payments implies to me that there is potentially a way for consumption to stay at the same level while labor supply dries up.
    But I also think you are correct that it won’t be clear until the supplementary measures roll off.

  31. Anecdotally, my market the number is now moving to $20/hr. It’s settling around $23/hr for seasonal work in our resort market. I’m not saying you can’t find $15/hr jobs, but nobody is advertising $15/hr anymore because those ads will just not get any applicants.

  32. Avatar for Zenzei Zenzei says:

    In our small town - the moment the kids went back to school and back to college…the for hire signs all came up and nobody is biting at $15. Even more concerning (to me) is that EMTs and qualified medical technicians at hospital earn somewhere between $16 and $18 an hour in our county. Those are generally prevailing wage structures in NY state. Becoming a parademic comes with somewhat higher pay but a commensurate increase in workload and pressure.

    All three of those jobs are hard jobs (lifting, moving, cleaning, long hours, etc) that also require a meaningful amount of training (EMT is 250 hours, Paramedic is 18months to 2 years) and that come with a lot of added pressure (regulatory, exposure, fear of hurting a patient, lousy working environments, etc).

    At some point, if wage scales for less skilled jobs start to hit $20 an hour, etc….absent benefits as an equalizing constraint (i know a lot of folks that only work because they want affordable healthcare) - we are going to see shortages of labor in critical areas and/or a real rise in costs at essential institutions (ie places where consumption is not an option - it’s a fundamental need).

  33. Avatar for rguinn rguinn says:

    Funny aside that is far too anecdotal to be useful to this conversation but still interesting to me: we used to pay babysitters $20/hour regardless of asking rate (which was usually $12-15/hr) because that was a rate that ensured that my wife and I would always get a “yes!” when we asked if one of our main babysitters was available. And then we’d usually tip a little bit more. For those who aren’t parents, a reliable babysitter is the most precious human resource in the world.

    Now? I’m getting negotiated with over my offers of $20/hour. My house’s brand equity within local high schools is evaporating.

  34. Thanks. Yes, I have a lot of sympathy with the idea that, if we see inflationary pressure, the US economy is much less interest rate sensitive than it was. That there’s much more scope fore household re-leveraging and that the Fed may have to raise rates more than expected.

    I think getting to the inflation really depends on the distribution of the balance sheet improvement. I remember for years people would show charts like this about wealth effects and the potential for increased spending, but just stopped working:

    The argument for this wealth effect being different should be made two ways 1) that its well distributed, so people across the income spectrum can change their labour supply preferences or 2) that its different because its in cash (rather than housing or securities). In the credit card data, I think you can make a case that it’s pretty well distributed - most clear I think if you compare the US & Canada (cash handouts bigger) to the UK (sadly this data for UK only until Dec 2020):

    ABS Credit Card Indices (fitchratings.com)

  35. I think that where I fall on this debate can be summarised as: Even if stimulus has boosted balance sheets up and down the spectrum, that’s very likely to be a short lived phenomenon at the lower end (of wealth). And because of that, many households will sadly still not have much bargaining power.

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