Are We Suffering From “Reverse Money Illusion”???
by James Paulsen, Chief Investment Strategist, Wells Capital Management
Last Friday’s monthly employment report left many wondering when wages will finally begin accelerating in this recovery. As Chart 1 shows, wage inflation has been remarkably tame throughout this recovery hovering about a 50-year low near 2%. Indeed, since wage inflation remains so anemic, despite 68 months of uninterrupted recovery and despite nearing full employment, many fear the current recovery is seriously flawed. This fear is exemplified by a Federal Reserve which suggests wage gains are worrisomely anemic and which continues to employ an unprecedented, crisis-like monetary policy with a zero short-term interest rate target, by bond investors which show little concern about owning 10-year Treasury bonds despite earning one of the lowest yields ever in U.S. history and by recent outcries to raise the minimum wage in order to stem the plight of laborers. Most seem convinced the lack of stronger wage gains is evidence of economic failure and the primary cause of unfortunate suffering among Main Street workers.
Chart 1: Annual nominal wage inflation
However, in the 1970s, we learned our enthusiasm for pay raises needed to be tempered by the overall rate of inflation. That is, the 1970s culture was educated about “money illusion”—confusing nominal wage gains with rising real purchasing power. In a similar fashion, is it possible that today’s culture is suffering from “reverse” money illusion—weak nominal wage gains with a lack of real purchasing power?
Chart 2 illustrates that despite conventional wisdom suggesting wages are not keeping pace with consumer prices, real wages have actually been climbing steadily for much of the last 20 years! The real U.S. wage rate has risen by 5.1% since the end of the last recovery in December 2007. It will likely rise more in the next couple months as consumer price inflation slows further due to recent energy price declines while wage inflation accelerates.
Indeed, the real U.S. wage rate is higher today than at any time since 1979! Isn’t the Fed’s current hesitation to back off monetary stimulus somewhat shaped by its worries over very anemic wage gains? Don’t U.S. bond yields remain low today at least in part because wage risks are perceived as dormant? And finally, would there be such a push to raise the minimum wage if nominal wage inflation was stronger? Does it make sense that so many economic and investment decisions are today being based on “weak wage gains” when the real U.S. wage rate just jumped to a 36-year high? Or, does much of the reaction to weak nominal wage gains mostly reflect a culture suffering from “reverse money illusion”?
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