US figures help foster illusions
Once again we have a case of economic figures out of the United States widely hailed as proof of there being no inflationary danger when closer examination says this is too hasty a conclusion.
These figures show year-on-year productivity growth in the second quarter at 5.7 per cent, the highest in 27 years.
It has encouraged commentators to say that if US workers have improved their output per hour by 5.7 per cent there need be no worry about the US economy overheating with a 6 per cent growth rate. Efficiency gains are driving this boom, not inflationary pressures.
It is true that the record of US productivity growth shows just the inverse correlation with inflation that the optimists hail. As the first chart shows, over the last 40 years low productivity growth has been correlated with high inflation and high productivity growth with low inflation. We are moving to high productivity growth. Inflation and overheating should therefore decline.
It is not quite so simple, however. Think about it. If you pay your workers 5 per cent more and they produce 5 per cent more all is fair and square. You get troubles only if you pay them more and they don't produce more. The money has to come from somewhere and invariably you then see it coming through inflation.
But this says that the key variable is not that they produce more. It is rather that they are not paid more than they produce. In other words, there is more inflationary pressure in an economy where they produce 5 per cent more but are paid 10 per cent more than in an economy where they do not produce more but their wages are also frozen.
What you need to look at is unit costs - how much is the cost of producing any unit of goods or services rising or falling? Mostly this is done by looking at the labour element, unit labour costs, which are actually declining in the US at the moment.
But this is also not quite enough.
With oil prices rocketing you also need to look at non-labour unit costs, which are actually greater at the moment and rising fast.
Put the two together, calculate their combined year-on-year growth rate, take a 12-month moving average of the resulting figures (you need to smooth them out this way when you are looking at a 40-year time span) and you get the second chart.
It tells you that there is a very close match between inflation and unit costs of production. What is more, it shows you that unit costs of production are now rising swiftly and that, in fact, those most recent US labour statistics do not tell you there is no inflationary danger. They tell you the exact opposite.
Remember this if these figures lead you to think there is little danger of rising interest rates in Hong Kong. If US inflation rises, US interest rates will rise and our peg to the US dollar will then inevitably push up our rates as well.