Greenspan's Conundrum and UK Gilt Yields

SkyNews is writing UK Manufacturing Jobs Go.

Around 25,000 jobs were lost in the manufacturing industry over the past three months, says the CBI's latest survey.

Manufacturers have been struggling to pass on rising costs to customers as customers themselves tighten their economic belts.

Firms hampered by sharp rises in the cost of gas and oil cut staff numbers in a bid to relieve squeezed profit margins, employers' body the CBI said.

The total number of jobs lost in the manufacturing sector over the past year was 106,000, the CBI's quarterly industrial trends study revealed.

"Conditions for manufacturers are getting increasingly tough as costs continue their seemingly inexorable rise," said the CBI's Ian McCafferty.

"But weak demand keeps prices down, squeezing already thin profitmargins even further.

"The sustained high level of oil and sharply increased gas prices have driven up energy and raw material costs.

"Manufacturers are continuing to respond by cutting employment to curb the wage bill and boosting investment in efficiency-improving measures."

Hmmm. Let's see.

• Oil prices rise.
• Natural gas prices rise.
• Raw materials prices rise.
• Weak demand prevents passing along those prices.
• Manufacturers respond by cutting employment.
  

Let's play 4 UK questions:

1. If employment is cut, what will that do to demand?
2. If demand falls, what will that do to prices?
3. What happens when Brown is forced to raise taxes?
4. When did the slowdown start?

Now let's play 4 US questions:

1. If input costs do not matter in the UK will they matter in the US?
2. What happens to demand if Bush raises taxes or cuts government spending?
3. If costs can not be passed on will it matter if the US$ falls?
4. What happens if housing slumps?

It's answer time.

• Whether or not we are talking US or UK, prices either can or can not be passed on.
• Right now it seems that they can't, at least in the UK.
• Demand for goods is falling.
• UK unemployment is rising because of falling demand.
• If Brown raises taxes it will further decrease demand for goods and further increase unemployment.
  
• Prices at the pump and heating costs can and have been passed on because gasoline and heating oil prices are inelastic.
• Medical expenses are also inelastic. If you need an operation to save your life you will get it regardless of what it costs.
• Laying off workers will decrease the ability of consumers to pay higher prices.
• Problems started happening in the UK with a slump in housing.
• Problems are now starting in the US over housing on a 6-8 month time lag vs the UK.
• If credit dries up people simply can not buy what they can not afford.
• Credit is starting to dry up in the US when looking at home equity lines and cash out refis.
• A falling US$ is mostly irrelevant to the equation. Prices simply can not rise unless beyond people's ability to pay unless further credit is extended.

The key issue here is prices.
Input prices are soaring, yet output prices are not (expect where prices are inelastic).
Housing prices soared because of nonsensical credit standards, and that credit seems to be drying up.
Those are the facts.
Those will be the facts regardless of what the US$ or the British Pound does.

That is why those focusing on the supposedly inflationary effects of a falling pound or a falling US$ are wrong. That is also why the FED and the ECB are wrong to be worried about rising energy prices. There will be no passthru unless and until there is an overall increase in the ability for consumers to pay higher prices. I see little evidence of rising wages in either the UK or the US. Instead I see 14 consecutive rate hikes in the US that are now hurting both home prices and credit lending.

Economic Factors

1. Global wage arbitrage is hugely understated as a deflationary force.
2. Rising energy costs are hugely overstated as an inflationary force.

A good portion of Greenspan's Conundrum as well as the Gilt yield Conundrum in the UK are wrapped up in those two points. Add in credit that is just beginning to tighten in the US, in conjunction with the lagging effects of those 14 hikes, and there are huge deflationary forces brewing in both the US and the UK.

Mish note to inflationists:
If these conditions persist, there simply is no way to get inflation out of this mess.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/