Squeeze This

JACKSON HOLE, Wyo. -- The

Greenspan

literature is littered with references to profit margins.

The Humphrey-Hawkins testimony delivered in July 1988.

Given that compensation costs are likely to accelerate at least a little further, productivity trends and profit margins will be key to determining price performance in the period ahead.

The remarks delivered to the National Association of Business Economists in October 1998.

As a consequence of steady price levels, we have seen some very modest pressure on profit margins, which have been going down over the last two or three quarters, really. This has been a very unusual phenomenon, because it's been my experience over the years that when we are dealing with falling or moving profit margins, moving down in the context of still fairly good business activity, that price pressures tend to become difficult to deal with. It's not happening now, and the major reason, at least from a strict statistical balancing, is that the productivity data are behaving far better than I think any of us expected.

The testimony delivered to the Ways and Means Committee in January.

Despite brisk demand and improved productivity growth, corporate profits have sagged over recent quarters. This is attributable in part to some acceleration in labor compensation, but other factors have also been pressing, especially intensified competition and lower prices facing our exporters and those industries competing with imports. In these circumstances, businesses will feel under considerable pressure to preserve profit margins should labor costs accelerate further, or should the falling prices of commodity inputs, like oil, turn around. But, to date, businesses' evident pricing power has been scant. Either that would change and inflation could begin to mount or, if costs could not be recouped, capital outlays might well be cut back.

And the Humphrey-Hawkins testimony delivered last month.

Another downside risk to the economic outlook is that growth in capital spending, especially among manufacturers, could weaken appreciably if pressures on domestic profit margins mount and capacity utilization drops further. And it remains to be seen whether corporate earnings will disappoint investors, even if the slowing of economic growth is only moderate. Investors appear to have incorporated into current equity price levels both robust profit expectations and low compensation for risk. As the economy slows to a more sustainable pace as expected, profit forecasts could be pared back, which together with a greater sense of vulnerability in business prospects could damp appetites for equities.

The

BEA

released fourth-quarter and full-year 1998 profit margin figures this morning. Recent numbers appear in the table below.

Margins recently peaked at 13.8% during the third quarter of 1997. That performance went down as a 30-year best; margins have been falling since. They dropped to 12.9% in 1998 from 13.5% in 1997 and now (as of the fourth quarter) stand at their lowest level in roughly three years.

Technical note.

You can calculate these numbers yourself by heading to

Table 12 in the latest

gross domestic product

release. Margins equal profits divided by (in this case) the gross domestic product of nonfinancial corporate business. Alternately, unit profits from current production divided by price per unit of gross domestic product yields (roughly) the same result.

Now look back on the G. Love

comments. Then think hard about the tremendous burden that now rests on the productivity numbers to show robust increases each and every quarter.

Margins are falling. Unit labor costs in the nonfinancial corporate sector are currently

running at a 1.5% year-on-year rate (compare to 0.4% four quarters earlier) and nominal wage growth in the same sector is currently running at a 4.3% rate (compare to 3.2%). Drum-tight labor markets through March guarantee that both will continue to accelerate. The frenetic pace of business activity, meanwhile, refuses to let up.

Final sales to domestic purchasers

, which vaulted 5.7% on a nominal basis last year, were soaring at a 6.2% rate when 1998 began; recent retail sales and chain-store reports show that similarly big increases persisted through March.

And, miracle of all miracles, the price measures are creeping up. The

chain-type price index for gross domestic purchases

, which measures the prices of everything Americans buy (including imports), turned in progressively bigger quarterly increases throughout 1998. It is currently on track to post a first-quarter increase bigger than anything we've seen since the first quarter of 1997.

Fed members are clearly too busy gawking at productivity numbers to notice that prices and costs are rising and accelerating. And not only are they banking on huge productivity numbers to save the day, but they are also counting on them to hold up even under the marked deceleration in growth they continue to forecast.

New Era indeed.

Side Dish

Best cup of Joe?

One lump.

Two lumps.

Anything not Starbucks.

Thick and black. Like oil.

Enough cream and sugar to kill the taste.