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Onward and Upward: Profit Margins and Turning Points

Will today's data discourage the Fed from an aggressive tightening? Plus, a word about the Fed and margin requirements.

Black Coffee in Bed

JACKSON HOLE, Wyo. -- "Wise men profit more from fools than fools from wise men; for the wise men shun the mistakes of fools, but fools do not imitate the successes of the wise."

Thus Cato the Censor.

He's been dead for a few years now ... but he provides as good an introduction as any to the 1999 profit-margins numbers released this morning.

All apologies for the short history. The gubmint bean counters who put these numbers together positively suck at posting comprehensive revisions in any kind of a timely manner at all.

Top-line margins equal "corporate profits with inventory valuation and capital consumption adjustments" divided by the gross product of nonfinancial corporate business; after-tax margins equal "profits after tax" divided by same. (Your narrator presents these measures of profits and output because Greenspan expresses a

preference for data from this sector.) Note that top-line margins also equal unit profits from current production divided by price per unit of gross product; Table 12 in the gross domestic product

release contains all the numbers you need to calculate and track these ratios yourself.

Three observations here.

The first is that our policymakers are most certainly monitoring these numbers closely. Central-bank literature going back almost two years tells us so.

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.


testimony delivered in July 1998.

An increase in the stock of labor-saving equipment and an improved level of efficiency and cost containment through high-tech capital investment have created a broad range of potential innovations that have granted firms greater ability to profitably displace costly factors of production whenever profit margins have been threatened.


testimony delivered in July 1999.

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Imbalances in the labor markets perhaps may have even more serious implications for inflation pressures. While the pool of officially unemployed and those otherwise willing to work may continue to shrink, as it has persistently over the past seven years, there is an effective limit to new hiring, unless immigration is uncapped. At some point in the continuous reduction in the number of available workers willing to take jobs, short of the repeal of the law of supply and demand, wage increases must rise above even impressive gains in productivity. This would intensify inflationary pressures or squeeze profit margins, with either outcome capable of bringing our growing prosperity to an end.


testimony delivered last month.

The second is that while policymakers still view the pricing-power thing as a non-threat, they also seem to think that the very best news on that front is behind us.

In October they

cited "noticeably fewer comments by business contacts about their inability to raise prices." In November they

noted that "the turnaround in energy and import prices could tend to feed through more directly into the prices of U.S.-produced goods by raising costs and reducing competitive pressures to hold down prices." Last month they

reported that "while there seemed to be an increasing number of exceptions, business contacts continued to report that raising their prices was very difficult to carry out successfully and often impossible."

This might seem like a bit of a stretch to some market participants ... but think of it in terms of the recent acceleration we've seen in core prices. Yes, it's only mild, and yes, it comes from a very low base; but the fact remains that it's there. The trough is what's important. It's the turning point that matters.

And the third observation brings the first two together: Only very very wonderful news stands a chance of stopping the Fed's steady march onward and upward.

The thing to take away from ordinary good news like the kind we got today -- profit margins holding roughly steady, at worst -- isn't that it will keep central bankers from tightening further.

The thing to take away is that it might keep them from tightening aggressively.

Side Dish

The focus of this column does not include shares.

Yet here's

something about margin requirements that will probably interest many of you.