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How Long Will This Economy Last?

By Joseph Minarik

This article originally appeared in The Hill on October 07, 2018.

The labor market of the American economy continued its march in a straight line upward in September. The unemployment rate hit 3.7 percent, which is the lowest level since 1969. The economy created another 134,000 nonfarm payroll jobs. By these standard headline indicators, everything looks well. The upward trend from the end of the financial crisis, about 2010 or so, continues unabated with no end in sight. This kind of growth might hint that the labor market is getting tighter.

But the major indicators of tightness remain essentially flat. The employment to population ratio, or the percentage of adults who have jobs, increased by 0.1 points last month, but to precisely the same percentage that it held one year ago. The labor force participation rate, or the percentage of adults who are either working or looking for work, is the same as last month and down 0.3 points since last year. Hours of work remain essentially flat, and inflation is staying near the Federal Reserve target. The central bank is raising interest rates gradually, while the labor market continues flying straight and level despite this limited buffeting.

How long can this go on? Most economists would be happy to watch this movie run for hours more. But history says that adding this many jobs month after month will sooner or later exhaust the pool of potential workers. Firms will have to begin to bid against one another to hire the workers they need to expand. Wages will begin to grow too fast and inflation will result, followed by the inevitable economic squeeze as the Federal Reserve tries to stabilize prices while facing a downturn. But so far, no such bad luck. What might stop the progress?

One thing we have going for us is truly intense competition in the marketplace. Sellers cannot raise prices, because if they do, their competitors will step in to take their customers and expand share. Changing that mentality will require a strong sense in the marketplace that inflation is inevitable, such that the first firm that raises prices will instead show other sellers that they too can raise prices.

One potential inflation enabler is trade, although developments are actually favorable in recent weeks. The game of chicken with our North American neighbors appears to have been resolved by the addition of another lane to the highway. Some economists and trade negotiators feared that the hard bargaining of this administration could end in a costly collision. Instead, the art of that deal appears to have resulted in modest changes in our hemispheric trade agreement with Canada and Mexico. So an outright trade war, at least on that front, is now unlikely.

However, even without the imposition of retaliatory tariffs upon retaliatory tariffs, the new trade deal will still lead to inflation. Requirements such as more automobiles coming from high wage labor might be good for the workers who benefit, but inevitably it will raise the cost of cars. Similar restrictions in other sectors will have the same effect. At the end of the day, it is inflation that is most likely to derail progress on employment.

Meanwhile, the markets have become more bullish on the economy, but that inevitably means a greater fear of inflation. The bond market has sent the prices of Treasury securities down, which means that interest rates are going up. Higher interest rates will ultimately hold back economic growth. Higher interest rates will also increase the federal budget deficit, which will send interest rates higher still. It will be more expensive for businesses to invest, and that could slow the economy and the job market.

If we want solid prosperity, we need to follow the fundamentals. Tax cuts and spending give the economy a shove, but only at the cost of uncertain footing. Protectionist trade practices, whether through trade wars or through costly tariffs, are harmful. Massive budget deficits are worse. The outlook in the short term is bright. But there are clouds on the horizon.