By Rick Glaze
Last month the U.S. service industries index reflected continued growth after reporting the biggest acceleration in more than three years in October. Productivity rose at its fastest pace in two years.
When each worker can produce more, then the cost of that product or service goes down. “So what?” you might exclaim. Well, there is a complex relationship among productivity, interest rates, inflation, standard of living and apple pie. Well OK, not the apple pie, but the others are for real. Actually though integrated, the relationships are not that complicated unless you are a politician or a financial journalist trying to squeeze flashy headlines out of thin air.
The story goes back to the beginning of the industrial revolution in America, when steel, automobiles and railroads created a nation. As an entrepreneur and creative financial innovator, J.P. Morgan helped make capital available for business development, but he also took it upon himself to avert a few showstopping disasters that threatened to collapse the entire economy. Soon after, the Congress created a government entity that would regulate the financial system - The Federal Reserve System.
Now it uses several tools to keep the economy on an even keel. Don’t go to sleep yet, the story picks up from here.
An economy that rises too fast is a problem because it can result in high inflation. When prices of the things we use like groceries, gasoline and building products go up, we tend to buy less of them. Then fewer new jobs are created or worse, layoffs occur and jobs are lost. An economy that moves too slowly does not produce enough sales to generate new jobs and economic growth.
The Fed can raise short-term interest rates to slow an inflated economy and lower interest rates to stimulate a slowpoke. When worker productivity is high, the economy produces more goods and services with the same number of jobs. Wages may go higher, but prices can stay low. A growing economy, low inflation with continued low interest rates and worker productivity help stabilize the economy.
Rick Glaze is the president of Glaze Capital Management of Los Altos and a registered representative of and offers securities through First Allied Securities Inc.
