A story in The Wall Street Journal this week said that GM finally decided to pay higher steel costs to its suppliers instead of hauling them off to court. The story is apocryphal. Suing steel makers is a really stupid idea. And what's a raw-material supplier to do, anyway?
Plentiful liquidity at home and the China boom abroad have worked to raise all raw-material prices and costs. The Commodity Research Bureau's spot index of raw materials has gained about 25 percent over the past year, recouping about 90 percent of its losses since the mid-1990s peak. As for the case above, hot-rolled steel has nearly doubled in price this year, from $330 to about $600. Steel, as with other basic materials, is booming.
Steel-using manufacturers like GM really have only two choices: They can pass the cost increases along to consumers in the form of higher car prices, or they can internalize these costs by accepting lower profit margins. The auto business is brutally competitive, so it's doubtful consumers will eat the full price increase. Foreign carmakers, especially Toyota and Honda, are picking up market share by keeping quality high and costs low.
So, how is GM to stay competitive? The same way everyone else is.
U.S. manufacturers across the entire spectrum are using big productivity gains of nearly 6 percent to reduce costs and raise profits. The spread, or difference, between unit prices and unit costs is therefore unusually wide -- and profitable. This profit spread, as much as any other variable, has driven the stock market higher over the past year. Once the current market correction has run its course, share prices should continue to rise as a result of unexpectedly strong profit gains (and steady low interest rates).
If only the Federal Reserve got all of this.
The central bank's latest policy statement equated deflation and inflation pressures, which is false and misleading. Deflationary pressures are gone, and raw-material price increases are showing up everywhere. But that doesn't mean a big inflationary rise is imminent.
After roughly two years during which the value of the dollar declined relative to domestic commodity prices and foreign-exchange currencies, deflation is a thing of the past. In all likelihood, future core inflation will gradually creep upward, from less than 1 percent today to something less than 2 percent. The Fed should acknowledge the likelihood of this outcome by writing it into their policy statements.
By the same token, the central bank should inform the public that the risk assessment between recession (a thing of the past) and recovery (the business at hand) is no longer balanced. Recent increases in industrial production and factory shipments show clearly that a business boom is in the cards. Lower taxes and higher mortgage refis will continue to propel consumer spending. Gains in gross domestic product between 4 percent and 6 percent will also be sustained.
Clearly, the Fed has reverted back to a Phillips-curve tradeoff between unemployment and inflation as their guiding lodestar in policy setting. This worthless model ignores the powerful price effects of money supplied by the government bank relative to money demands from the economy. Even though lower tax rates, record productivity and strong economic growth are absorbing liquidity, rising commodity prices suggest that excess money is around.
The economic power of money has been increasing as the rate at which money changes hands inside the economy -- commonly referred to as velocity -- continues to pick up. This recovery of monetary turnover is also an important signal that the threat of deflation has passed.
Financial markets know full well that a 1 percent fed funds policy rate is completely out of line with a rapidly recovering economy. The Fed is playing cat and mouse with respect to the timing of future interest-rate hikes. The longer this duplicitous game continues, the greater the chance the central bank's poorly baited trap will ensnare traders and investors into large losses.
It's not going to happen, but a far better approach would be a 0.5 percent rise in the fed funds rate this spring, followed by another in the summer. That would still leave a miniscule 1.5 percent policy rate, something that would not interfere with either stock market or economic recovery. But it would better inform investors, businesses, and consumers about the value and price of their money.
The wise heads at the Fed are always talking about the need for greater policy transparency in emerging economies around the world. Honesty is a virtue. How about starting right here at home?