Parsing Greenspan Vs. Bernanke

A good article at Bloomberg, “Bernanke, Greenspan Disagree on Impact of Corporate-Profit Peak,” takes a stab at explaining why, personal issues aside, why the current and former Fed chairman are saying different things about the outlook for the economy.

In a nutshell, “It’s the profit margins, stupid.” Corporate profit margins have hit a level unequalled since 1969. Greenspan thinks this means that growth has gotten so robust that we’ll start seeing wage costs rise (some data point to that already). He believes companies will cut spending rather than suffer lower earnings, which will reduce growth. But Bernanke thinks that the fact that margins are so high permits companies to pay more to workers and still have attractive profits.

The overall data would seem to favor Bernanke’s view. This expansion has been noteworthy in how low a proportion of GDP growth has gone to workers, either in the form of hiring or pay increases. However, behaviorally, public companies have become very short term oriented, preferring the certainty of earnings generated by expense cuts rather than top line growth.

One also has to wonder what this public disagreement is all about. Is it Greenspan’s need to be in the limelight? Or is this actually carefully orchestrated to take a little air out of overly complacent and somewhat frothy markets without creating a rout?

To the Bloomberg story:

The disagreement between Alan Greenspan and Ben S. Bernanke about where the U.S. economy is headed boils down to just one word: profits.

For the 81-year-old former Federal Reserve chairman, a peak in profit margins is a sign the economic expansion may be past its prime and the risks of recession are growing. For his 53- year-old successor, the topping out of margins may instead herald better times for U.S. workers as wage increases start to catch up with the five-year boom in corporate profits.

Many economists — including some who worked with Greenspan at the Fed — side with Bernanke. If companies are accepting lower profit margins instead of raising prices to help offset increasing wages, that helps contain inflation. It also helps forestall the kind of Fed-engineered interest-rate rises that have often triggered recessions in the past….

Profit margins for non-financial corporations rose to 13.7 percent in the third quarter from 12.8 percent in the second, according to the Commerce Department. That’s the highest level since the second quarter of 1969 and more than double the 6.2 percent in the fourth quarter of 2001, just as the current expansion began.

Meanwhile, corporate profits increased to a record 12.4 percent of the economy in the third quarter from 7.1 percent five years earlier, as companies held down wage increases while their revenues rose.

That may be about to change. Unit labor costs rose at a year-over-year rate of 3.4 percent in the fourth quarter, versus 1.5 percent a year earlier. Almost half of the Standard & Poor’s 500 companies reporting fourth-quarter results showed narrower margins, according to data compiled by Bloomberg.

Wall Street analysts surveyed by Bloomberg see per-share earnings growth among S&P 500 companies slowing to 6.7 percent this year from 16.6 percent in 2006.

That’s what’s bothering Greenspan, who puts the chances of a recession this year at one in three…

Behind his forecast: concern that contracting profit margins will force companies to cut capital spending and hiring.

Signs of this pressure are already evident. Shipments of non-military capital goods excluding aircraft dropped 2.7 percent in January, the biggest month-to-month decline since September 2001. Orders slumped by the most in three years.

“When earnings growth slows and margins narrow, American business is very quick to cut back on expenses,” says Allen Sinai, president of New York-based Decision Economics. He sees the odds of a recession this year at about 20 percent.

Still, most economists, including those at the Fed, say it’s premature to declare the expansion near an end. Indeed, some have grown more optimistic as the economy continues to expand and employment keeps growing in the face of the housing slump….

Rather than seeing peaking profit margins as a precursor of tough times, Bernanke portrays them in a more positive light. He calls it “normal” for rises in inflation-adjusted wages to catch up with profits, especially when productivity has been strong….

History seems to side with Bernanke. In the last expansion, margins began falling in the fourth quarter of 1997; there was no recession until March 2001.

“I think we are closer to the middle of an expansion than the end,” says Laurence Meyer, who served with Greenspan at the Fed from 1996 to 2002 and is now vice chairman of St. Louis-based Macroeconomic Advisers LLC. His firm sees the economy growing 2.7 percent in 2007 after expanding 3.1 percent in 2006 as profit growth slows to 6.6 percent from 12.8 percent.

Alan Blinder, a Princeton University professor who was Greenspan’s vice chairman from 1994 to 1996, says the probability of a recession this year is “pretty low, not more than 20 percent.”….

The stock market has also been more restrained than it was during the go-go years of the late 1990s. The S&P 500 rose 14 percent last year and 3 percent in 2005. That compares with jumps of 20 percent in 1999 and 27 percent the year before. The index now trades at about 15 times forecast earnings, less than the monthly average of 27.3 times during the past 10 years.

“There’s been a healthy skepticism on the part of investors and corporate executives about the surge in profit margins,” says Jack Ablin, who oversees $50 billion at Harris Private Bank in Chicago. “That’s going to give us a cushion as margins contract.”

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