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This time, wage slaves can't revolt

The Fed is banking on a weak labor market to keep employees from demanding wage hikes that could boost inflation. But consumers are feeling pinched.

Colin Barr, senior writer
Last Updated: August 14, 2008: 2:13 PM EDT


NEW YORK (Fortune) -- With the price of practically everything jumping, you probably wouldn't mind getting a bigger paycheck.

But your employer isn't the only one who's unenthusiastic about that idea. Fed chief Ben Bernanke is counting on a weak labor market to keep employees from demanding wage hikes, which could in turn boost inflation. With unemployment rising and jobs moving overseas, you're probably not in the mood to push it anyway.

So the good news is that the Fed's probably right when it says that we're not headed for a replay of the stagflation of the 1970s, replete with its so-called wage-price spiral. Unfortunately, that means Americans are going to be feeling poorer - with no end in sight.

Soaring costs

On Thursday, the government said consumer prices soared 5.6% from a year ago in July, the biggest year-over-year rise in 17 years. Much of that increase was driven by the soaring costs of food and energy, though Bank of America economist Lynn Reaser notes that prices were sharply higher across the board.

"This number was a shocker," Reaser says, adding that practically "the only benign increase was in health care," where prices - after years of strong growth - were a modest 3.5% above year-ago levels.

The textbook response to soaring inflation is for the Fed to raise interest rates. But Fed chief Ben Bernanke has spent the past year slashing rates in a bid to prop up the financial sector, which is laboring under a mountain of bad loans and broken credit markets. Where financial institutions used to borrow heavily in short-term markets such as the repo market, they now get much of their cash via various federal lending programs.

Fed's limited options

"They can't tighten credit now, because of where banks are getting their funding," says Howard Simons, a strategist at Bianco Research in Chicago.

Moreover, the Fed appears willing, for now, to accept a few months of big headline inflation numbers as long as there's no sign of the dreaded wage-price spiral - the 1970s phenomenon in which inflation took root as pinched workers demanded raises.

With the economy slowing, and wages stagnant for most of the past decade, a weak labor market is giving the Fed room to stand pat. Unemployment has risen by more than a percentage point, to 5.7%, since the housing boom peaked in the middle of this decade. The four-week seasonally adjusted moving average of new jobless claims was 440,500 last week - up 40% from a year ago.

Along with the recent decline in energy prices and a rally in the value of the dollar, the soft labor market numbers should ease the pressure on wage growth, Reaser says. She adds that next month's inflation numbers should look better, given the 20% drop in the price of crude oil since mid-July.

But what's good for the Fed, in this case, is bad for consumers. Combine a slack labor market with falling prices for stocks and houses, and it's clear that Americans' finances are getting stretched by the month - with no end in sight.

"The American worker does not have a whole lot of bargaining power right now," says Simons. "We're looking at the impoverishment of the American wage earner." To top of page