By Michael Baxter, Economics Writer
In the final quarter of 2012 US corporate profits were 11.8 per cent of US GDP. To find the last time the ratio was so high you would have to rewind the clock all the way to the beginning of time.
Maybe, it would be more accurate to say you would have to rewind the clock to the date when data was first available, which an economist might say is indeed the same thing as the beginning of time. In fact quarter on quarter data only goes back to 1947. Year on year stats are available from 1929, however. As far as the data is concerned Q4 2012 was a record.
It may surprise you to learn that until just under ten years ago, the record for corporate profits to GDP belonged to 1929, with a ratio of 9.9 per cent. It is a shame the data does not go back further, because 1929 is an awkward year for a story to begin. It was, after all, the year when Wall Street crashed, and the point when the US Great Depression began. So had corporate profits surged just before 1929, and was the high level of this ratio a cause of the Great Depression, or was it normal for corporate profits to GDP to be so high back then? We can only really speculate.
What we can say, however, is that, according to data going back 80 or so years, the only two periods when US corporate profits to GDP approached 10 per cent or went over it, the US economy was either in, or about to enter one of its two worst periods of economic performance during that period. Is that a coincidence? Maybe it is, but there are good reasons to think this apparent correlation is not random.
Drilling into the numbers we find that the ratio of profits to GDP actually passed the 1929 record in Q4 2005, fell back in 2007 and 2008, hit a new record in Q4 2011, and has pretty much being going upwards ever since.
The downturn in the US has some odd things about it. Employment has been improving, but is still lower than we need it to be. GDP has been growing, but, just as is the case in the UK, households have been struggling. US median wages, on the other hand, have seen an awful performance. US median wages, relative to inflation, were lower last year than in 1995. As households have struggled, markets have soared, with the Dow and S&P 500 hitting all-time highs in the last few weeks.
Investors and corporate bosses may say: so what? They may say it is good that profits are rising, that an increase in profits will be followed by an increase in hiring. But that is not how it is panning out. Sure we are seeing a modest rise in M&A activity. Sure dividends and share buy-backs are increasing. But to a very large extent US companies are sitting on the cash, as indeed are large UK companies.
This cash sloshes around the banking system, and much of it finally ends up buying US and UK government bonds.
To grow, the US economy needs to see demand rise, and without seeing a corresponding increase in debt, demand can only rise if wages go up.
Without this rise in demand, sooner or later the surge in corporate profits will stop, and go into shuddering reverse.
It may seem counterintuitive, but the rise in the ratio of profits to GDP is not in the long term interests of companies. It is most certainly not in the interests of the people who work for them, and it is not what we need to create sustainable economic growth.