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My Sad Thesis on Minimum Wage

 

We are seeing a growing trend towards the public demanding an increase in minimum wage. Last weekend on Real Time with Bill Maher, Bill mentioned how the median fast food worker in America makes $8.65 per hour and is 29 years old.  In reference to Ronald McDonald he said "until he starts paying his employees a living wage, he has to wipe that f--ing smile off his face."

 

From the Globe and Mail, in Canada we are starting to see "several groups pushing for the minimum wage to be set at 10 per cent above the province’s poverty line. In 2013, that would work out to $14 per hour." I am absolutely in favour of raising the minimum wage to a level that is liveable; but the I fear the consequences of doing such could lead to a hyperinflationary spiral.

 

So first off, we need to understand what happened following the financial crisis of 2008. Both in the United States and in Canada, we saw massive monetary easing programs aimed at not only recapitalizing the banking system, but also at keeping the economy above water. If you have ever taken a course on economics or banking you have probably seen the formula:

 

GDP = money supply x velocity

 

The government is desperate to keep nominal GDP from decreasing, because most loans and other contracts are fixed. So if we saw a contraction in GDP, it would lead to some organizations having to default on loans and contracts which would lead to other companies having to default on loans and contracts; creating a domino effect. This is deflation and it's why it's the government's goal to always increase nominal GDP.

 

But here's the thing, central banks can't speed up velocity. They can give lip service to try, but ultimately that will only go so far. Thus, if the economy is sputtering they have one option to maintain GDP, increase the money supply. And that is exactly what's been happening.  They have other incentives as well (ie. devalue the dollar to increase exports, monetize treasury debts to help governments reckless spending), but in the end it's really about keeping the economy from collapsing.

 

You have probably seen the growth of money supply in the US and Canada, but in case you haven't here's a look at how base money has grown.

 

usmoney

 

 

So it's clear that central banks are expanding their balance sheets.  Now obviously we are just talking about base money, but remember the more base money there is, the more banks can lend, and thus multiply the total money supply (m3).

 

So here's where the minimum wage stuff kicks in. With a liveable minimum wage of $14.00, velocity will pick up. This isn't a huge stretch; more people with money, means more people looking to spending money. But this is where I start to get nervous.

 

We don't feel quantitative easing yet, because the economy isn't healthy (velocity isn't growing). When the economy get's healthy velocity will speed up.  And it brings us back to that formula:

 

GDP = money supply x velocity

 

Before the economy wasn't doing well, so central bankers increased money supply to maintain GDP.  This is only a temporary fix. I believe there is no exit strategy. I don't understand how central banks can reduce the money supply.  In order to do so, they would need to increase interest rates and with federal, provincial, state, and personal loans at such extreme levels this can't happen.

 

But the main concern is hyperinflation. Hyperinflation is a the loss of faith in a currency. Central banks can't control people's faith.  And when that faith starts to deteriorate people will want to unload cash positions as soon as they receive them. Thus speeding up velocity until it reaches scary levels.

 

Which brings be to my sad thesis, due to the monetary policies in Canada and the US, we can't afford to have our lower class citizens make a liveable minimum wage. It would speed up velocity and lead to hyperinflation; otherwise known as a currency collapse.

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