Boffo U.S. corporate profits for the second quarter are to be savored. Double-digit returns, far ahead of revenue growth, are good anytime. To get that kind of performance 101 months into a business expansion is unusual. To see such profits when companies lack any pricing power is quite exceptional. No one really knows how long the good times will roll on, but for the moment, the U.S. is in the grip of a virtuous cycle. High corporate profits provide the cash to invest in capital, which boosts productivity, curbs inflation, promotes growth, boosts profits....
So it's important to remember how we got there. Of course, the Federal Reserve and the bond vigilantes have done their part in tempering a red-hot economy. CEOs have also been smart enough to use corporate cash to increase efficiency and capacity. Even with the economy growing at nearly 4% annually, capacity utilization remains below 80%. A decade ago it would have been over 90%, pushing inflation higher. The Internet is also turning out to be a great deflator by distributing price information, removing costs related to middlemen, and often lowering prices. T. Rowe Price Associates Inc. lowers brokerage commissions. E-Loan provides cut-rate mortgage financing. Wal-Mart Stores Inc. goes on the Net selling books and soon everything else.
Without pricing power, companies all over the world now have to make their profits the hard way--by cutting costs and selling in volume. In Britain, the euro zone, Korea, and Japan, corporate profits are on the rise as inflation falls. The world economy outside the U.S. is growing again. Inflation is not.
This could change if soaring U.S. equity or housing prices spill over into the rest of the economy. Or Asia returns to hypergrowth. Or there is another debt crisis. But for the moment, profits are up, inflation is down, and a virtuous cycle is making us all richer.