Prices of goods and services have to go up. Right? At least that is what everyone keeps telling me. After all on the producer side of the equation, energy prices are soaring, raw materials prices are soaring, wages are rising in China, and a new minimum wage in the US will send wages up $.70 this summer and $2.10 by 2009 to $7.25 an hour.

Try again. Wal-Mart is Cutting Prices on 16,000 Items.

Wal-Mart Stores Inc., the world’s largest retailer, set the stage for price wars Monday as it announced it’s cutting prices on more than 16,000 items starting this week in a bid to turn around sales for the critical back-to-school season.

Shares of key retailers such as Sears Holding Corp. and J.C. Penney Co. (JCP) were down, as investors worried about how ensuing price wars would affect profit margins.

Wal-Mart’s price cuts, which range from 10 percent to 50 percent, will be backed by a new ad campaign on how to save money as gas prices remain high and kids head back to school. The cuts are deeper and involve even more items than in the year-ago period and top the 11,000 items discounted in advance of last year’s holiday season, according to Melissa O’Brien, a company spokeswoman.

Retail consultant Burt Flickinger III said that while he applauded Wal-Mart’s move, he noted that the jury is still out on whether it will be effective.

“While it is a smart strategic move, it is going to add profit margin pressure, ” Flickinger said.

Pricing Pressure

Pressure on corporate margins is only just beginning. What it costs to produce goods is basically irrelevant if supply is outstripping demand. There is currently overcapacity in damn near everything. We do not need more Wal-Marts, more Pizza Huts, more Applebees, more Targets, more auto capacity, more furniture stores, more Home Depots, or more nail salons. All of those and then some were way overbuilt as new housing subdivisions went up at a frantic pace. Commercial real estate followed residential and provided huge numbers of jobs (although at the low end of the scale).

The payback for this reckless expansion is now underway. Housing has blown up, and corporate expansion of retail is about ready to follow suit. Consumer discretionary spending will take a big hit as rising energy prices and mortgage rates eat away at paychecks.

Rising Minimum Wages Will Not Save The Day

Unfortunately, don’t look for rising wages to save the day. That minimum wage bill is going to do nothing but cause problems. Businesses under pressure already will be reluctant to add workers. Instead look for increased layoffs from retail, financial, and service sectors.

Expect economists to be telling everyone “We can’t have a recession with unemployment so low.” Well we can and we will. That is what happens when overcapacity meets changing time preferences on behalf of consumers. Before this mess is over unemployment will be soaring. How much the government admits will be another story, but look for massive revisions with the next administration in 2008.

Corporate Profits Will Sink

Corporate profits are under pressure with financials leading the way. Kevin Depew was talking about this on Minyanville in point #2 of Five Things: Housing Slump Contained to Only Those Things Affected by Housing Slump.

Countrywide Financial (CFC), the biggest U.S. mortgage lender, reported its third straight decline in quarterly profit due to increases in late loan payments.

  • Countrywide this morning reported that second-quarter net income fell 33% and revenue fell 15%.
  • The company also reduced its forecast for earnings for this year.
  • Why the grim forecast?
  • The company said profit was hurt by impairment charges on securities backed by prime home-equity loans.
  • Well, of course, they said that. This sub-prime mess is going to continue to hurt for awhile. Even Bernanke said so last week.
  • No, sorry. Read that bullet point again: The company said profit was hurt by impairment charges on securities backed by prime home-equity loans.
  • Countrywide Chairman and Chief Executive Angelo Mozilo said “delinquencies and defaults continued to rise across all mortgage product categories.”
  • The company also noted it has set aside $293 million for loan losses in the quarter, more than triple the level a year earlier, blaming a loan-loss provision of $181 million on prime home-equity loans, the Wall Street Journal said.

So profits are now being hurt by “Prime Loans“. Fancy that. But this contagion is not going to stop with either housing or financials.

Check out this headline: FedEx Freight cuts fuel surcharge.

FedEx Corp.’s FedEx Freight and FedEx National LTL said Monday they will reduce their fuel surcharge by 25 percent, effective immediately.

Rates at FedEx Express and FedEx Ground are not impacted by change, FedEx said.

FedEx National is a long-haul, less-than-truckload service of the shipping corporation’s freight unit.

Less-than-truckload, or LTL, carriers, usually fill their trucks with freight from a variety of sources and might re-sort and redistribute it at a company terminal along their route.

Overcapacity in shipping? You bet. What else can it mean when fuel surcharges are removed in smack in the face of crude prices near all time highs.

A few Charts
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Containment is spreading to retail, consumer discretionary spending, and even shipping. The underpinnings that has kept speculation high and the stock market buoyant, are being removed one by one, sector by sector. The party is all but over but no one seems to have recognized it yet.

Mike Shedlock / Mish/