Monday, October 29, 2012

Inflation, deflation, and the iPad mini

The debate over inflation—which ranges all the way from those who see the imminent risk of deflation to those who see hyperinflation just around the corner—continues, and with good reason. Inflation is alive and well in the services and nondurable sectors of the economy, while deflation is the "new normal" in the durable sector of the economy. Some prices are going up, but others are going down; on average, the government is telling us that inflation is only about 2%. That's a calm surface on a body of water that is roiling underneath.



The first of these two charts shows the average price level for each major sector. Service sector prices have risen about 60% over the past 18 years, while the price of nondurables are up a little over 50%. But durable goods prices have fallen steadily, and are now down a total of 28%. In the entire history of these series, there has never been a sustained period of declining prices except for the past 18 years in the durables sector. Not coincidentally, that period corresponds to the emergence of China as a powerhouse producer of durable goods (e.g., computers and TVs). Memo to Romney and Obama: China has done us a great service by producing products so cheaply.

If we make the assumption that the price of services is a proxy for wages and salaries, then what we see here is arguably the most incredible increase in workers' purchasing power in the history of the world. Do the math: over the past 18 years, services are up 161% and durables are down 28%. 161/.72 = 223.9. Salaries have more than doubled relative to durable goods. Put another way, an hours' worth of work now buys more than twice as much in the way of durable goods as it did 18 years ago—it takes 55% less work today to buy the typical durable good than it did 18 years ago. Bottom line, labor has become a whole lot more valuable and more expensive than things, especially very sophisticated and powerful things like computers.

Which leaves me puzzled as to the brouhaha over whether the iPad mini—the newest durable good to be offered to the public—is a whole lot more expensive, at a price of $329, than the Amazon Kindle Fire HD at $199. As the link demonstrates, there are some significant differences in features between the two devices. My point is whether the price of those differences—$130—is a huge amount. Is a 35% larger screen + a 5 mp camera + greater video compatibility + hundreds of thousands of extra apps + aluminum construction (vs. plastic) worth an extra $130? Consider what $130 gets you these days: a dinner for two with a bottle of wine at an upscale restaurant; a pair of jeans at Nordstrom; two tanks of gasoline; admission for one to Disneyland; a bottle of Dom Perignon; a small basket of groceries.

The average person now has available to him or her gadgets that 18 years ago would have been considered magical, if not impossible. With only one week's worth of minimum wages in California ($8/hr), you can buy yourself an iPad mini: a device that connects you to all information in the world; that holds and displays and edits and takes thousands of videos and photos; that holds your entire music library; that lets you read millions of books; that holds and displays maps of the entire world; that lets you explore the cosmos by simply pointing at the stars at night; that lets you read hundreds of newspapers; that lets you plan and reserve flights and hotels all over the world for free; that let's you play and record all kinds of music; that gives you access to thousands of video games that never before existed; that let's you correspond with people instantly all over the world; that's lets you fly dozens of planes realistically. I could go on, but I hope my point is clear. 18 years ago a device like the iPad mini would have been inconceivable no matter how much it cost. Today, in contrast, we are quibbling about whether such a device should cost $200, $250 or $330, when the difference is almost insignificant for the vast majority of people.

It is undeniably deflationary when a week's worth of work at minimum wage buys you things that only 18 years ago would have been unavailable to even the richest person on the planet. But at the same time, it costs an employer 2.2 times as much to hire that minimum wage worker, and it costs us all 5 times more to fill our tanks with gasoline. That's a lot of inflation. Or is it?

No wonder the debate rages.

10 comments:

Dr William J McKibbin said...
This comment has been removed by the author.
Dr William J McKibbin said...

Scott's observations are instructive as to what is happening via globalization. Durable goods (including consumer electronics, but ex-defense spending) is experiencing real declines in labor costs (Chinese factory workers start at about $15/day). Moreover, durable goods are easy to transport via ocean transports. Bottomline, is that durable goods (ex-defense durables) are doomed in the US and Europe because we simply do not have workers who will work for $15/day. Conversely, non-durables (food for example) is difficult to ship via ocean transports, and have short shelf lives (sometimes in the days or even hours), and so firms such as Pepperidge Farms have pricing flexibility that enables goods to be sold at higher prices, and for workers to be paid more than similar workers in China.

My conclusion is for the US to throw in the towel with regards to durables manufacturing (again, ex-defense) and emphasize non-durable manufacturing processes instead, which remain competitive in the US. My reasons are stated above.

Unfortunately, the military-industrial Republicans and big government Democrats are averse to letting voters know that "durables manufacturing" in the US essentially means defense production. Said another way, without defense spending, the US would not have a competitive durables manufacturing offering in the global economy.

Last year, the US spent more on "guns" than the rest of the world combined (!), including China. Herein lies the essential "secret" that the Washington politicians do not want anyone to understand -- that the US is a military-industrial power tethered to a government bureaucracy that the military-industrial Republicans and big government Democrats will protect regardless of the damage caused along Main Street USA -- this is the opposite of the way things are supposed to be, that is the Main Street economy and prosperity taking priority over the military-industrial complex and government bureaucracy.

What is needed is an immediate 40% cut in real government spending. A nation cannot sustain itself on guns at the expense of butter indefinitely...

W.E. Heasley said...

Mr. Grannis:

“That's a lot of inflation. Or is it?”

Good question!

Benjamin said...

I really enjoyed this post.

I belong in the camp that contends the government is slightly overstating inflation. The iPad is one reason why, along with the Internet, 99 cent stores, Craigslist, digital photos, free books through Amazon.com (digital downloads) and much more.

Thought of the day: If you adjust the minimum wage to inflation, minimum wage workers make less today than in the 1960s. Not just relatively; but absolutely.

A half-century of rising incomes, but not for minimum wage workers.

Whether we even need a minimum wage is an interesting question. It would be interesting if a large state--say Penn. or Texas--could try a few years without one, and see what happens. It might "work," or lead to such a stratified society that we would choose not to go that route. But worth trying.

At any rate, microscopic rates of inflation when the economy is a perma-doldrums strikes me as a too-tight monetary policy.

Ben Bernanke, please let it rip.





Benjamin said...

I really enjoyed this post.

I belong in the camp that contends the government is slightly overstating inflation. The iPad is one reason why, along with the Internet, 99 cent stores, Craigslist, digital photos, free books through Amazon.com (digital downloads) and much more.

Thought of the day: If you adjust the minimum wage to inflation, minimum wage workers make less today than in the 1960s. Not just relatively; but absolutely.

A half-century of rising incomes, but not for minimum wage workers.

Whether we even need a minimum wage is an interesting question. It would be interesting if a large state--say Penn. or Texas--could try a few years without one, and see what happens. It might "work," or lead to such a stratified society that we would choose not to go that route. But worth trying.

At any rate, microscopic rates of inflation when the economy is a perma-doldrums strikes me as a too-tight monetary policy.

Ben Bernanke, please let it rip.

steve said...

pretty much sums it up nicely I think:

http://www.alhambrapartners.com/2012/10/28/a-perfect-storm/

Kos said...

Scott love your insights and would be curious to see your thoughts on this piece by Eric Sprott on declining wages and its effect on consumer spending going forward. http://www.zerohedge.com/news/2012-10-30/eric-sprott-americas-great-endangered-species-99

Dr William J McKibbin said...

@Benjamin, your comments about declines in real working wages since the late 1960's is spot on -- but, we have to also admit that real working wages are regressing to the global norm, which means much lower for US workers -- wage regression to the global norm is inescapable for consumer durables -- herein lies the dilemma the root challenge for the US economy: how to avoid real working wage regression to the global norm -- the only industries that have thus far avoided wage regression is the US defense industry, government employment, and banking, which are all regulated industries enjoying Federal financial and/or policy support -- Main Street USA enjoys no such advantage.

At some point, the US is going to have to confront the reality that the military-industrial complex, government workers, and banking, cannot be the extent of a national economy -- Main Street USA (now represented by movements such as Libertarianism and the Tea Party) will not tolerate a national economy that permanently favors the military-industrial complex, government employment, and banking at the expense of Main Street growth and prosperity -- the military-industrial Republicans and big government Democrats are secretly terrified that the American people along Main Street will figure this out and demand that the US economy be realigned along Main Street interests.

My bet is the that military-industrial Republicans and big government Democrats will create a hoax in the form of a national crisis that will bamboozle voters into supporting an even larger nationalist movement that will deeply erode personal freedoms and commit the US to permanent wars overseas in an effort to shore up permanently the interests of a unified military-industrial Republican and big government Democrat alliance that will doom most Americans to destitution -- the film, "V" is a fictional description of what that may look like.

I am terrified for Americans -- I fear the military-industrial Republicans and big government Democrats -- I seek solace amongst my Libertarian brethren -- I hope for the best.

PS: Be sure you are buying up cheap equities during this period of maximum pessimism -- everyone's goal should to join the 1% club of wealthy Americans so as to avoid the coming mayhem we know as Federalism...

PPS: Everyone else should already be under cover...

randy said...

Scott, I've been giving a lot of thought to what my wish list for governing. IMO, the Fed's mandate is one of the most important factors in our future. You have written that "price stability" should be the mandate, and that perhaps some version of the gold standard may be an answer. At the same time you have written that gold prices have been driven to speculative heights - is the barbarous relic a reliable indicator? You have also written quite a bit about "no shortage of money" and evidence that the Fed got it just about right because inflation has been tame. And, you have written about the headline inflation masking high inflation in services and consumables and deflation in durables.

All that highlights a very complicated task of seeking "price stability". How do you believe a mandate of price stability could best be effected?

Scott Grannis said...

The two leading contenders for monetary policy that can reliably deliver "price stability" are a gold standard and the Taylor rule. The key ingredient of both is an absence of discretion: the Fed needs to follow a rule that is objective and verifiable. Scott Sumner is pushing hard for a commitment to a nominal GDP target, but the problem I have with this is that the Fed needs to employ discretion and judgment in order to target nominal GDP. I don't think that's easy or predictable.

As John Taylor has argued repeatedly, the sluggish growth of the past decade can be directly attributable to the monetary and fiscal policies which have strayed far from the predictable and objective. We need rules-based policies that the world can count on.