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Markets are in correction territory, and the economy is flirting with a recession. There's a lot of concern about the impact of Trump's beloved tariffs, and the judicial system, with the help of a weakened Democrat Party, is trying its darnedest to stymie Trump's efforts to put the federal Leviathan on Ozempic.
In any event, I detect no reason to worry about inflation. I do worry because emerging economic weakness stems from several sources: the fallout from DOGE cutbacks, the fallout from tariff wars, and the ongoing weakness in the housing market coupled with unsustainably high prices and mortgage rates. Another factor may be due to the uncertainty surrounding whether Trump's 2017 tax cuts will be extended prior to year end, when they are scheduled to revert to much higher levels. Worry about growth, not inflation.
Chart #1
Chart #1 compares the year over year change in the CPI index with the same change in the CPI index ex-shelter. It's important to note that the ex-shelter version of the CPI has increased by 2.3% or less for the past 22 months (since May 2023). Only shelter costs have kept the broader CPI from long ago meeting the Fed's objective. And their impact is almost certainly fading away.
Chart #2
Chart #2 focuses narrowly on the rate of inflation in shelter costs. The one- and three-month annualized rates of increase in shelter costs have been declining since mid-2023, and the decline looks set to continue. As it continues, and without any help from the Fed, the gap between the CPI and the CPI ex-shelter (Chart #1) will also decline, and eventually approach zero. We just need to be patient. The decline in shelter cost inflation has taken quite a few months longer than I expected, but nevertheless it is occurring.
Chart #3
Today we learned that the Producer Price Index for Final Demand was unchanged in February, but is still up 3.2% over the past 12 months. Is this a problem? I've always paid more attention to the broader Producer Price Index for Finished Goods, and it has been quite well behaved, as Chart #3 demonstrates. Both the total and core versions are up only about 2% over the past year. More impressive, however, is that the PPI Finished Goods index has only increased by 1.3% since June 2022. That's an annualized rate of increase of only 0.04% over the span of 32 months. PPI inflation is on life support.
If we can make it to year end while avoiding a massive tax increase and runaway tariff wars, the long-term effects of Trump's (stupid) tariff wars and DOGE's cost- and regulation-cutting efforts should be very positive.
42 comments:
Thanks! Very good, as always. Much appreciated.
Why are Trump's tariffs "stupid" when all he is doing is saying the IS will put the same tariffs on you that you put on us?
Also you say that long-term Trump's tariffs will be good, so what is "stupid" about them?
Thank you Scott! Plenty of useful insights, as always.
Re: how can tariffs be stupid and also good. In Trump's view, Imposing tariffs on imports is a way of punishing other nations for their bad trade policies. In reality, the burden of the tariffs falls on Americans. They lower our living standards, and that's stupid. The best tariff is zero, because free trade is proven to raise living standards. What Trump really wants in the end is zero tariffs, but he thinks he needs to first raise them in order to then lower them. I see lower tariffs in coming years, and that will be a good thing.
Correct. As long as tariffs are used as a threat/reality with the true intention of negotiating them lower (to zero), I think the path we are following makes sense. With elections in numerous foreign countries trending Trumps way (Vive POILEVRE!!!!) I am optimistic over the long term. A good quick 1-2-3 punch would be (1) end the Ukraine War; (2) destroy Iran's nuclear facilities; (3) use the tariff threats to lead to a summit conference where lower (zero) tariffs and non-financial barriers would be reduced in stairstep fashion.
Any thoughts on this note? As the main reason for tariffs is more about national security? Bringing manufacturing back to USA? Trump admin is saying we couldn’t build enough ships, tanks, or drones if we had to at the moment due to China “dumping” cheap aluminum and steel?
I understand we would all prefer free trade, but that isn’t feasible. I also think the “living wage” has complicated matters in USA.
China USA
The USA helped lift China out of dire straits decades ago. The trade-off was an agreement: “We will help your country if you allow the USA to trade in China.” China accepted the deal, and it seemed to provide mutual benefits at the time.
Fast forward to today: China is now much closer to being our economic equal. Due to their reliance on what amounts to slave $2 (minimum wage in China) labor practices, they can undercut a significant portion of American manufacturing.
This trade-off is far less beneficial for the USA, especially since China doesn’t even allow many of our top-tier companies into their market.
China now has the ability to disrupt the American economy fairly easily, as we have outsourced so much manufacturing. 95% of Apple manufacturing is now in China. This is what the Trump admin is terming a national security threat. Essential we onshore manufacturing. USA manufacturing is only at 55% capacity currently.
The Trump administration’s aim is to bring manufacturing back onshore to regain control. The trade-off is that we will lose the luxury of cheaper goods produced by cheap labor, which carries a short-term cost and likely some long-term ones as well.
That said, our biggest companies, which dominate the S&P 500, probably need to be evaluated on a case-by-case basis. Apple, for instance, has significant exposure, while Meta likely has minimal exposure.
Thanks for explaining but I'm still unclear: you don't like Trump's desire to use tariffs to "punish" but how else do we get to universal zero tariffs?
I disagree with the idea that Trump's goal is to to negotiate tariffs to zero. Seems to me he and his supporters want to end income taxes and replace them with what amounts to a national sales tax (tariffs). Government spending is not likely to fall much as "red states" depend on it even more that the "blue states." What would a $5,000 "bribe" to everybody who files a 1040 cost and who will ultimately pay for that?
As Dr. Philip George says: “The velocity of money is a function of interest rates” Dr. Philip George wrote: "The Riddle of Money Finally Solved".
As Dr. Philip George puts it: “Changes in velocity have nothing to do with the speed at which money moves from hand to hand but are entirely the result of movements between demand deposits and other kinds of deposits.”
MMMFs have grown by 19% y-o-y. All the motives which induce the holding of a larger volume of money will tend to increase the demand for money – and reduce its velocity
https://www.yahoo.com/finance/news/five-charts-show-credit-complacency-190000091.html
The income tax was designed to be a TEMPORARY way of paying for WWI.
Commercial bank credit, all banks, is up, so then are loans/investments = deposits.
The FOMC’s proviso “bank credit proxy” used to be included in the FOMC’s directive during the period Sept 66 – Sept 69.
Scott Bessent interview
https://x.com/theallinpod/status/1902223565203665084?s=46&t=RMHlxkwcr5wESIDLrpx9og
Actually started in 1862 during civil war.
Total interbank demand deposits haven’t dropped volumes in 9 months, coincident with the stalling in the fall in inflation.
2024-05-01 3376.1
2025-01-01 3255.6
Friedman advocated simultaneous abolishment of all tariffs, which would of course be textbook efficient in the long run. Since we have decades of huge trade distorting tariffs we of course have big trade distortions from them, hard to tell if what trump is doing is beneficial but what's true is that trade is already massively distorted by previous tariffs and taxes.
See: ANATOL B. BALBACH and DAVID H. RESLER: “Eurodollars and the U.S. Money Supply”
http://bit.ly/LVVuhI
A must watch interview. It changed my expectations to now prepare for large tariffs. They have a plan like it or not. We were all taught in economics free trade was the only way. Seems there are few who understand what this all means. I give credit for attempting to tackle the deficit. No president would dare to since Bill Clinton had the luxury of a hot economy. This likely requires years of pain while America builds out manufacuring to replace foreign suppliers. Coming out the other side could be the best thing for America. But this seems like a risky experiment. Many companies such as retailers will feel pain while consumers get squeezed. Watch this interview leaves much to think about.
"In reality, the burden of the tariffs falls on Americans. They lower our living standards, and that's stupid. "
This overlooks the underlying point, presuming that right now no American is affected by the fact that the U.S.'s free market inclination is exploited by other markets.
American households are 100% paying for the Chinese abuse of the global trade system.
It also neglects the long-term implications. Over time, if current policies allow China to lead technologically, economically, and militarily, then those policies should be revised.
Inflation is the most destructive force capitalism encounters. It accelerates the rate at which the bottom income quintiles lose purchasing power to the upper income quintiles (income inequality).
Readers should note that calculating inflation on a year-to-year basis minimizes, over time, the rate of inflation since the rate is being calculated from higher and higher price levels. A $ today, using 1967 (a former base year), is equivalent to $9.70 of consumer purchasing power today.
In absolute terms, each year confronts all of us with a higher and higher level of prices with no end in sight.
"calculating inflation on a year-to-year basis minimizes, over time, the rate of inflation"- For those of us who are focused on numbers/math, this seems obvious, but the average person (in my experience) does not perceive the world like this. So, this yearly, "small/~2%" inflation target seems acceptable to joe and jane public.
The other item that even many economists don't seem to grasp, (that profession appears to be weakening over time!), is that the central bankers have tools that can more effectively deal with inflationary problems. If inflation slips into deflation, they are VERY afraid. So, they want to keep a small inflationary target.
Also agree that this is very bad for the socio-economic contract, i.e. income inequality gets worse because of this.
Off Topic- AI - some explanation into the methods, from sciences.
https://scienceofclimatechange.org/wp-content/uploads/SCC-Grok-3-Review-V5-1.pdf
https://magazine.hms.harvard.edu/articles/did-ai-solve-protein-folding-problem
Since I used to work in a similar field to protein folding, I believe I understand part of the secret sauce. The AI is taking a data and variable sets determined by people, and breaking down the problem (protein) into smaller or larger segments. It then compares the one under study to the ones in the learning set. Then incremental folding/positional adjustments are made and repetitively compared. It's a gigantic correlation/incremental/empirical comparator engine. At least that's the way I understand it.
Interest is the price of credit. The price of money is the reciprocal of the price level. I.e., monetarism has never been tried.
The demarcation was in 1965, when the interbank demand deposits reserve requirements were removed for the member banks. At the same time TDs became > DDs.
That’s when William McChesney Martin Jr. re-established stair-step case functioning (and cascading), interest rate pegs (like during WWII), thereby abandoned the FOMC’s net free, or net borrowed, reserve targeting position approach in favor of the Federal Funds “bracket racket”.
The FED should cut short-term interest rates as soon as possible. But at the same time, they should have continued with, even increased, existing QT.
Interest is the price of credit. The price of money is the reciprocal of the price level.
The effect is to drive the banks out of the savings business, which doesn’t reduce the size of the payment’s system. The effect is to activate bank-held deposits.
The commercial banks are credit creators. Lending by the DFIs is inflationary. The non-banks are credit transmitters. Lending by the NBFIs is non-inflationary (other things equal). Lending/investing by the DFIs expands both the volume and the velocity of new money. Lending by the NBFIs increases the turnover of existing deposits (a transfer of ownership), within the commercial banking system.
The FED’s correct response to stagflation is the 1966 Interest Rate Adjustment Act.
Waller, Williams, and Logan seem to agree. They “believe the Fed can keep unloading bonds even when officials cut interest rates at some future date.”
That’s called targeting N-gDp as Scott Sumner advises.
Link: “Changes in Wealth and the Velocity of Money”
Financial investment applies to all those uses of funds which are involved in the transfer of title to goods, properties, or claims thereto.
Savings dissipated in financial investment, or impounded in idle savings, or as leakages in transfer payments, are stoppages in the flow of funds derived from the main income stream and have a direct and immediate dampening impact on the economy.
Voluntary savings require the prompt utilization if the circuit flow of funds is to be maintained, and the deflationary effects avoided.
Scott, how do you respond to Brian Wesbury's following comment in his "Monday Morning Outlook" today: "In the past 12 months, PCE prices are up 2.5%, barely better than the 2.6% gain in the year ending in February 2024 in spite of the Fed thinking that monetary policy is currently restrictive or tight. Core PCE prices are up 2.8% in the past year versus 2.9% in the year ending February 2024. Some investors might still think this is due to the lags associated with housing rents, but the Fed developed a measure a few years ago called the SuperCore, which excludes food, energy, other goods, and housing rents, and that measure of prices is up 3.3% in the past year. No wonder the Fed doesn’t mention it anymore." He seems to be disputing the housing cost "lag" you have mentioned as a reason inflation data is not reflecting reality. Thoughts?
Interest is the price of credit. The price of money is the reciprocal of the price level. So, the optimum thing to do is target N-gDp (tolerate a little higher inflation).
Happy Liberation Day, everybody!
A fall in our exchange rate will not correct our trade deficit problem. The only solution is to sell higher quantities, of higher quality, and lower unit costs of production, relative to our trading partners.
Tariffs show up early in the money transmission chain as (reduced) corporate profits. Which transmits to stock prices, as is being demonstrated this week.
Would love an update now Scott. Markets are not happy to say the least and recession seems be being priced in. We don’t know how long this tariff war will last, but what are the credit markets showing us? Any stress there?
Hi Scott, what are you seeing in the credit markets in the wake of Trump's tariff announcement?
Scott. Need a post!
We have to remember the yield curve was predicting recession for an extremely extended time anyway. With that, DOGE activity, and trade negotiations underway, market uncertainty is maxed out right now.
Absurdly, we're "waiting for Godot." $7 trillion lost worldwide? Where did it go? It was created in the imaginations of investors and it was lost the same way - through fear. The current occupant of the White House knows this and how to use it. Face it, we're financial hostages now.
Good point.....should we be worried? I hope he's OK!
Hi Scott:
The price of risk is being adjusted in all markets and this is a good thing... It seems reasonable for money managers around the world to trim USD holdings-- but in favor of what in the long term? Gold? Euros? Europe seems like a powder keg... How long will FR/UK standby in silence as DE builds muscle mass again? The Yuan? Southeast Asia may descend into regional chaos as tariffs impacts bite... The BRICS? <- LOL
It's easy to become distracted today-- but Americans have always been wise in the long run. We know our Navy keeps sea lanes open as a force for Global Good. And we know our Capital Markets still seem ready to trade risk without much fuss or friction. Many of us know these things because of you!
Hope you're feeling & traveling well, Scott! <- hat tip.
500 years ago, China destroyed its navy because the rulers of the country were afraid of free trade. Some of the Chinese ships were five times the size of the ships built in Europe at the same time. However, by 1525, all the ships of the Chinese "Treasure Fleet" were destroyed — either they burned in their docks or simply rotted away because the government had left them to their fate. China was capable of circumnavigating the globe decades before the Europeans, yet instead, the Ming Dynasty retreated and fell into a 200-year-long decline.
Are there any analogies to that? Trump Dynasty and Ming Dynasty?
Scott, any updated thoughts on the tariffs and the direction of the economy? Behavior of the bond market?
The entire world like puppets in one man hands. Impossible to stay in investment.
Txs for posting Scott. I was getting Yippy so I needed a post to stay in line
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