Wednesday, April 14, 2010

Inflation at the consumer level subsides

Inflation at the consumer level has turned out to be less than I have been expecting. Indeed, over the past three months the CPI is up only 0.9% at an annual rate, and the core CPI is actually down 0.18% at an annual rate. Much of the decline in inflation can be traced to "Owner's Equivalent Rent," the BLS's estimate of how much a homeowner would be paying if he were renting his home. OER is roughly unchanged over the past year, thanks to the depressed housing market. Abstracting from this, as Brian Wesbury points out, we find that "cash inflation" is up 3.2% over the past year.

I agree with Brian that sooner or later we will see CPI inflation moving higher. The CPI is the last place that true inflation trends will show up, because of the way it's constructed and because inflation at the consumer level is very "sticky." Wages don't change much or very fast in response to changing monetary policy, but gold prices, for example, can change on a dime. It can take years for a loss in the dollar's purchasing power to find it's way through the maze of the U.S. economy and through labor contracts. I think it makes a lot more sense to watch the leading indicators of inflation than it does to watch the official measures of inflation.

Sensitive prices that are set in real-time by the market are where the action is. On that score, we have the following evidence which points to higher, not lower inflation: 1) the dollar is weak against most other currencies, having lost one-third of its value in the past 8 years, 2) gold prices have risen 350% since 2001, and are within inches of their all-time highs, 3) industrial commodity prices are up strongly across the board, 4) oil prices have doubled in the past 16 months, 5) real estate prices have bottomed and are now rising in some areas, 6) short-term real interest rates are negative, meaning that effective borrowing costs are unusually low, 7) money velocity is on the rise, which effectively amplifies the Fed's extremely accommodative policy stance, and 8) the yield curve is extremely steep, a classic sign of easy money. I believe that these are all leading indicators of a coming acceleration in inflation at the consumer level that will likely unfold over the next year or so. You can't wait for the CPI to go up before realizing that inflation is a problem.


Benjamin Cole said...

Inflation? Fuhgetaboutit.
Wages and property rents are dead.

I concede that health care and military hardware-services are going up in price. That's about it.

Sure, the CPI is the last to know. But it is still headed south.

I think the Fed has a wide-open field to stimulate and flood as many dollars as possible into markets.

Not so sure about China. China's monetary growth figs up 22 percent in last year, and I saw on CCTV that there is a land boom in Beijing, so much so that authorities are pondering price controls.

BTW, if you can, watch China News on channel 44.8 digital in SoCal. They even have a business news show. How much is propaganda and how mcuh is news I cannot say. But China is definitely developing a business culture.

It is easy to becoe USA-centric.

But with globalization, now we must also know the monetary and fiscal policies of other major players. Obviously, within a few years, China will eclipse the US on the world commercial scene.

They already dominate commodities markets.

W.E. Heasley said...

Mr. Grannis:

Excellent analysis. Agree with your eight (8) bullet points regarding inflation factors. Velocity is odd out right now and is worth keeping an eye on as it could leap frog ahead.

The eight bullet point are not stand alone items. The eight points interact. It could end up a sudden, very quick breakout of inflation.

The 1970’s inflation was a loose bull in the glass shop. And as 1981-1983 showed, getting the inflation bull out of the glass shop and back into the barnyard is very, very, very painful.

brodero said...

Inflation is what will eventually
kill this bull market....but it is
far away...My amateur formula....S&P 500 divided by NIPA
corporate profits after tax multipied by the year ove year CPI is currently 2.62. When this hits 5
look out....

Benjamin Cole said...

Meanwhile, Dr. Perry pooh-poohs inflation, and even hints at deflation..........

"According to the Cleveland Fed's report today, the median CPI has increased by 0.60% in March over the last year, the 18th consecutive monthly drop in the median CPI annual inflation rate, and the lowest year-to-year inflation rate in the history of the Cleveland Fed's series back to 1984 (see chart above). In contrast, the regular CPI has increased by 2.3% over the last year (March 2009 to March 2010).

Historically, the median CPI has been 50% more accurate at gauging future inflation than the traditional CPI (based on the Cleveland Fed's research), and the median CPI is certainly not now showing any signs of inflationary pressures. In fact, a stronger case could be made for deflation right now than inflation, according to the median CPI."

The last sentence is telling.

Benjamin Cole said...

Wall Street Journal - Jon Hilsenrath - ‎1 hour ago‎
Federal Reserve Chairman Ben Bernanke pointed to a sharp and widely dispersed slowdown in inflation in recent months and indicated he saw little threat of it picking up any time soon, an important diagnosis as the Fed plots out its ...

Hey, don't argue with me. Talk to the "other Ben."

John said...

chesseBullish. Nothing but bullish. Low inflation means continued low interest rates and the potential for rising price-earnings ratios.

puffer said...

All oil and other commodity prices have to do is stabilize here and they will exert more downward pressure on inflation. Surely you don't expect them to continue to go up at the same rate (or even close) as they have over the last year, going forward?

Scott Grannis said...

Why should commodity prices decline if the Fed and other central banks are trying very hard to make sure that there is no shortage of money in the world?

Charles said...

Why should commodity prices level off? Demand is growing from the emerging economies. The cost of the goods and services we buy is increasing at an alarming rate - 3.2% per year when unemployment is at 17%.

Wages are not stagnant except in the most competitive sectors of the economy. The minimum wage is way up over last year. Federal employees and employees of large corporations are getting increases as are most state and local govt employees. Salaries for faculty at the University of Akron are up 2% and tuition is up 3.5%.

For all the talk about low levels of capacity utilization, a large part of the excess capacity is non-economic. There are no jobs for people to go back to. People have the wrong skill sets, they live in the wrong places and can't move, if they are low-skilled people they are not worth the minimum wage and/or plan to wait out their unemployment benefits.

Who cares about owner-equivalent rent in Las Vegas? Gasoline is up 30% in one year. The ground coffee I buy is up 20%. Beer is up 13%. Milk, I grant you, is flat. Starbucks coffee in the cup is up where I work. Salt for my water softener is up. Trash pickup increases every year without fail. I went to a restaurant with friends Friday evening - new menus, yes prices are up. But, of course, if I want to open an office as a notary public in Youngstown, Ohio it's real cheap.

The only deflation in this economy is a collapse in the prices of uneconomic assets.

Scott Grannis said...

Charles: very good point. The widespread belief in deflation is misplaced. Yes, there are numerous prices that are falling, but since there are lots of other prices that are rising, what we are seeing is big shifts in relative prices. The falling prices are not due to monetary deflation, they are due to an excess inventory of unwanted goods and services.

Public Library said...

There is a looming disaster on the rise and it's probably going to come from the sovereigns mismanagement of their new found debt crisis.

Some may time the market well enough to make handsome profits, bout the majority will get fully wiped out by the next debacle. And it won;t take another 10 years to rear its ugly head.

I have zero confidence the Fed knows what it is doing simply because there is no precedence for their actions. In addition, the precedence that exists is an abomination.

John said...

Public Library,

Specificly, what woud YOU do if you were running the Fed?

puffer said...

Scott & Charles -

So oil and copper will more than double again in the next 12 to 18 mos? Oil will be $175 next yr and $350 the year after that? No... the huge gains we've seen since the collapse were a one-time event due to a mispricing for Armageddon. Commodity prices will not continue to increase at the same rate and that tapering will create downward pressure on inflation. All prices have to do is not continue at the same rate for the inflation rate to go down.

Scott Grannis said...

puffer: not necessarily true. If commodity prices stopped rising, for example, it's entirely possible that other prices that are now falling would begin rising.

Public Library said...


I don't have the answer but my gut tells me the lack of will power to deal with the ills will ultimately make the day of reckoning more spectacular.

Our society is now plagued with moral hazard in every nook and cranny. Everyone gets free passes so the faux parade can continue.

Banks, borrowers, and unemployment recipients, you name it, and the Fed/Treasury/Congress has a cocktail to cure your owes.

We transferred the private woes onto the sovereigns books and yet we all know government is the least equipped to manage private affairs.

If that's not irony then I am not sure what is...