Monday, August 29, 2011

Durable goods once again contribute to inflation

On a six-month annualized basis, using the Fed's preferred measure of inflation (the Personal Consumption Expenditures Deflator), both headline and core inflation are above the Fed's target range of 1-2%. As recently as late last year—about the time that QE2 got underway—both measures were below the Fed's target range. We're now back to a 2-3% inflation environment, much as we were in the years leading up to 2008.

What has changed so much since late last year? This second chart gives us a clue: durable goods prices are no longer deflating. In fact, durable goods prices have risen at a 1.2% annualized rate since the end of last year, and that's the first sustained rise in durable goods prices since 1994. The seemingly relentless decline in durable goods prices was a major factor holding down overall inflation for the past 16 years, but that's no longer the case.

The above chart shows the three major components of the PCE deflator: services, nondurable goods, and durable goods. Note the dramatic differential between the rise in service and non-durable goods prices, and the decline in durable goods prices. Since the end of 1994, service sector prices have risen 57%, nondurables have risen 47%, and durables have fallen by 27%. Since 1994, service sector prices have more than doubled relative to durable goods prices. Since service sector prices are dominated by labor costs, that's roughly equivalent to saying that an hour's worth of work today buys more than twice as much in the way of things (e.g., autos, TVs, appliances, computers) as it did 16 years ago. That's a unique, and for most folks, a very fortuitous development, since prior to 1994, durable goods prices never declined on a sustained basis. Unfortunately, those good times look like they have come to an end.


Benjamin Cole said...

I am puzzled with this current hand-wringing about inflation.

Over at Carpe Diem, Dr. Perry is reporting inflation at 50-year lows.

If you buy a house today, a new computer, shop at 99-cent stores, rent an office, rent industrial space or hire labor, you are experiencing deflation.

If we are frightened and hysterical about inflation now, when would we ever have the nerve to stimulate the economy?

Jeez, our ancestors crossed the Atlantic in little sail boats? We beat Japan and Germany?
And now we whimper in the face of low single-digit inflation?

Are we destined to become Japan?

Is preserving the value of the Ben Franklin in monetary formaldehyde worth decades and decades of depressed output?

I am far more interested in pursuing boom times than in pursuing zero-percent inflation rates.

Looks like I will have to pursue those boomtimes in another country. Many other investors are making the same choice.

burmanhands said...

Doesn't that simply mean that the cost of importing Chinese goods (which is nearly everything) is increasing due to rising standard of living and wages there.

McKibbinUSA said...

I expect the Main Street Depression that is devastating America to get much worse in the coming months -- more at:

Much worse...

Junkyard_hawg1985 said...

"Since the end of 1994, service sector prices have risen 157%, nondurables have risen 147%, and durables have fallen by 27%."

Not to be picky, but looking at the chart it looks like service sector prices rose 57% and nondurables rose 47%. Am I reading the chart wrong?

Scott Grannis said...

Junkyard: oops, forgot to subtract 1. Should be 57% and 47%. Text has been corrected. Thanks for pointing that out.

TradingStrategyLetter - Weekly Summary said...

After devaluing currency by 50% Belarus is now fighting hyperinflation and just hiked its central refinancing rate by 5% to 22%. Just wait and see how much fun those people have dealing with that.