UPDATING THE (LACK OF AN) INFLATION THREAT

Some of the recent inflation data is causing consternation in some corners of the investment world.  At 3.8% headline inflation sounds rather high.  But if we study the post-war era, inflation is still low by any measure.  If we look at the data going back to 1957 we actually find that headline inflation has averaged just 4% per year.  Through the first 8 months of 2011 inflation has averaged 3% – nearly a full 1% below the historical average (latest reading was 3.8%).  If we look at core inflation, the picture looks even less alarming.  Core inflation is currently running at just 2% while the average since 1957 is 3.9%.

Now, some people will refute this data by claiming that the government’s CPI is flawed or misleading.  But we know from the Billion Prices Project AND the ECRI’s independent inflation gauge that the government’s data is actually quite accurate.  In fact, the BPP is a near perfect reflection of the government data over the last few years while the ECRI is showing declines in inflation:

(BPP Inflation)

The more important point here is that the inflation risks are now skewed to the downside following several quarters of rising prices.  Admittedly, inflation has run hotter this year than I predicted (3% vs 2.5% expectations), but as the hyperinflation meme collapses, the global economy weakens and commodity prices tumble (down 10%+ in September) we should see a return of the disinflationary trend.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • Tom Hickey

    Gary Schilling calls deflation. (video and transcript at ZH)

    See also Randy Wray’s recent posts on commodities at Great Leap Forward. He anticipates an imminent popping of the bubble.

  • Hillbilly

    The latest inflation mask has been accomplished by increasing default risk. The FIAT morons who think they are in safe havens and can get out quick enough will wake up one day to find their heads are missing.

  • LVG

    It sounds to me like your net worth has been sliced by 30% in th last few weeks as your gold and silver investments get smashed to bits and pieces. Meanwhile, US bonds rally.

  • Wulfram

    I would argue that the CPI percentage by itself is not what is important. What is important that increases in the prices are not being matched by an increase in incomes. This is particularly true for “super-core” necessities, such as gas, food, education, and healthcare.

    As they say, you can’t eat an iPad. An iPad is also not a substitute for an education from a reputable college — unless you develop apps for one.

    If this trend continues for a longer period of time — and I see no reason why it wouldn’t — the middle class will continue to be eroded. Since the middle class is where aspirational innovation mixes with the necessary virtues of educational and mobility to enable entrepreneurship, I think even a small increase in the CPI over a long period of time does great damage to our competitive advantage as Americans.

    Fortunately thanks to robotic hands (and the millions of tiny Chinese hands putting them together), access to technology has never been greater. Despite excessive government regulation, I would also argue that the start up costs have never been lower.

    You’d think the government would put two and two together. By reducing regulation , taking advantage of the cheap pool of talent, technology, and low “borrowing” costs, it is more than possible to unleash a wave of innovation. But Washington seems content on trying to prop up the FIRE economy.

    It’s been frustrating to watch.

  • nikko

    3.8% headline inflation IS high for a country facing a balance sheet recession.

    Also you may want to consider “real yields” instead of inflation.
    Inflation is not necessary a bad thing. And real yields is a more important economic indicator then raw inflation when it comes to investing.

  • Anonymous

    Gold dropped $350 in three days and silver drops some 30% in the same three days, and you don’t have any inkling of market manipulation. They can’t do it forever. They do it once every month or so, and it marches higher than it was before. I’m still up from where I purchased. They raised margins on silver 5 times in one week back in May. They’ve done it to gold 3 times in the last month, and we’re above where we were trading 6 weeks ago. I don’t know why people have such a hard on for gold and silver, it’s like people want us to fail. The American economy is wrecked, and the only way for us to get out of it is for the politicians and bankers to do the right thing. You buy your US government bonds and hope they do the right thing. We’ll buy our gold and silver, and in a few years we’ll see who’s ahead.

  • pigfarm

    Most commodities made their highs in April/May and have been plummeting rapidly ever since. Gold and Silver have been decimated. (CME margin hikes sure helps)

    To the extent that food and energy have been coming in off of their highs, and pricing for durable goods has been soft, and you have core CPI below the 50+ year average, you can make the argument that deflation is the problem not inflation.

    However, I think that we are just pulling back as nothing goes straight up or straight down, and too many commodities were extended. In addition, I recently finished a book called The Great Wave (http://www.amazon.com/Great-Wave-Revolutions-Rhythm-History/dp/019512121X) which analyzes prices for goods and services going back over 1,000 years. I highly recommend it because I really don’t think that 50 year or even 100 year time frames give enough perspective to analyze historical data, especially when some waves are 100 years to begin with!

    One interesting historical fact I got out of the book was that back in medieval Europe, when they were undergoing a multi decade inflation wave, the prices for armor and skullcaps, which were important durable goods not only for soldiers but also merchants, were very stable in prices. However, prices for firewood and wheat continued to climb rapidly. Labor costs stayed low, while rents increased. Rich people hoarded food and other resources, and fought every move by the kings to collect taxes to finance their armies.

    I honestly think that this is just a pullback in commodity prices right now, and that it should continue through next year. However, everything I’m looking at both in recent history and ancient history indicates that we should be getting a once in a life time long entry for commodities mid next year.

  • VRB II

    Thanks pigfarm…good stuff.

  • http://www.pragcap.com Cullen Roche

    How can you make such a definitive statement based on almost zero evidence?

  • MMTer

    Cullen, I was wondering if you’d seen this article by a new MMT convert who says he thought you were a Fed shill. He’s pretty condascending about your work in general and quite insulting at points in his posts:

    “My introduction to Modern Monetary Theory was in the form of comments in a SeekingAlpha.com article. Judging by the quantity and quality of most anti-MMT articles I see these days, my initial reaction to MMT was fairly common. I was fully convinced that the comment author was a paid shill from the Fed peddling his nonsense as far and wide as possible to fool everyone into a false sense of security. That was only a few months ago, and after some long nights and lots of reading, I’m a full convert now. I’m not sure how many people who are exposed to MMT ever actually make it past the disbelief stage, but I think the MMT crowd is fully to blame for this reaction. MMT supporters need to up their game a little, and be more explicit and precise in discussion.

    A reasonable introduction to Modern Monetary Theory can be found on Pragmatic Capitalism: Understanding The Modern Monetary System

    The linked article is actually written by the guy who I was convinced was a Fed shill. So what is the problem? Why does MMT generate an astonishingly hostile response? ”

    He’s now dedicated an entire website to MMT after reading your work and being introduced to it by you:

    http://www.modernmt.net/2011/07/20/the-process-of-understanding-modern-monetary-theory/

  • MMTer

    He sounds like an economist of some sort so it makes sense that he would read MMT and brush it off. Krugman and Sumner do the same thing. Thoma as well. Anyhow, this guy could be a valuable contributor if he models MMT well. It would score big points with the academics even though it probably wouldn’t accurately reflect reality (as not economic model truly can).

  • Wulfram

    Actually, here’s a fun little story for you. I was primed for MMT years ago by my high school AP US History teacher.

    I remember in one lecture, my teacher asked us what determines the value of the dollar. Several of us answered gold, but he explained that view was no longer correct after the Nixon Shock and that the dollar only has value because of the government and that because other people also accepted it as value.

    At the time, it was a disturbing shock to me. It does make a little more sense now, so I thank you.

    Except for the fact that you were several years too late to help me with the final.

  • ESS

    Hi Cullen
    On a college-related note. It would be useful to see (at least to me) a post that does direct comparison among the current main economics schools and point out the main MMT sticking points and how they contradict the classic models.
    Regards
    \E

  • Robert K

    What gives the dollar its’ value? Before 1971, gold, for international settlement purposes, but within the US, the legal
    tender statute. After 1971, OUTSIDE the US, the dollar has value ONLY as the currency MOST IN USE for settlement of
    trade, and that status derives almost totally from the agreement by oil exporters to settle all world oil in dollars. As
    oil is the MOST important internationally traded commodity, whoever was privileged to settle oil would win the battle
    for currency most in use. Lose that status, and the dollar becomes nothing more than idea in the mind of another
    person about what he might be able to obtain in exchange.

  • Jay

    An FBI agent, funny. I don’t put myself in any camp, but MMT continues to make more and more sense the more I read, and I see deflation being more of a problem than inflation. But what do you think of currency wars, racing to the bottom. Aren’t currency wars typically what happens after serve recessions. Is this not inflationary, as all fiat currencies become weaker. Are we not starting to see currencies tensions, with CHR and YEN intervening to lower them.

  • Pod

    TPC,
    I would be curious what Ray Dallio thinks of MMT. That guy seems to have the broadest and deepest understanding of the global financial system, markets, etc – i.e. “the machine” – than anyone else.

  • Adam

    Sadly, because the mainstream is convinced that a soveriegn currency issuing government is fiscally constrained (which is false) they look for (perceived) easy solutions to unemployment – export expansion. And they attempt to achieve that with currency depreciation, however not every nation can be a net exporter it’s just not mathematically possible.

    For those importing it will arrive as import inflation and if currencies are allowed to properly float that import inflation should force an adjustment as imports become relatively more expensive versus domestic production.

  • Coolidge Low

    To add to your post Tom, The Federal Reserve (Bernanke) is petrified of deflation and will start the inflationary “talk” soon if not already. Gary Shilling phrased it properly.

    “In effect, [the Fed] tried to do that with QE2. Because you remember at the time they were worried about deflation… That was one of the objectives. Of course, they spurred commodities, they spurred stocks and they got a temporary offset. But I think the forces of deleveraging in the world are greater than the Fed can handle. We’re marking things down to equilibrium. Look at government sovereign debts around the world. They’re much greater than taxpayers can handle. You either have to mark them down or get somebody else to handle them, like the Germans, or try to inflate them away. Inflating away is an excess supply world is almost impossible, even for the Fed.”

  • Robert K

    The nation that prints the global reserve currency, just as the nation which discovered vast new reserves of
    gold (Habsburg Spain) under the old gold standard, does not NEED to produce, but can import at little cost
    what it needs with its currency. This naturally increases imports and undermines domestic industry. Why
    work to produce what you can obtain virtually for free. If I had a press, I would be tempted to do the same.
    Gresham knew this in 1650 -”Industry is destroyed at the source of money creation”. You could look it up.
    Eventually, Triffin’s dilemma catches up with you. Triffin is dead, but his observation is very much alive.

  • SBG

    Cullen,

    Isn’t it amazing that the one trait in which humans excel, the ability to adapt, is the very thing that we struggle with the most.

  • SBG

    Robert,

    At the end of the day it is all perceived value.

  • Nathan

    Cullen:

    Great stuff as usual. I have been reading your articles for a little while now and while my skepcism waxes and wanes, I find you (and many times the commenters) share nuggets of genuine wisdom that cannot be found many other places (if any where at all). Thank you.

    I had two questions regarding your inflation numbers: (1) How does the cost of housing play into the inflation calculation? I am relatively new to finding this data online myself so if there is a reputable source that you or another commenter could recommend, I will get the answer myself.

    (2) I understand that (a) inflation often lags government spending in a somewhat unpredictable fashion and (b) the government cannot change its spending habits overnight. I have no data to back that up– instead I am repeating what I have learned previously. It makes sense that people do not raise prices immediately. It also follows that spending on “shovel-ready” projects require longer-term commitments that cannot be turned on and off quickly. Assuming I am not disabused of (a) and (b), then, isn’t additional deficit spending great in the short term but dangerous in the medium term? i.e. Won’t the inflation momentum we create by committing to spend today potentially constrain our ability to spend (at acceptable inflation levels) tomorrow? Thank you for the eductation.

  • Different Chris

    So you are flat out saying either Hyperinflation or a conversion to either gold, silver or combied backing of the USD in the next few years?

    I’ll take that bet. Genuinely hope your gold and silver investments work out, though, as they have been great investments and could continue to be.

    And I do take a bit of umbrage with the idea that “the US Economy is wrecked” for no other reason than after I left my apartment this morning I bought a tank of gas (in NJ so someone was at work pumping my gas), got breakfast and a cup of coffee from someone working behind the counter at Dunkin Donuts, stopped at shope rite (right outside my office) to pick up a thing or two, got to work, there were checks waiting for me from some clients. “Wrecked” implies inoperability, things could be better but people still get up and go to work in the morning, still do their jobs, still buy things, still sell thing. The economy could be in better shape, but it is far from wrecked.

  • ES

    What do you mean by “just” 4%? 4% compounded over 5 years is 21%. We lost 10% of purchasing power due to inflation since 2008 while wages stayed flat . This is not healthy. This kind of inflation is very high for a slow growing economy. We lost around another 10-20% since 2000. In short, most people standrd of living declined by 20-30% since 2000. These are people who are driving the real economy, doing the real jobs, like engineering, manufacturing, teaching and so on.
    In normal environment I expect wages rise by 3-5% a year and inflation at 2% a year, allowing for 3% real growth. Currently we got -3% growth.

  • KB

    I also have a feeling that current inflation (specifically, change in price) is somewhat artificial, given balance sheet recession. At least, for launching another real QE, it’s too high. But again, who am I to decide this.

    Then, talking about inflation as change in money supply, we are open to unproved wide guesses, as the statistic is limited. Would be nice if somebody can elaborate on that.

  • DR01D

    4% inflation is pretty bad for an economy that has been at a standstill for a year.

    http://online.wsj.com/article/SB10001424053111904800304576475811201857064.html
    WSJ: Slow Growth Stirs Fears of Recession

    “Gross domestic product—the sum of goods and services produced in the U.S. and the broadest tally of economic growth—increased at a paltry 1.3% annual rate in the second quarter, the Commerce Department said Friday. First-quarter revisions—down to 0.4% from 1.9%—reflected an economy at a near-standstill early in the year.”

  • Peter D

    I don’t think he blames you for him not being able to understand MMT first! I think he’s actually very complimentary to you. He says that at the time he thought you were a Fed shill, but he clearly knows that he were wrong in his ideas back then, and this is thanks to you, not in spite of you.

  • rfr

    How is inflation even possible in an economy that is operating at sub-capacity?

  • Colin, S.Toe

    I couldn’t agree more that college, and even high school students can grasp this stuff, and may be a key audience.

    Their teachers may also be a good target. The best, most-open minded teaching I experienced was in high school (compared to Swarthmore College, and the University of Chicago – a very distant third).

    Unfortunately, it seems that the more reputation (and influence) at stake, the more resistance there tends to be to new ways of thinking – hence the dominance of neoclassical and monetarist economics at the most prestigious universities.

    However, colleges, smaller universities, and public institutions contain many more bright students and dedicated teachers. With their families in straitened circumstances, and their futures at risk, they may be open to ideas that show the way forward.

    Thanks to all at this site who contribute both ideas and positive energy.

  • ES

    IMported inflation via relative currency devaluation. Low interest rates depress the currency.

  • nikko

    Headline inflation is important to an economy facing a balance sheet recession when considering to implement greater deficit spending. Deficit spending stimulates headline inflation and produces little impact to core inflation.

    Discretionary income which is needed to boost GDP consumption is funneled into headline inflation and away from productive job creation consumption. Bernanke and co. can ignore volatile headline inflation but consumers with limited discretionary income cannot.

  • sfamc2

    Grant’s Interest Rate Observer reports the following stats as of September 23, issue:
    Annualized Rates of Growth
    3 Months 6 Months 12 Months
    Currency 6.0% 8.0% 9.2%
    M-1 41.7 27.1 20.7
    M-2 24.4 15.0 10.3
    MZM 17.2 13.7 9.6
    Comerical-Industrial Loans
    9.7 10.8 6.3
    Comerical Bank Credit
    4.0 2.7 0.5
    Increasing bank loending indicating the balance sheet recession is easing?????

  • sfamc2

    Sorry about my poor typing ability.

  • Oroboros
  • Fred

    That is correct. MMTer misinterpreted the page he linked.

  • Bond Vigilante/Willy2

    For inflation or the lack thereof I simply look at the CRB index. Not a perfect gauge but good enough. Better than that farce called CPI.

  • http://www.learning-it.nl/about-me.html Gem

    I agree with Nikko about the general level of inflation in the US. The problems are very deeply rooted. The big problem which has not been really tackled is of the deficit. Dealing with that in the traditional way – printing money – will mean further inflation. There is little else that can be done when industry is in a deep trough – and that means eventually the markets will cotton onto the fact that the US has effectively weakened the dollar.

    That is when it goes out of control.

    Of course, there are things that can be done. Will the Senate and President have the courage to make that sort of decision?

  • Fred

    Yes, thats my post… wasn’t meant to be insulting at all ;) I do owe my introduction to MMT to you, so of course there is plenty of appreciation for that. I’m not easily offended, so no worries. I fully understand the common problems with converting classically educated economists. I went through a similar process, and describing that was the intention of the post. Thanks for the welcome though. best,
    Fred

  • Oroboros

    I reference to several posts … according to govt data:

    % yearly change of (Personal Income/Civilian Population)/CPI(NSA) =

    http://research.stlouisfed.org/fred2/graph/?g=2va

    Wherein it looks like citizen’s incomes are growing by about 1.0% YOY in “real” terms (inflation adjusted, but not trade weighted dollar adjusted) at the present moment (well, a month ago, really).

    I am fairly sure that ‘Personal Income’ includes dividends, interest, and transfer (welfare, SS, etc) payments. Using ‘Compensation of employees received’ instead of ‘Personal Income’ we get the following graph:

    http://research.stlouisfed.org/fred2/graph/?g=2v9

    Wherein citizen’s incomes based upon employment wages & benefits are growing by about -0.6% YOY in “real” terms at the moment. With a long term trend line looking not so spectacular.

    Things to consider:
    1) What would result if the top 10%, 5%, or 1% of wage earners were removed from the calculations. My guess, a substantially higher negative reading on both graphs.
    2) Graphs do not adjusts for currency valuation. Just a note.
    3) Given the recent reduction in the civilian labor force (and non-civilian, come to think of it), compensation per working individual may be going up more than these graphs show, even if per capita compensation is effectively stagnant.
    4) It would very roughly appear that transfer payments of all forms are swinging per capita civilian income growth by approx 1.6%, from slightly negative to slightly positive.
    5) If you download the data recent working compensation hit a nadir of -5.5% in November of ’09. Ouch.
    6) Thought experiment: What would another recession do to these graphs.

  • ES

    Numbers confirm what I am seeing. This is the root of the deflation – the discreationary income of the middle class is deflating, causing the price deflation everywhere except for protected industries (protected from global competition) such as health, education and insuarance.
    The deflation cannot be defeated until the real incomes start rising and it is not happening. Tax cuts could help, but it looks like they are not happening before the 2012 elections. By then we’ll be in the recession again , unless we get a fiscal stimulus somehow. All the monetary tinkering does is driving the inflation in wrong places due to increased speculation with overflowing hot money.

  • Dismayed

    “We’ll buy our gold and silver, and in a few years we’ll see who’s ahead.

    History is *not* on your side.

  • beowulf

    One guy kept emailing me convinced I was an FBI operative working for the govt.
    Wait, you’re not?

  • beowulf

    I don’t know why people have such a hard on for gold and silver, it’s like people want us to fail. The American economy is wrecked, and the only way for us to get out of it is for the politicians and bankers to do the right thing. You buy your US government bonds and hope they do the right thing. We’ll buy our gold and silver, and in a few years we’ll see who’s ahead.

    Your trust in the good faith and fair dealing of the United States Govt is touching, maybe you should be buying Savings Bonds. I’ll be thinking of you the day Uncle Sam drops all 8,000 tons of gold for sale at market.
    “One Cross of Gold, Coming Up
    How the government could get even with right-wing cranks.”
    http://online.wsj.com/article/SB10001424052748703837004575013373812096744.html

  • Different Chris

    Cost Push inflation (typically from rising commodity prices)