Inflation Is Going to Get Ugly

From the WSJ:

Federal Reserve officials are acknowledging increasing weakness in the economy, signaling a willingness to cut rates again at their next meeting. But inflation concerns are rising among some officials, indicating the magnitude of their next move may be a matter of contention.

.....

Some officials, however, expect growth to rebound in the second half, and they are wary of cutting rates so low now that they would spur higher inflation as the economy recovers. Monetary policy works with a lag, so interest-rate cuts tend to boost the economy six months to a year after they are implemented.

"The Fed has to be very careful now to add just the right amount of stimulus to the punch bowl without mixing in the potential to juice up inflation once the effect of the new punch kicks in," Richard Fisher, president of the Federal Reserve Bank of Dallas, said in a speech in Mexico City yesterday. Mr. Fisher dissented in the Fed's latest vote, which lowered the interest-rate target half a point.

Charles Plosser, president of the Federal Reserve Bank of Philadelphia who also is on the voting rotation this year, suggested this week that he would need to see a deeper deterioration in the economy -- beyond the weak numbers already expected -- to support further easing.

But Mr. Plosser, who backed the last two rate cuts, said he expects "little progress" in lowering a key inflation measure this year or next, "and I am skeptical that slower economic growth will help," he said. "All you have to do is recall the 1970s when we experienced both high unemployment and high inflation to appreciate that slow economic growth and lower inflation do not necessarily go hand in hand."

This has been one of the main reasons I have argued against the rate cuts over the last few months. The bottom line is inflation is nowhere near a good level.

Here is a chart of the year-over-year change in inflation:

And here is a chart of the year-over-year change in money growth

Let's look at the prices some important commodities that form the bedrock of our economy.

Wheat:

Gold:

Copper:

Oil

Corn

Inflation looks really tame, doesn't it (end really sarcastic, smart-ass tone)

I first started to become concerned about inflation after my twice weekly shopping trips. I noticed that things I buy regularly -- milk and chicken -- were increasing in price to uncomfortable levels. In Houston Texas, a gallon of milk was roughly $2.99/gallon for the longest time. Over the last 6 months it has increased in price to $3.39/gallon. Bonless skinless chicken has increased from approximately $5.50/package (roughly 4 chicken breasts) to over $7.00 package. Then I started to listen to check-out conversation and it was all centered on prices. I realize the Bonddad's shopping list is hardly exciting reading, but this is where my concern started.

Now we have stories like these about agricultural prices hitting record highs and inflation hedging commodites like gold and sliver doing likewise. Anyone who follows these markets -- wheat, corn and the like -- has seen huge price increases over the last 5-7 years. While the Fed was concerned about "core" inflation -- great if you don't eat or drive anywhere but completely useless for anything else -- non-core inflation was running through the roof.

And it's not as though interest rates were sky high in the first place. Take a look at the following charts from the St. Louis Federal Reserve:

Effective Federal Funds:

10-Year CMT

30-Year CMT

AAA Corporate paper

BBB Corporate paper

Interest rates are cheap beyond belief. It's not as though money is expensive right now. The central problem isn't the cost of money -- it's a poorly managed financial sector. But thanks to 17 years of Alan "cheap money" Greenspan, we're all use to the Fed cutting rates whenever we feel economic pain. Thanks for nothing.

From the WSJ:

Banks are tightening lending standards for businesses and consumers -- even beyond real-estate loans -- and companies' demand for credit has weakened, a new Federal Reserve survey of senior bank-loan officers shows.

The January survey offers the hardest evidence yet that the credit crunch is spreading. Although banks also reported some tightening of lending requirements on credit cards and other consumer loans, commercial and industrial loans have been the most severely affected.

One-third of the U.S. banks and about two-thirds of the foreign banks responding told the Fed they had tightened lending standards on commercial and industrial loans during the three months ended Jan. 31. About half the banks said they have widened the spread between their cost of funds and what they are charging borrowers.

"Bankers are becoming more cautious," said Keith Leggett, economist at the American Bankers Association in Washington, "but also borrowers are getting more cautious."

About a third of the banks participating in the survey reported weaker demand for commercial and industrial loans, while about one in 10 reported strong demand. Among those that saw a reduced appetite for loans, "a decrease in customers' needs to finance inventories and investment in plant and equipment" was cited frequently. 70% of the respondents cited a drop in businesses' needs for merger-and-acquisition financing as a reason for lower demand.

Here is a link to the Fed's report

So now we hear the Federal Reserve actually talking about inflation. That's nice. It's what they should have been talking about all along.

Comments

[ibsteve2u]

Some European analysts are suggesting that America may REALLY have to go into the hole buying back our increasingly devalued assets to avoid a global recession (http://www.reuters.com/article/ousiv/idUSGOR27660220080212).

Yesterday, Paulson said "The U.S. economy is fundamentally strong, diverse and resilient" - somehow managing to overlook the steady CONSOLIDATION of our economy as first most industrial sectors and then many service sectors went offshore.

Today, we get a big splashy headline about the trade deficit having narrowed - despite record oil prices - from an Administration world-reknowned for having Departmental propaganda ministers who are authorized to change or censor data and press releases in order to stay "on message" with this Administration.

In the meantime (as noted in HuffPo yesterday), http://www.economicindicators.gov/ is going out of business due to "budgetary constraints" - further resticting access to data that may or may not be valid.

Who ya gonna trust?

[ashleybaines]

Here's an SOS from the trenches. I am a small retailer. All my costs are going up - but people are only buying mark downs. My figures for February look flat, but to achieve parity with last years gross - my margin is slipping.

So my bottom line is less.

Stagflation.

I am getting price increases on what I call institutional merchandise every time I re-order.

But customers aren't buy at the higher prices. So this crap about costs being "passed on" is just that, crap.

All the Chinese stuff is going up in price [shoes, socks, some clothing and costume jewelry] - but its getting harder and harder to pass on the increases.

I think things will get better once some of my competition is lost to this downturn.

That's always the upside of recession/­depression - if you are well positioned, liquid, and cautious, you can wait for competition to thin.

That's exactly what's happening in our city. My competition [in the malls specifically] can't control their costs - the insane mall management has stores opening at 4 am to bring in more business at Christmas.

Just those increased Christmas hours destroyed the profit for stores. You just can't squeeze that much out of extra hours because of the draconian costs of labor.

Anyway - we got out of the mall a while back, and I'm happy. One of my competitors went belly up last year because she stayed.

I like destination retailing in a small, obscure location. It's cheap, and it works.

[SisterAnn]

If the republican conservatives, repug cons for short, find out something doesn't work, they keep doing it.

The reason for the housing bubble was low interest, now they are lowing interest to help those who can't afford the homes they have.

Excuse me, there is not enough poor people to cause all this mess. They can't blame Clinton so they blame the poor. Sweet.

Where are the Adults?

[Dunnage]

You know damn well that Core CPI is the correct indicator of inflation. To make your argument, at least, don't mislead. And I don't care how much a loaf of bread costs or a gallon of fuel. Hight oil is like a tax -- unfortunately a tax being expropriated. People sure as hell get hurt, but it is not an indication of inflation.

We have enough serious problems without wandering off into red herring waters.

[therealredstateblues]

CPI that conveniently leaves out costs for food, fuel, utilities, medical costs and so forth that take a real bite out of working and middle class incomes

[LeftRight]

So...... You never eat, or drive anywhere, or heat your home in winter, or cool it in summer, or turn on the lights? Cause Core CPI only applies to a person if you don't do any of those things. Core CPI USED to be a usefull indicator, back when energy and food were actually volatile! However, for the last several years, both has simply gone up, never down. Therefore, we need to include the numbers for them, since we still need to buy them!

[LeftRight]

Further, when the high cost of energy causes the cost of everything else (from a loaf of bread, to a big screen tv) cost more, that's inflation, and therefore Core CPI doesn't look at the whole thing, and since the price of energy has gone up several times, without going down other than for a couple of months, the inflationary pressure of that needs to be looked at!

[rwt1138]

Core CPI is a shell game, the cost of a loaf of bread or a gallon of fuel has a direct impact on real people, not the rich idiots who decide to exclude these costs. While I really appreciate the administration and it's sycophantic peanut gallery at the "venerable" wall street journal explaining to me how great the economy actually is, I preferred the 90's when I could just consult my pay stub.
I suspect a lot of people gauge the economy more by how they and their friends and family are doing than by what they hear from the financial "geniuses" who made this mess in the first place.

[olephart]

I think that inflation will be a mixed bag. Some items like food and energy will continue to be pricey but other items will not, like apparel and crap. Until China decides it doesn't need our funny money to maintain its growth, they'll keep their currency undervalued and crap will remain cheap. Inflation in China may be exported with their crap so this is may cause some price pressures. The Fed used to raise interest rates if wages started to rise on the premise of fighting inflation (funny, they didn't raise rates when CEO pay went up or profit margins expanded). As we all know, wages aren't rising and with the export of millions of jobs and the import of millions of illegal immigrant slaves they aren't going to rise. This lack of wage pressure argues against inflation and for stagnation. The housing ATM has hidden the effects of stagnant wages but that's over. The Fed may be cranking out money but it isn't going into the hands of those who would spend it. It's going to replace what was stolen and stashed away in the accounts of Bush's haves and have mores. Many big ticket items that were once purchased with the help of the housing ATM will suffer from decreasing demand. This will mitigate any upward price pressures.

So, with the exception of necessities, most items will not come under inflationary pressures because most people will be too broke to buy them. If Chinese crap goes up, people will buy less. This will in turn cool the Chinese economy and reduce their inflation. The American people will fight inflation using a tried and true economic weapon, poverty. Rather than prices rising, standards of living will be falling. This time it will reach up and touch the upper middle class McMansion owners as their million dollar homes fall by 50% in "value".

The Fed has long used the expedient of "substitution" to understate inflation. What will now happen is that consumers will substitute dog food for hamburger and the Fed will continue to report no inflation.

[jackpinesavage]

Excellent post.

And may i say, i read the whole comment thread and almost forgot what site i was on.

[avraamjack]

You want to fix the economy? Legalize marijuana. Happy horny people are great for the economy and might even get us some good rock and roll.

[swift goat pet for truth]

Legalize pot and let the hundreds of thousands who are in for possession out of jail. That will save the taxpayers $50K+ for each body out of the slammer.

[mcostello]

this is exactly what any pragmatist who valued a balanced budget would do. But as long as we live in the age of "magic money" (read borrowed money we never intend to pay back), leaders never make those choices.

Also, if you ran on it you would lose.

[SingingBird]

In addition, the government will make money off the taxes they collect on legalized pot.

[Purple Girl]

We've let these private banker fiddle and gamble with our money and economy long enough
What a scam "federal' "reserve' ,nothing Federal (gov't run) about them and the only thing they reserve are their own profit margins. They just pass the debt on to US.
These Private banking corporations have been gambling not only with our money since it's inception in '34, to now- but well into our nations future.
Let's cut the contract with these corp'ist and return the business of our nation to the Treasury and Commerce Dept- that's what they were menat to do in the first place.
These criminals have sold out our Nation to multinational conglomerates and foreign investors- they must be FIRED and tried for Corruption , treason. EVeryone that has got breath in theri lungs who have deciieved US with this fraud and profiteering.
We'd also like to get an accounting of all the gold you've been "Holding ' for US.
WE can also Print our own damn currency.
Add the IRS (labor=wage,no profit to tax) to the list of brick & mortar that must come down. These tools for man have become Frankensteins and detrimental to the well being of all that exists- the plague of mankind.

[retarius]

I don't think we are going to see inflation. I think that the most likely outcome is a deflationary spiral lasting many years....something like Japan. The interest rate cuts will not stimulate the economy, because the problem is creditwort­hiness...a­s individuals and as a nation we are too much in debt, why would you lend money to someone who is already too deep in debt to pay off his loan at a reduced rate....isn't gonna happen, sorry...
The Japanese drove their interest rates down to zero...and there was no stimulus...
Here is what is going to happen...stimulus, no response; further stimulus, no response; no more room to cut rates, foreigners that lend US money want higher rates they get sick of losing money in dollars; interest rates start to go up to prop up the currency; disinvestment and unemployment; consumers buy only essentials; firms are forced to cut prices and profits; stock market tanks; consumers won't buy because they believe that prices will come down in the future...long term downward spiral....woe, woe and yet more woe.

[mcostello]

This would be a great argument if we haven't already seen huge inflation.
I don't see my house dropping in price more that 10-15% (in an inflated market: Denver), and I don't see police detectives getting a cut in pay (from $80k per year.) So the only other thing that can occur as credit disapears is huge inflation. If you havent seen it yet, look at the price of anything made for you where you are, like new prescription glasses, or a cap for a broken tooth. My wifes eye exam and glasses cost $850. this year. That is a weeks pay before taxes for her.

[SingingBird]

You may not see a pay cut for the police detectives, but you may see layoffs as the city budget falls and the need to balance the budget. Hence, increased unemployment, which in tern creates a lowering of the standard of living, less money to spend and less businesses to support. Retailers no longer have as many customers, need to layoff more employees as the demand isn't there.

FYI...Macy's just announced the other day that they are laying off over 2000 employees. The cycle is already starting. You will also notice it in the stock levels of stores like Target. I see many empty shelves and open spaces.

[CharlesMac]

OPEC pre-announced they will likely cut production in the face of falling oil prices from us cutting consumption. Oil futures went up $3 a barrel today because of that. In what chapter of the Free Market Gospel can I find that?

What inflation? I have excluded gasoline, food, housing, and medicine from my expenses. I now live under a bridge in an empty Chinese TV box, and ride around in a Mexican made shopping cart to experience core inflation. (quote fourex)

Hale you now have a pulpit. Use it.

No retreat. No surrender.

[mcostello]

Add to your opec woes the fact that half of the value of a barrel of oil is from speculation. It feeds itself because investors speculate that it will be worth more (in case of calamity) and we continue to buy it at any price.
Now opec expects $100/barrel and cuts production to keep it there.

[therealredstateblues]

speculation and the "regional instability" factor.

Where are the millions of gallons of free flowing oil Wolfowitz and the rest of the neoCON artists said we would get from invading Iraq?

[Hopalongpoppyseed]

Re inflation: I like a vegetable spread with no trans fat, but the one I use went up from $2.38 a tub, to $2.99 yesterday. I wonder if that is another blowback from high corn prices. Anyhow, I bought a pound of real butter for $3.99. I'll bet that goes up soon.

[LadyXoc]

Very good but definitely missing the effect of the tanking dollar. European goods have almost doubled in price to Americans. Chinese goods are still cheap, but this will only continue as long as the Chinese manipulate their currency. Think of China as a global Wall-Mart cutting prices until the Mom-and-Pop stores, that is Europe and America, are out of business. Of course, no action has been taken about oil prices (energy adds to the cost of everything). Fasten your seatbelts, amigos, it's going to be a bumpy ride.

[realitytrumpsbull]

I think they should bring all the troops home, and go to town in Washington and find out what, exactly, happens to all these hundreds of billions and trillions of dollars. I'm holding my breath, no, really, I am. Congress has the authority on paper to do this...they can refuse to spend another red cent, if they united as a body to make that decision. Now, figure the odds of that happening...

[dolphy]

Zero?

[WIpatriot]

Try a number less than....

[goldenshaman]

Buy Euro's and put them in a safety deposit box.

My bank lets me do this without commission.

Central banks are selling gold, and the commissions can be very high, so that is no way to protect your money.

Buy a piece of south-sloping land with a water supply. You can put a trailer on it and grow food.

[jackpinesavage]

Well said.

[swift goat pet for truth]

I believe one can open accounts in American banks in Euros. However, I do not think the European economy is that much better off than the US economy. I might think Swiss francs or NZ dollars might be a better bet.

I agree arable land is good. But make sure the water supply has no chance of drying up come the climate change. Actually, New Zealand has a lot going for it. If only the whites there were not such racists....

[SingingBird]

Hey Swift...great post. New Zealand currency has gone from $.63 to almost $.79 in a couple of years. The only problem is that New Zealand exports a lot of their goods to the US and Europe. They can only afford to the keep the exchange rates at certain levels before it starts affecting their exports and they bring it down.

Oceanview (or waterview) land in New Zealand, on the other hand, is a great investment. Ours has increased 70% in less than four years. The real estate market there is kept afloat by the Japanese and the Brits buying up what they can.

In addition, you have a lot of NZers doing an overseas exchange in the UK, earning UK money and after 3-5 years moving back to NZ with the UK money.

[legalgirl]

What about a wind-fall profits tax on Big Oil to pay down the national debt?

[littleblackcat]

I would love to make a reply to you, but I don't know whether to laugh or cry. Are you just crazy or just returned from a Rip Van Winkle-style nap or are you in need of a politically correct term to describe your intellectual grasp? I say this jokingly because if any one (it would actually take quite a few working together) of our "elected officials" brought such an honest, practical, reasonable, simple, and FAIR bill to the table, I do believe the rest of the room's occupants would set upon them and tear the very flesh from the bones like ravening hyenas. "ASK THE OBSCENELY WEALTHY TO PAY THEIR FAIR SHARE?!?!?!?!!!!? ARE YOU OUT OF YOUR MIND? HOW WILL THEY SLIP US THE OFFSHORE BONUSES FOR OUR RETIREMENT IF THEY PAY THEIR FAIR SHARE?" There are way too many big businesses that are getting away with murder (ours) and not paying the share they should be so shareholders can reap ever-larger dividends. If taxes were paid by those who should pay them, rather than the big breaks going their way and the little guy being forever stomped down to where he cannot make any gains, we wouldn't have the mess we have. Only the little people, when they have the chance to create a business, lift the economy. Once a business becomes large, the owners want only to keep the profits for themselves rather than paying their employees generously. This keeps a good paycheck from helping anyone else get a foothold.