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

[LeonBNJ]

One problem with cutting the Fed interest rate, is that it leads to much larger cuts in interst rates paid to bank and other interest paying account. Several months ago, you might have got a 6 month Certificate of Deposit paying 3.75 to 4.0%. Now you would be lucky to get 2.5%. This discourages people to save money as well as badly hurting those, especially the elderly and retired who rely on decent interest income to live on.

[Mormondude]

America doesn't save money anymore, so having a low return doesn't hurt very many people.

Meanwhile almost everyone is in debt up to their eyeballs, so having lower interest rates helps them a LOT.

When the savings rate is so abysmally low, I don't think we have to worry so much about disincentivising savings.

[WIpatriot]

Is that sarcastic?

[therealredstateblues]

But low interest sure doesn't help savers - so we should be worrying about the disincentives to save precisely because it is so low

[huffnpuffn]

Come on everyone, look on the bright side! We as a country are carrying $943.5 billion in credit card debt. Including loans other than mortgages and home equity lines of credit, Americans are shouldering a record $2.5 trillion in debt http://www.cnn.com/2008/POLITICS/02/08/economic.stimulus/index.htmll)

And let's not forget this number:

http://www.brillig.com/debt_clock/

Now what happens with inflation? Our dollar is devalued. If you have dollars, your wealth becomes smaller. If you owe dollars, your debt becomes smaller.

Why have we as Americans not more fully embraced inflation? In fact why are we not working for more robust inflation?

[swift goat pet for truth]

You did not mention the $429 billion INTEREST ONLY payment on the National Debt. Or about the same amount of our annual Fed Deficit. The third largest item on the Fed budget.

AND for this money we get....what?

[Wulfstan]

High inflation pisses off the buyers of Treasury Bills, which are financing the Federal Debt of $9 trillion, because when they mature thay are worth less than they anticipated.

[huffnpuffn]

All kidding aside, that's really the point here. We don't want to piss off the buyers of Treasury bills because they have alternative forms of investment. Who's buying all these T-bills anyway? China for one.

http://www.treas.gov/tic/mfh.txt

When China decides they don't want to lend us any more money, we are most certainly screwed. But we are screwed even before then because we are at their financial mercy. We must appease them lest they bankrupt us.

But who cares? No one if you look at the mainstream Dems and Repubs. Then look at Ron Paul.

http://www.house.gov/paul/tst/tst2005/tst082205.htm

[biwee]

As measured by the CPI, the inflation rate from 1 Oct 06 to 30 Sep 07 was 2.3% The calendar 2007 inflation rate was 4.1%. So, just shifting this 12 month period forward three months took the CPI from 2.3% to 4.1%. The annualized inflation rate for the last 3 months of calendar 2007 was 5.6%. Inflation is a big poblem. The Fed's dropping of interest rates is like pouring gasoline on a house fire. Oh, also, don't give me that garbage of "core" inflation (excludes food and energy). Everyone I know alive EATS, and most consume a lot of energy!!

[LeftRight]

AGREED! And since the price of food and energy are both continually going up in the last few years!

[barely normal]

The rat bastards have held sway way too long, and like the problem with the environment, it is time for change now. Better some discomfort now to stave off catastrophe later.

Whomever becomes President will need to have the fortitude to stand and speak to subjects that are not popular. (Any President who really has the country's best interests at heart will become so unpopular with the average citizen that a second term will not happen, but that person could go down in history as one of the best presidents ever.)

[Rockyman]

I agree 100%. America has shown an unwillingness to swallow any "bitter medicine". We will disregard it's need and turn to hope and optimism instead. But doesn't this delay and make the "illness" even greater? As you say, we badly need a strong and decisive leader who will practically force us to do the fiscally "right" thing. I wonder if one exists. America is an addict that is in denial. Our fundamentals are deteriorating and our credit-buying frenzy is history!

[goldenshaman]

The runups in some costs are not inflation- an excess of money over goods.

They are genuine increases in relative costs due to increased competition for resources.

Any attempt to "manage" this "inflation" by "traditional" means will cause a depression.

Under the surface of the financial system, there is pure panic.

No entity, including the US, has an unlimited line of credit. We have used ours up.

[domokat]

I just want to know when I can enjoy strawberries and blueberries again! Has anyone been able to afford strawberries, blueberries, blackberries, lettuce, etc. without taking a loan out?

[WIpatriot]

I grow those foods in my gardens. Except for the bluberries....

[Rule Of Law]

Put the blueberries in last year--expect a small but tasty crop this year! You need good drainage and a high acid soil accomplished with either peat moss or the same fertilizer you use for hisbiscus--it acidifies the soil. Hey, I'm pushin' 60, I need those anti-oxidants!

[Hopalongpoppyseed]

Yeah, you gotta grow them at home. Most berries like slow release nitrogen like you get from manures and then you water them more before they are ready to pick, to increase the size. b
Blueberries freeze wonderfully and are often cheaper frozen that they are fresh. You need a Victory Garden, for victory over corporate food.

[WIpatriot]

Victory Garden is right, Hopalong. Food is trucked, on average, 1500 miles to get to the shelves. Increasing fuel costs mean higher food prices coming. Fresh from the garden veggies is soooo much better for you. And you don't have to live with pink tomatoes. Mrs. p. freezes tomato sauce, beans and corn from the cob (we don't grow it, farm is 5 miles up the road) so we have fresh staple veggies all winter.

Also, save your seeds. Why do you think they're building the seed vault in the Arctic? For fun? Have you heard about Monsanto's plan for non-germinating seeds?

[Rockyman]

Energy costs have skyrocketed and will continue to stay high as demand continues to rise and push up against a production "ceiling". Therefore production and transport costs rise reflected in the end-result price. Yet the American worker has lost leverage to negotiate wage-raises. Unions are weak and jobs are threatened to go to cheaper labor markets. American's will be forced to learn to find happiness through other means than more "stuff". Tighten your belts and put on the sweater. Our abundance had been "earned" years ago. Recently it was from borrowing. Now it will be neither!

[dolphy]

Come on. That's not true. W implied yesterday that there is peace and prosperity right now.

[GnitenGoodLk]

.....making treasonous statements otherwise threaten it..shh..leave the elephant in the room out of this.

[Rockyman]

Bush likes to think of himself as "The Decider-in-Chief. A more appropriate name would be "The Deluder-in-Chief!

[joexmd]

Fine and dandy outlook but do you have any suggestions for us poor bastards that have worked hard all our lives, put away what we could in our 401's, are in our mid-50's, and see the future going to hell???

[seawolf77]

Buy property in a 3rd world country that raises it's own food and has plenty of water and is oil independent. Brazil,Uruguay, and Argentina come to mind. When peak everything hits,and it will prices are telling you so, the USA is not the place to be.

[WIpatriot]

GWB has 100,000 acres in Paraguay...what does that tell you? Sure, there's a lot of brush to be cleared (and he's so good at doing that), but what else?

[frappe]

Yes, and of course the Fed will apply it's remedial medicine when the Democrats win the White House. Then the Republicans can blame the Democrats for the latest iteration of the "misery index".

[veracitatus]

There is an historical strong correlation between the cost of oil (energy in general) and inflation. Energy is fundamental to everything we do, production or service. When the cost of energy goes up, it ripples through everything and there may be an amplification effect or at least an accumulation of higher costs as products move from raw materials to finished goods. So even though energy is seen as a small percentage of costs at each stage, it adds up as value is added.

This is no surprise. And it will get worse as we move into the post-peak oil era. Tighten the belts folks.

V.

[Wulfstan]

Increases in the price of energy increase the cost of living. They are not the cause of inflation of the currency, which rests with the Federal Reserve.

If the money supply remains constant then the price increase of one commodity means there is less money available for other commodities, the price of which decreases.

Inflation absent pay increases also effectively translates to an increase in the cost of living or to put it another way, a decrease in the standard of living.

[rabun666]

$5 per gallon is on the horizon.

[WIpatriot]

Plan for it. If it doesn't happen, you'll be pennies ahead, then.

[Craig]

I'm not so convinced the Fed has any impact whatsoever on short-term rates. It seems to me they just track 3-monthe T Bills.

Why do short rates fluctuate? I think we need to look at the dollar bubble (declining), federal deficit bubble (inclining), unfair trade agreements (many are not free trade), pork barrel spending in the military sector(we spend 6x more than the rest of the world combined-the cold war is over), the health care sector (private companies charge 20-30 % overhead while Medicare costs 2-3 % for the same thing,and nobody complains about the quality of Medicare),and tax sector (the IRS overhead is 20%, a flat tax of say 13% with no deductions and no credits), subsidies in oil and agriculture, lack of financial regulation at the federal level, and improperly funding of Social Security (future contributions could be used to purchase shares in broad US and brosd global index funds until the Trust is composed of 30% bonds and 70% stocks-rebalancing constantly using new money to maintain this balance).

We could also consider a flat (across the board but variable with the dollar)import tariff to maintain a constant dollar.

We could also make repayment of the National debt a mandatory budget item, say 1% per year.

Improvements in the military can be obtained by closing most of our overseas bases and beefing up our intelligence services by factors.

[Aaror]

A flat tax of 13%? Where will you get the other 3/4ths of what we now get in taxes?
A flat tax by nature must keep tax rates close to the middle class rate, so you are looking at 26% if you want to keep running huge deficits, more like 35% if you want to pay 1% of the national debt each year.
And by making the tax "flat," you will get less money from the richest, and far more from people whose children go to bed hungry every night.
If you want to simplify the tax code, by all means get rid of the deductions and credits, but leave the variable tax rates alone. Please drop the flat tax, it is the worst idea ever.

[WIpatriot]

I'm with you, Aaror.

[swift goat pet for truth]

No capital gains rate. No taxing wealth differently than labor.

Its all income.

BTW, I like 50% tax rate on anything above $1 mil/year.

[outnow]

Sounds like the Fed is hoping to stabilize the real estate asset bubble by providing buyers with low interest loans. But if their credit is bad or they have no documentation of income, then the landing in the real estate market will not be as soft. Raising Freddy Mac and Freddy Mae limits will pass on more loss to the tax payers from the lenders.

Reducing interest rates will enable the Republicans to lie about the real inflation and the rising unemployment until after the November elections, then all hell will break loose.

There is no way that the U.S. can continue its military and intelligence spending with sluggish financial institution profits amid the losses of these institutions. There is relatively little manufacturing except for high tech armaments going on in the U.S. Consumer spending is down and imports are costing more.

The problem is systemic. Free trade policies have eroded the middle class's purchasing power. The Fed is a one-trick pony leading us into hyper-inflation and more debt. Just reducing the interest rate will cause more inflation.

[Wulfstan]

Instead of giving tax rebates a better idea might be to cap the Mortgage interest rate at 5% and have a moratorium on foreclosures.

[swift goat pet for truth]

Better yet, give everyone flourescent light bulbs. Its saves everyone money in the long run.

[LeftRight]

Okay, I'm not an economist, and I never understood how Supply and Demand ever worked in a regulated economy, but here's a simple question:

Since the fed cut rates 1.25% in a week, less than a month ago, and it takes six months to a year to affect the economy, how can they tell if it's done any good? And why are they talking about cutting rates again, since it's been less than a month since they cut rates last time!?

[CaveatMagnusFrater]

They are comtemplating lowering the rates again because time is running out on them. They are political and have been instructed to lower the rates. Bush and his friends only have 11 months left to pillage the national teasury. Soon the doors will be locked and the debt will have to be paid.

[Veri]

The debt will have to be paid by every American as they are the ultimate guarantor of the federal debt. And no, the doors will not be locked to those who will loot and pillage the treasury.

How so? The Republicans and Democrats (almost spelled Emocrats) have been complicit in this debacle. Bill Clinton and NAFTA, anyone? Reagan and trillion dollar dollar deficits? Remember.

Everyone living in the 90's thought they were well off and rich. That turned out to be an illusion. Tech bubble? And before someone tells me Clinton managed to eliminate the deficit, how long was that going to last?

Euro's accepted here.

[rabun666]

Bush and Reagoon with their irresponsible and planned borrowing is intended to borrow with the proceeds going to the wealthy and the borrowed money and interest being paid back by the individual taxpayers. It's a sweet deal when you get the loan proceeds and have others pay it plus the interest. That's what going on with Bush in his last 11 months and why he wants to increase his war spending which is all financed with the proceeds going to his cronies and the public getting stuck with the bill.

[LeftRight]

I'm still pissed off since they said that the 75 points was god, when they hadn't even had time for the news to go around the globe when they were cutting it 50 more points! Now they're talking it again! We're going to turn into Japan, which has had 0% rates for the last several years, and NOBODY is investing in the country, just in the currency, and then only long enough to get a loan, then convert it to some other currency!

[LeftRight]

correction: 75 points was GOOD, not god!

[swift goat pet for truth]

Doing good is not the point.

Doing SOMETHING in the face of financial panic is the point.