Paradoxically, the latest inflation numbers show that the Fed’s various attempts to keep us out of a deflationary spiral of wages and prices aren’t yet working. That is, the lowest interest rates since the 1950s plus wholesale purchases of Treasury Bonds and Mortgage Backed Securities by the Fed have not boosted aggregate demand sufficiently—i.e., the demand of consumers and businesses for more housing, consumer and capital goods—to stop wages and prices from continuing to fall.
That is the real goal of the Fed’s QE2 Quantitative Easing program. The problem is reversing the downward spiral—which only decreases the demand for more products and services—and creating some upward push in wages and prices.
The most looked at gauge—the Consumer Price Index for retail prices (CPI)—has been literally flat for the last 3 months, while the Producer Price Index for raw materials and wholesales goods has risen slightly. The Personal Consumption Expenditure Index, the broadest gauge of prices used by the Fed, is still falling.
The overall CPI in October posted a 0.2 percent boost, following a 0.1 percent rise in September. The market consensus had expected a 0.4 percent boost for the latest month. Excluding food and energy, core CPI inflation was unchanged for the third month in a row.
Year-on-year, overall CPI inflation crept up to 1.2 (seasonally adjusted) from 1.1 percent September. But the core rate slipped to 0.6 percent from 0.8 percent the prior month, the lowest core rate in 50 years of record keeping by the Labor Dept.
Inflation at the producer level was more moderate than expected in September with the core tugged down by discounts in motor vehicle prices. The overall Producer Price Index inflation rate held steady at 0.4 percent in October, coming in significantly below the consensus forecast for a 0.8 percent increase. At the core level, the PPI surprisingly fell 0.6 percent, down from a 0.1 percent gain in September and coming in lower than the median forecast for a 0.1 percent uptick. The core was led down by a 3.0 percent drop in passenger car prices and a 4.3 percent decrease in light truck prices.
For the overall PPI, the year-on-year rate increased to 4.3 percent from 4.0 percent in September (seasonally adjusted). The core rate softened to 1.4 percent from 1.5 the previous month. This shows moderate inflation at the wholesale level, mainly in petroleum prices, due to the lower dollar exchange rate. When its value drops, oil and commodity producers raise their prices to compensate for the cheaper dollar.
Meanwhile, the PCE price index rose just 0.1 percent in September after rising 0.2 percent in August. The core rate was flat after nudging up 0.1 percent in August. Year-ago headline PCE inflation held steady at 1.4 percent. Year-ago core PCE inflation fell to 1.2 percent from 1.3 percent the prior month. Both series are below the Fed's implicit inflation target of 1.5 to 2 percent, hence the deflation worries.
So why is the Fed easing when there is such concern about budget deficits and too much debt? Because inflation is caused by an overheating economy, not one such as ours with so much excess production capacity and unemployment. Historically, inflation hasn’t become a problem until our unemployment rate has fallen to the 6 percent range—which might not happen for years, according to most economists.
In fact, inflation is caused by too much money in circulation with too few goods to purchase. But right now almost no money is in circulation. The M2 measure of dollars in circulation has been falling because it is being hoarded by consumers and corporations. This is while the exporting countries are producing so much that there is a surplus of goods and services—which is why imported goods are so cheap, in spite of the weaker dollar exchange rate.
Fed Chairman Ben Bernanke has been vociferously defending QE2 in recent speeches. ““Fully aware of the important role that the dollar plays in the international monetary and financial system, the [Federal Open Market Committee] believes that the best way to continue to deliver the strong economic fundamentals that underpin the value of the dollar, as well as to support the global recovery, is through policies that lead to a resumption of robust growth in the context of price stability in the United States,” said Bernanke.
So now is not the time to worry about inflation. Consumers can’t spend what they don’t have, and businesses won’t spend until they see some increase in demand for their products and services. Hence the stalemate we are in. It isn’t only the congress that is in gridlock at the moment, but most of our economy.
Harlan Green © 2010