Prices Are Falling!

 Popular Economics Weekly

Today could be historic for inflation watchers. It’s the first time since July 2022 that retail prices in June as measured by the U.S. Consumer Price Index (CPI) have declined.

It will be history making and effect the financial markets, housing, and maybe the presidential election where inflation has seemed to be Americans’ major worry—at least according to the polls.

The easiest signs of actual deflation for consumers are the drop of gas prices to pre-pandemic levels. Gas prices dropped 3.8% in June, the government said. And the cost of used cars and trucks fell 1.5%.

I said last month that it will probably be hard to believe for many scarred by the post-pandemic inflation scare that still believe inflation is too high, but there was no inflation increase in May for both wholesale (PPI) and retail (CPI) inflation indexes.

FREDcpi

The FRED graph illustrates that we now have had two months of no price increases. It could have been predicted because consumers have known for months that stores were discounting, and been frequenting big box retailers like Target, Walmart and Costco.

It also tells us that housing (rents) have been declining after an initial uptick in the first quarter due to various shortages. Housing inventories have increased some 40 percent year over year, per the National Association of Realtors.

This will cause bonds in particular to rally because interest rates, including mortgages, will finally begin to decline from their two-year highs.

San Francisco Fed Chairman was the first to jump on the rate cutting bandwagon this morning. She said she now supports cutting interest rates.

“With the information we have received today, which includes data on employment, inflation, GDP growth and the outlook for the economy, I see it as likely that some policy adjustments will be warranted,” Daly said in a roundtable with reporters cited my MarketWatch’s Greg Robb.

The increase in rents in the past 12 months slowed to 5.1% in June from 5.3% in the prior month and touched the lowest level since April 2022. Rents are expected to slow even further, but just how much is unclear. Before the pandemic, they were rising about 3.5% to 3.9% a year.

The cost of "imputed" housing, meanwhile, rose a scant 0.3% in June. That's the smallest increase since July 2021. This category, known to economists as OER, is a indirect proxy for how much the cost of housing is rising.

The Biden administration’s Treasury Department is doing its part with funds to support building more affordable housing.

“Executive agencies have the power to act quickly to promote homeownership. We applaud the Biden Administration’s comprehensive, multi-agency response targeting solutions at every level of government. It will take an all-of-government approach to yield results in this fight,” said NAR’s Chief Advocacy Officer Shannon McGahn.

So, Fed Chair Powell was correct in saying at his latest congressional testimony that the Fed will not have to wait for inflation to decline to its 2 percent target rate before cutting interest rates

He was making a brave statement, because the inflation hawks will now say easing credit could stimulate another inflation surge, because consumers will therefore be able to borrow more, thus increasing the demand side of the supply-demand equation.

But lower interest rates will also stimulate more home building, increasing the supply side of the housing shortage that has kept most housing unaffordable for entry-level and first-time homebuyers.

The rather sudden drop in prices could mean more, maybe economic growth itself slowing further, and we see actual deflation? Let’s wait and see.

Harlan Green © 2024

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Why No Real Inflation?

Financial FAQs

This graph portrays the history of inflation since the 1970s, when the Arab oil embargo caused oil prices and inflation to soar to unacceptable heights.  It made Americans realize how dependent they had become on 1) fossil fuels to run the economy, and 2) other people’s oil.

Inflation since then—at least the Fed’s preferred PCE Index that is the broadest measure of price fluctuations—has been tamed. In fact, so much so, the worry today is too little inflation via ever more efficient manufacturing that now employs a fraction of the employees it once did for the same output.

Why such a worry? Because the globalization that drove most of the higher-paying jobs overseas to cheaper climes has driven down most households’ incomes as well as prices that could lead to a deflationary spiral, which would signal an incoming recession. It worried the Fed under Ben Bernanke so much that he brought on the various QE programs after the Great Recession to ease credit by bringing down interest rates to the record lows of today.

In fact, the 10-year Treasury yield has slipped to 2.29 percent from a seven-year high of 3.23 percent last October, and it’s been under pressure to go even lower from a flareup in trade tensions between the U.S. and China.

It hasn’t done much for growth.  The distribution of household wealth in America has become even more disproportionate over the past decade, with the richest 10 percent of U.S. households representing 70 percent of all U.S. wealth in 2018, compared with 60 percent in 1989, according to a recent study by researchers at the Federal Reserve.

“The share of assets held by the top 10 percent of the wealth distribution rose from 55 percent to 64 percent since 1989, with asset shares increasing the most for the top 1 percent of households. These increases were mirrored by decreases for households in the 50-90th percentiles of the wealth distribution,” Fed researchers said.

Wealth has transferred from those that work for a living to those that live off rents, which is income from existing assets—whether it’s stocks, bonds, real estate, or even charitable foundations where many of the wealthy shelter their incomes.

Economics Professor Gabriel Zucman has researched what happened, especially since 1980 when Republicans began to dominate the political landscape. The top 1 percent of income earners controlled 7 percent of the wealth then, whereas today they control 39 percent.

A second result has been the cutbacks in health care spending to the tune of $1.5 trillion over 10 years from the Republicans 2017 tax cut bill that reduced corporate taxes to 20 percent. So instead of spending on such public benefits as expanded health care and infrastructure spending, the tax savings went into the pockets of corporate shareholders and their CEOs.

President Trump acknowledged as much with his latest walkout of the scheduled meeting with Democrats on an already agreed upon $2 trillion infrastructure bill. Washington Post’s E.J. Dionne, Jr. said as much in his comment about Trump’s latest blowup.

“Trump’s theatrics were also very convenient because they disguised the fact that he cannot now, or ever, deliver on his signature promise to create a “great” infrastructure program. This is why Trump “infrastructure weeks” have become a standing joke in Washington. LaTourette (a Eisenhower moderate Republican) was right: The Republican Party is no longer interested in spending public money to solve big problems if doing so gets in the way of cutting taxes.”

How dire is this trend?  Americans are so stretched to maintain a decent standard of living that they aren’t saving much of anything.  The Fed announced recently that 40 percent of working Americans haven’t saved more than $400 for emergencies.  

“When Reagan took office in January 1981, the net domestic saving rate stood at 7.8 percent of national income, and the current account was basically balanced. Within two and a half years, courtesy of Reagan’s wildly popular tax cuts, the domestic saving rate had plunged to 3.7 percent, and the current account and the merchandise trade balances swung into perpetual deficit.”

It has hovered in the 3 percent range ever since and government revenues now cover just 79 percent of public spending. The rest must be borrowed, which cannot go on forever.
Where have all those corporate profits gone? Ask Professor Zucman, who estimates $8 trillion is sheltered in offshore accounts—some legally, but much of it hiding from the IRS.

Harlan Green © 2019

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

The Economic Ruination of Greece

Popular Economics Weekly

It is now beyond a reasonable doubt that Germany and its austerity cohorts want to drive Greece out of the Eurozone by insisting that it adhere to its agreement to pass most of its meager budget surplus to service its foreign debt, rather than invest it back into the Greek economy. It is insisting that Greece cut government spending enough so that it carries what is called a huge ‘primary’ budget surplus of 4.5 percent (a surplus before its bills are paid—ie, largely interest to its creditors).

The EU, led by Germany, had crafted several agreements that gave Greece large loans to service that debt, while forcing it to submit to severe austerity and wage cuts.

“The results have been catastrophic, said the Guardian in a 2013 article: “cumulative economic contraction approaching 25 percent, adult unemployment at nearly 30 percent, youth unemployment close to 65 percent, unprecedented poverty, destruction of the welfare state and humanitarian crisis in the urban centres. Greek debt, meanwhile, is currently higher than in 2010, standing at €321bn and, since the economy has collapsed, its ratio to GDP approaches an exorbitant 180 percent. This is the background to the current debate.”

But to do so would in effect drive Greece even further into its depression, since it means lower tax revenues, which means even more debt. The consequence is the layoff of more workers and further reduction of average household incomes. Paul Krugman put up a graph of the cutbacks in spending that in turn have made Greece’s debt burden worse, compared to other countries that agreed to the EU’s austerity terms.

 

Greece has already paid the piper, in other words, while Germany now has the largest budget surplus of all western countries. “Greece has done a lot more austerity than those countries cited as supposed success stories,” says Krugman, “(which is another issue — success being defined as “not total collapse, and slight recovery after years of horror” — but that’s a different story).”

Graph: Trading Economics

So Greece has little choice but to exit the euro currency, unless some last minute compromise with the EU is possible. Its unemployment rate is currently 25.8 percent, the worst in the Eurozone (slightly more than Spain’s 23.7 percent), as it has been in a deflationary spiral, further depressing its economic activity.

Graph: Trading Economics

Although Greece mostly lived up to the terms of the bailout, the promised growth never materialized. As Greek Prime Minister recently said: "We are not negotiating the bailout; it was cancelled by its own failure.” Calculated Risk tabulated the difference between the forecasted results of its austerity cutbacks and the actual result.

Greece: Annual GDP, Forecast and Actual

Year Promised      Actual

· 2009 -2.0            -4.4

· 2010 -4.0            -5.4

· 2011 -2.6             -8.9

· 2012 +1.1             -6.6

· 2013 +2.1             -3.9

The only choices are to allow Greece to run a smaller primary surplus (currently 1.5 percent), leaving more of its revenues to benefit its own citizens, or for Greece to leave the Eurozone and default on all their debt. What will it be?

Harlan Green © 2015

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Low Inflation Everywhere Is Shrinking Growth

Popular Economics Weekly

Deflation is a rising risk for the U.S. economy based on import and export price data where contraction is at its most severe since the 2008-2009 recession, as well as for the rest of the world. U.S. import prices fell 2.8 percent in January alone for year-on-year contraction of 8.0 percent. And it's much more than just the impact of the strong dollar as export prices are also in contraction, at minus 2.0 percent for the month and minus 5.4 percent on the year, reports Econoday.

Graph: Econoday

Another sign of deflationary tendencies is that U.S. consumer spending barely rose in January as households cut back on purchases of a range of goods, suggesting the economy started the first quarter on a softer note. Sluggish spending came despite cheap gasoline and a buoyant labor market, leaving economists to speculate that consumers were using the extra income to pay down debt and boost savings.

 

Graph: Thomson-Reuters

The Commerce Department said retail sales excluding automobiles, gasoline, building materials and food services edged up 0.1 percent last month. But overall retail sales slipped 0.8 percent in January, declining for a second straight month as falling gasoline prices undercut sales at service stations. This is after consumer spending, which accounts for more than two-thirds of U.S. economic activity, expanded at its quickest pace since 2006 in the fourth quarter.

Graph: Trading Economics

But even falling gas prices are a sign of deflation, as it means there is lower demand for energy products everywhere in the world, as I said. In fact, consumer prices are already falling in the Eurozone, -0.2 and -0.6 percent, respectively, in the past 2 quarters, signaling an outright recession. Paul Krugman has even said the Eurozone is now in their Second Great Depression.

Graph: Calculated Risk

So why are consumers paying down debt with their extra pocket money? The preliminary University of Michigan consumer sentiment index for February was at 93.6, down from 98.1 in January. Higher gasoline prices are probably the reason for the decline in February, and that’s enough to make consumers more cautious with their spending.

Harlan Green © 2015

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Europe on Verge of Recession

Popular Economics Weekly

Oil prices are plunging below $50 per barrel, and the European Central Bank is about to announce whether it will begin its own Quantitative Easing program, similar to the Fed’s purchase of government securities that is designed to pump more money into Europe’s lagging economies. So economists are wondering whether this will have a net plus effect on growth, since the oil industry and countries like Norway that depend on oil revenues will lose profits, while the EU is slipping into outright recession.

A Saudi oil Prince has said oil prices will stay down for a long period—years, of necessary to support their market share. “If supply stays where it is, and demand remains weak, you better believe [the price of oil] is gonna go down more. But if some supply is taken off the market, and there’s some growth in demand, prices may go up. But I’m sure we’re never going to see $100 anymore,” said Prince Alwaleed bin Talal, the billionaire Saudi businessman, in an interview with Maria Bartiromo of Fox Business News published in USA Today.

The initial result seems to be that U.S. consumer confidence is soaring as gas prices have fallen more than $1 per gallon in a year, even below $2 per gallon in many regions. But other prices are falling as well, which is worrying economists, who see it as a sign of weakening demand. Weak demand may be elsewhere in the world, such as Europe, but it affects the U.S. economy as well.

Graph: Econoday

Such weakness is difficult to reverse as the Japan’s two decade example of outright deflation proved. It knocked them down from second to fourth largest world economy.

Europe is having the same problem, mainly due to its austerity policies that have cut back government spending, and so demand for its goods and services. Switzerland just rang the alarm bells when it very suddenly removed its 1.2 euros to Swiss Franc exchange rate cap, thus causing the SF value to skyrocket. Why did it take the cap off? There is lots of conjecture. The Swiss had been protecting their currency exchange value from rising too rapidly by buying euros, in order to protect their export industry.

But allowing the Swiss Franc to rise as much as 20 percent against the euro also raised the danger of a deflationary spiral such as happened in Japan. Why? A more expensive SF will counteract the upcoming QE purchases of the European Central Bank that are designed to put more euros into circulation in order to ease credit conditions! .

Nobelist Paul Krugman said in a recent blog, “By throwing in the towel on the peg to the euro, the SNB (Swiss National Bank) immediately convinced markets that its previous apparent commitment to do whatever it takes to avoid deflation is null and void. And this expectations effect trumped the concrete, immediate policy of drastically negative interest rates on reserves. It will continue to feed the deflationary trap Europe is falling into.”

European deflation is happening in a big way. Eurozone annual inflation rate was recorded at -0.2 percent in December, matching preliminary estimates. It is the first fall in consumer prices since September of 2009, due to a drop in energy costs.

Graph: Trading Economics

In December 2014, negative annual rates were observed in sixteen Member States. The lowest annual rates were registered in Greece (-2.5 percent), Bulgaria (-2.0 percent), Spain (-1.1 percent) and Cyprus (-1.0 percent). The highest annual rates were recorded in Romania (1.0 percent), Austria (0.8 percent) and Finland (0.6 percent). Compared with November 2014, annual inflation fell in twenty-six Member States, remained stable in Sweden and rose in Estonia.

The U.S. inflation rate is still 1.3 percent, but this month’s Consumer Price Index for retail prices was unchanged, which is hovering very close to deflation. Oil prices are the main culprit here as well.

There is a counterbalancing effect from lower energy costs, of course. Consumers have more to spend and production costs are reduced. So prices could begin to rise again as more jobs are created. But that means no more austerity that has damaged growth in the U.S. as well, and congressional opposition to spending measures that will create more jobs. Who is willing to bet that will happen?

Paul Krugman had the last word yesterday. “So the (EU) market is saying both that there are very few good investment opportunities out there — few enough that paying the German government to protect the real value of your wealth is a good move — and that inflation over the next five years will be around 0.4 percent, not the target of 2 percent.”

Look out below for more falling prices and slowing growth, if Draghi and the ECB can’t stimulate some EU growth with its upcoming QE purchases of sovereign debt.

Harlan Green © 2015

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Fed’s Yellen—No Inflation In 2015?

Popular Economics Weekly

Fed Chair Janet Yellen has given us a very good holiday gift. that boosted stock and bond prices.  She announced at her post-FOMC meeting press conference that Fed Governor’s see little or no inflation next year. In fact, if falling prices continue in the rest of the world, the Fed may be tempted to not raise interest rates at all next year.

That is a startling conclusion, but she made particular mention of the effects of falling oil prices. They will of course help consumer spending in the developed countries, but the oil exporting countries will be hurt. And lower oil prices also mean less oil is being used, so there is less worldwide demand for energy-based products and services, which means less business activity in general.

“At this point we think it unlikely that it will be appropriate that we will see conditions for at least the next couple of meetings that will make it appropriate for us to decide to begin normalization,” Yellen said at the press conference. The bank’s policymakers meet next in late January again in mid-March, and at the end of April. Most pundits and forecasters say the Fed isn’t likely to change policies until their April meeting, at the earliest.

Graph: Econoday

Consumer price inflation turned down in November on sharply lower gasoline prices plus dips in some core subcomponents. Overall consumer price inflation fell 0.3 percent after no change in October. Energy dropped 3.8 percent, following a 1.9 percent decline the month before. Gasoline plunged 6.6 percent in November after a 3.0 drop in October.

Excluding food and energy, consumer price inflation posted at 0.1 percent in November easing from 0.2 percent in October. The Fed’s own target inflation rates were lowered to 1.0 to 1.6 percent in 2015. Within the core, the shelter index rose 0.3 percent, and the indexes for medical care, airline fares, and alcoholic beverages also rose. In contrast, the indexes for apparel, used cars and trucks, recreation, household furnishings and operations, personal care, and new vehicles all declined in November.

There are others of the same opinion that rates may not rise at all next year. Nobelist Paul Krugman, for instance, has said, “Basically, while (U.S) growth and job creation have finally been pretty good lately, there is so far no sign whatever that the economy is overheating. Core inflation remains below the Fed’s target (the Fed focuses on a different measure that usually runs lower than the CPI, so this report is actually fairly far below target.)

“Add to this troubles abroad — the direct spillover from Russia or even Europe is fairly small, but the rising dollar means that good news on manufacturing may not last — and there is a real risk that any rate hike will turn out to have been a mistake. And it’s a mistake that would be very costly, because it could all too easily set the stage for a Japan/Europe style long-term low-inflation trap (yes, at this point I think we can put the euro area in the same category).”

We also have record high consumer sentiment, which is boosting retail sales, for one.  The expectations component that offers an indication on confidence in the outlook for jobs and income, is up 3 tenths from mid-month and up a very strong 6.5 points from final November. Inflation expectations are very soft reflecting the downdraft underway in oil prices with both the 1-year and 5-year outlooks at 2.8 percent. Today's report will be especially pleasant reading for the nation's retailers.

That should also mean longer term mortgage rates could remain low next year, bringing even more buyers into the housing market (read younger millennial buyers currently renters) and so contributing to the housing recovery.

Harlan Green © 2014

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Existing-Home Sales Highest in Year

The Mortgage Corner

The National Association of Realtors reports total existing-home sales, which are completed transactions that include single-family homes, townhomes, condominiums and co-ops, increased 2.4 percent to a seasonally adjusted annual rate of 5.17 million in September from 5.05 million in August. Sales are now at their highest pace of 2014, but still remain 1.7 percent below the 5.26 million-unit level from last September.

Graph: Calculated Risk

That has to be partly due to falling interest rates, with conforming 30-year fixed rates dropping as low as 3.625 percent for a 1 point origination fee in California. But also rents are soaring, up more than 10 percent year-over-year in five large rental markets -- San Francisco, Sacramento, Oakland, Denver, and Miami.

Lawrence Yun, NAR chief economist, says the improved demand for buying seen since the spring has carried into the fall. “Low interest rates and price gains holding steady led to September’s healthy increase, even with investor activity remaining on par with last month’s marked decline,” he said. “Traditional buyers are entering a less competitive market with fewer investors searching for available homes, but may also face a slight decline in choices due to the fact that inventory generally falls heading into the winter.”

Graph: Calculated Risk

Total housing inventory at the end of September (blue line in graph) fell 1.3 percent to 2.30 million existing homes available for sale, which represents a 5.3-month supply (red line) at the current sales pace. This is far too few homes available for sale, which means a greater demand for new home construction. Despite fewer homes for sale in September, unsold inventory is still 6.0 percent higher than a year ago, when there were 2.17 million existing homes available for sale.

And housing prices continue to rise, though more slowly than last year. The median existing-home price for all housing types in September was $209,700, which is 5.6 percent above September 2013. This marks the 31^st consecutive month of year-over-year price gains.

Why the falling interest rates? Worries of slower worldwide growth are worrying stock prices. The 10-year Treasury note yield dropped below 2 percent for the first time in 16 months. This has even caused Federal Reserve Vice Chairman Stanley Fischer to voice fears that the slowdown in the Eurozone in particular could slow U.S. growth. Why? Because it lowers the demand for U.S. goods and services.

Fischer said in a speech recently that, “if foreign growth is weaker than anticipated, the consequences for the U.S. economy could lead the Fed to remove accommodation more slowly than otherwise.”

Lawrence Yun added, “Economic instability overseas is leading to volatility in the stock market and is causing investors to seek safer bets, which will likely keep interest rates in upcoming weeks hovering near or below where they are now,” said  Yun. “This is welcoming news for consumers looking to buy, although they could temporarily become more cautious by less certain economic conditions.”

Of interest are all-cash sales, which tell us whether the mortgage markets are functioning better, or worse. Fewer all-cash sales generally mean banks are easing their credit standards. All-cash sales were 24 percent of transactions in September, said the NAR, up slightly from August (23 percent) but down from 33 percent in September of last year. Individual investors, who account for many cash sales, purchased 14 percent of homes in September, up from 12 percent last month but below September 2013 (19 percent). Sixty-three percent of investors paid cash in September. 

Distressed homes – foreclosures and short sales – increased slightly in September to 10 percent from 8 percent in August, but are down from 14 percent a year ago, another reason there are fewer all-cash purchases. Seven percent of September sales were foreclosures and 3 percent were short sales. Foreclosures sold for an average discount of 14 percent below market value in September (same as in August), while short sales were discounted 14 percent (10 percent in August). 

Harlan Green © 2014

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Deflation Is Now Major Concern

Popular Economics Weekly

We wrote recently about the Eurozone in danger of becoming Japan, which has suffered through some 2 decades of a deflationary spiral, before Prime Minister Abe opened the stimulus spigots. Why is deflation (or disinflation, which is lower inflation but not falling prices) such a bad thing?

Because it deflates everything, including profits, incomes and so job creation.   This starts a vicious circle of more job cuts and shrinking household incomes, which is what causes a recession, or depression. That danger is now slowly creeping into the U.S. economy, though the U.S.  is growing faster than almost all other developed countries at the moment.

Pundits, and even Fed Vice Chair Stanley Fischer are beginning to voice fears that the slowdown in the Eurozone in particular could slow U.S. growth. Why? Because it lowers the demand for U.S. goods and services.

Fischer said in a speech on Saturday that, “if foreign growth is weaker than anticipated, the consequences for the U.S. economy could lead the Fed to remove accommodation more slowly than otherwise.”

• Europe’s growth engine slashed its growth forecasts for this year and next.
• German economic sentiment turned negative for the first time in nearly two years
• U.K. inflation data also surprised to the downside, taking pressure off the Bank of England to raise rates.

This means the Fed would have to keep interest rates at the so-called zero bound longer than it wants to. That’s because too much cheap money feeds asset bubbles, as happened with the housing bubble. So the European data added to a slew of fears that growth could be slowing across the world.

U.S. growth at present is doing very well with 4.6 percent growth in Q2 after the 2.1 percent shrinkage in Q1, and third quarter growth could exceed 3 percent based on recent inventory rebuilding numbers.

Graph: Trading Economics

But there are headwinds, as interest rates continue to plunge, which signals worries of slower worldwide growth that is hurting stock prices. The 10-year Treasury note yield dropped below 2 percent for the first time in 16 months. But the good news is it will stimulate more housing sales, as 30-yr conforming fixed mortgage rates have plunged to 3.75 percent with 0 origination points, and the Hi-Balance conforming fixe rate is just 3.875 percent with 0 points. So the worries of slower U.S. growth, at least, have no basis.

Graph: Econoday

In fact,U.S. industrial production is approaching its historical average. Industrial production jumped an outsized 1.0 percent in September after a decline of 0.2 percent in August. Forecasts were for 0.4 percent. Overall capacity utilization jumped to 79.3 percent from 78.7 percent in August, close to its 80.1 percent long term average.

Manufacturing was solid, rebounding 0.5 percent in September after a 0.5 percent decline the month before. Within manufacturing, the production of durable goods increased 0.4 percent in September, led by the aerospace and miscellaneous transportation equipment. The production of nondurable goods also moved up 0.5 percent in September. With the exception of petroleum and coal products, each of the major components of nondurables posted gains in September.

So the warnings are real, but somewhat exaggerated. Europeans cannot allow prolonged slow growth policies that emphasize deficit reduction over job creation programs for long. And Fed Vice Chairman Fischer just emphasized that job creation is more important for Fed policy makers, and why the Fed will keep interest rates low for as long as possible, given almost no inflation, to spur more job creation.

Harlan Green © 2014

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Higher Economic Growth In 2014

Financial FAQs

We should be seeing a huge jump in economic growth this year. Why? Most economists are saying businesses are more optimistic with the federal budget agreement for 2 years, and no more tax increases hanging over consumers (and businesses). Republicans even finally agreed to spend $1.1 trillion this fiscal year—that is, until September when another fiscal year begins.

I maintain the increase in government spending, healthier state tax coffers, and a reviving housing sector with housing prices up 13.6 percent annually according the S&P Case-Shiller Home Price Index, will be the main reasons for faster growth and more job creation this year.

We know this because the Census Bureau’s JOLTS report now shows 4 million job openings, and a rising ‘quit’ rate, which means job seekers are feeling optimistic enough about their prospects to voluntarily leave their current job.

Graph: Wrightson-ICAP

“After having risen by an average of 0.5 percent per month from the beginning of 2011 to the middle of 2013,” says Wrightson-ICAP, “the number of voluntary quits since July has climbed by 2.0% per month. The quit rate is important on two levels: it is both a general measure of worker confidence that tells us something about developments in the labor market, and it is a direct contributor to worker mobility, which is a key driver of productivity growth. (Matching workers to better jobs contributes to overall economic efficiency.)”

The best sign of an improvement in business optimism is the boost in capital expenditures. That expectation is based on a variety of factors, including the recent strength in the ISM factory orders index, a pick-up in capital spending plans by small businesses, and strong balance sheets and ample financing for larger companies. The capacity utilization data in Friday’s industrial production report reinforced that expectation. Total capacity utilization climbed to 79.2%, which is only one percentage point below the long-run (1972-2012) average that the Fed publishes as a reference point.

Wrightson-ICAP agrees with me on this, also. “As the aggregate level of capacity utilization rises, says Wrightson, many individual sectors are approaching or surpassing their previous cyclical highs. In the December data published last week, industries accounting for 33 percent of the Fed’s industrial production index had operating rates that were equal to or greater than their peaks in the previous cycle.

Graph: Wrightson-ICAP

There are other factors, as well, such as the pickup in consumer spending with higher December retail sales, and consumer confidence. This could lead to a GDP growth rate in the mid-3 percent range for 2014, up from the average 2 percent growth rate of late. It is a huge jump and just reflects the pent up demand for everything, as household balance sheets are turning positive and businesses begin to spend the cash they have been hoarding.

So the Federal Reserve will probably continue with its tapering of QE3 purchases that will cause long term interest rates to continue to rise. But it’s still the beginning of this business cycle, believe it or not. And there is almost no inflation, which will keep interest rates from rising too fast.

Harlan Green © 2014

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Where is The Inflation??

Financial FAQs

The answer, in a nutshell, is it’s nowhere to be found. All current worldwide and domestic inflation indicators show depressed demand for goods and services, hence there is little incentive to raise prices. Therefore businesses are spending little on expanding capacity—with the exception of housing and autos. For instance, Ford just announced it will be hiring 5,000 additional workers and introducing 16 new models, while GM will spend $1.3 billion to expand 5 existing factories.

Graph: Calculated Risk

In fact, the Consumer Price Index for All Urban Consumers (CPI-U) was unchanged in November on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported. Over the last 12 months, the all items index increased just 1.2 percent before seasonal adjustment.

Why such a weakness in demand? It’s because consumer incomes are barely rising, and consumers account for some 70 percent of economic activity. The income side of the October report is especially soft, at minus 0.1 percent following two very strong months at plus 0.5 percent, said the Commerce Department. The decline is the first since January and may be related to the impact of the government shutdown on private wages. Wages & salaries are especially soft, up only 0.1 percent following gains of 0.4 and 0.6 percent in the two prior months, as the Econoday graphs shows.

Graph: Econoday

So is it any wonder that consumers are spending less, with the Federal Reserve keeping interest rates at record lows? Spending has been increasing just 2 percent annually. Housing in particular has been boosted by those low rates, with conforming 30-year fixed mortgage rates still at 4.375 percent for zero origination points.

And housing starts are at 5-year high. Construction surged in November-and this time it was not just the multifamily component. Starts in November jumped 22.7 percent after rising 1.8 percent in October. The November starts annualized level of 1.091 million units topped expectations for 0.952 million units and was up 29.6 percent on a year-ago basis. September starts were 0.873 million and October was 0.889 million.

Low interest rates go with low inflation rates, which in turn are due to barely rising wages and salaries. Only a lower unemployment rate will boost consumers’ incomes, and that means a commitment by both political parties and the White House to policies that encourage greater growth.

Harlan Green © 2013

Follow Harlan Green on Twitter: www.twitter.com/HarlanGreen

Our Poor Inflation Record

Popular Economics Weekly

Inflation has fallen so low that it threatens this economic recovery. Why? Producers can’t charge more for their products, therefore can’t increase profits unless they use fewer workers and greater automation to replace them.  So there is no incentive to hire more workers, which would increase the demand for their products, and so increase economic growth.

The median household income declined some 10 percent from 2000, after inflation because of less need for highly skilled workers.  And the unemployment rate is still above 7 percent, some 4 years after the end of the Great Recession.

Chart: Trading Economics

That’s because with automation and the Global Information Age, things can be produced more cheaply anywhere in the world where things are cheapest to produce, which puts pressure on workers’ incomes everywhere.  So we know there can’t be as much inflation with unemployment remaining so high. 

In fact, it is remarkable how closely disinflation (falling inflation) has tracked historical unemployment rates in these charts that begin in 1948, the beginning of the modern consumer economy.  For instance, inflation began its steep decline after 1980 when Fed Chairman Volcker pushed interest rates as high as 16 percent, causing the 1981 and 1983 recessions, and a jobless rate of more than 10 percent. The result of the Great Recession has been the same—high joblessness with too low inflation.

Chart:  Financial Times

            So Fed Chairman Bernanke basically inherited an almost deflationary economic environment in 2006, with the Great Recession that began December 2007 and ended June 2009.  That is why the Fed has been keeping interest rates so low, and why the Fed Governors aren’t yet ready to end the QE3 purchase of securities.  Without QE3, we could be in deep trouble with real estate still in the doldrums.

Chart: Calculated Risk

            The good news is that July existing-home sales rose to the highest level in 4 years, since the end of the Great Recession.  The consensus is that most of these homes were put into contract before the recent rise in interest rates, and that the current rise in mortgage rates since then will slow down sales.

            Total existing-home sales, which are completed transactions that include single-family homes, townhomes, condominiums and co-ops, increased 6.5 percent to a seasonally adjusted annual rate of 5.39 million in July from a downwardly revised 5.06 million in June, and are 17.2 percent above the 4.60 million-unit pace in July 2012, said the National Association of Realtors. 

But with just a 5.1-month supply, inventory levels are historically low during this sales season.  That means values haven’t raised enough to allow more homes with positive equity on the market that would create a sustained recovery.  With such a low inventory level there is no danger of either a new housing bubble (meaning too many homes for sale), or inflationary pressures.

Harlan Green © 2013

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Where is the Inflation?

Financial FAQs

If we would listen to the Europeans advocating austerity measures to punish Greece and Italy in particular for their profligacy, then inflation is right around the corner, according to the Germans, at least. Germany’s Finance Minister Wolfgang Schaubele is the most hawkish in advocating that the Greeks won’t get the next installment of their rescue package unless they shave off 130M euros in spending cuts to bring down their some 400M euros in debt.

Herr Schaubele is the principal advocate of what Paul Krugman calls the “confidence fairy”. The confidence fairy is the myth that too much debt causes the loss of confidence in a sovereign currency, driving up interest rates and inflation, even during recessions. It is the rationalization extreme fiscal conservatives use to justify their ideology that all debt is bad (though it is their wealthy supporters who do the most lending), and so debtors must be punished for their borrowing.

That is behind Herr Schaubele’s attempts to drive Greece out of the euro by insisting on such draconian austerity measures that Greece cannot possibly fulfill. Herr Schaubele’s efforts have succeeded instead in pulling several EU countries back into recession, as prices and output are falling, which is what one would expect, because such austerity measures cause a huge drop in incomes, and so any stimulus to grow economies. Great Britain, Ireland, Italy the Netherlands, and Spain are just a few countries suffering from its effects.

“We doubt that the euro zone will be able to avoid further contraction in the first quarter and very possibly the second as well in the face of tighter credit conditions, a further tightening in fiscal policy in many countries, the ongoing pressures facing consumers (high and rising unemployment, and still squeezed purchasing power) and limited global growth,” said Howard Archer, chief European economist at IHS Global Insight, said in a Marketwatch interview.

Economists have been discussing the dangers of inflation since the beginning of economics, but don’t really spell out that there are at least 2 kinds of inflation. There is consumer inflation measured by such as the Consumer Price Index, and there are many commodity price indexes that measure asset inflation.

Graph: Econoday

Consumer price inflation was nonexistent in December at the headline and core levels. The consumer price index in December was unchanged for the second month in a row with lower energy costs playing a key role. Excluding food and energy, the core CPI decelerated to a modest 0.1 percent increase after gaining 0.2 percent in November, and is up just 2.2 percent year-over-year. 

Graph: The World Bank

For the U.S., commodity prices are best measured by the U.S. Producer Price Index for producer goods, which at the producer level in December was tugged down by gasoline and food costs but the core was warmer than expected.  Producer prices edged down 0.1 percent after rebounding 0.3 percent the prior month.

The two are not necessarily related, because producers cannot always pass on their costs to consumers, though economists still take sides. The so-called monetarists, or neo-classicists tend to be fiscal, small government conservatives that believe all economic activity depends on the size of the money supply. And government should not be in the business of boosting the money supply with stimulus, which only causes more inflation.

Whereas Keynesians, or neo-Keynesians, believe that there is really no danger of inflation as long as unemployment is high, which happens during recessions. That’s because consumers who power some 67 percent of aggregate demand cannot create inflationary pressures as long as personal incomes, wages and salaries and the like are stagnant.

In fact, Keynesians maintain from their Great Depression experience that the overall money supply doesn’t increase during recessions, but is hoarded, causing deflationary pressures. And deflation is the hardest to root out, as Japan found out since their bubbles burst in 1990. In fact, corporations are the largest hoarders of cash (some $2 trillion to date), so don’t expect much hiring from them.

Yet, it is really small businesses that provide 70 percent of new hires, so that is where we should look for jobs’ improvement. A good measure of small business is the National Federation of Business Optimism Index, which hasn’t yet risen above recession levels. But the jobs market is tightening, in line with U.S. overall improved employment.

“Reports of workforce reductions are at their lowest level since October 2007,” said the latest NFIB report. “Forty-one percent of owners hired or tried to hire in the past three months, but 31 percent reported few or no qualified applicants for the position(s). The increase in the percent of owners with hard to fill job openings indicates that job markets are tightening somewhere, and correctly anticipated a decline in the unemployment rate.”

So beware of the confidence fairies, says Nobelist Paul Krugman. If you believe in them, you will surely lose confidence in the very institutions that create economic growth.

Harlan Green © 2012

Jobs Decline—Fed QE3 in the Works?

The Popular Economics Weekly

It should be obvious from today’s horrid June Bureau of Labor Statistics unemployment report—just 18,000 net nonfarm payroll jobs added and the Unemployment Rate up to 9.2 percent—that we are still in some sort of a disinflationary spiral. Yes, I said disinflation, which means the rate of inflation is falling, not rising, as the holders of debt would have us believe. And because employers find it difficult to raise their prices, they won’t create more jobs.

And that is the Federal Reserve’s greatest fear.  So we will probably see a ‘QE3’ round of Fed stimulus this fall.  There is just not enough demand, folks, to create any sustained sustained hiring, and the Fed is now the only entity willing to provide more stimulus, it seems, with Obama and the Congress locked into downsizing government further. 

Their fear?  A Japanese-style deflation that has plagued Japan since its twin  real estate and stock bubbles burst in 2000. 

As Nobelist Paul Krugman noted this in his latest blog, “Let me emphasize that last point. My bottom line on the inflation-deflation issue has always been to look at wages; you can’t have a wage-price spiral if wages ain’t spiraling. And they aren’t, to say the least.”

We are in fact facing the opposite problem of the 1970s, a wage-price disinflationary spiral, at the moment, although most economists won’t call it such. Wages and salary earners that make up 80 percent of our workforce haven’t seen a real wage increase since the 1970s.

The last wage-price inflationary spiral occurred in the 1970s with inflation spiking at some 14 percent, while today we saw a brief spike of the Consumer Price Index to slightly above 3 percent, when it was above 5 percent at the height of the bubble. To most wage and salary earners it feels like inflation, because their real incomes have stagnated since the 1970s, which means not risen in relation to inflation. Real stagnant wages plus rising energy and food prices smells like inflation to those who with limited incomes.

At last, we are seeing the effects of the supply side revolution of the 1980s to date; the “reverse Robin Hood” effect mentioned by Reagan Budget Director David Stockman in a past blog. It was a revolution that said ‘government is the problem’, when it wasn’t governments that caused inflation in the 1970s. Its major causes were rising oil prices from the formation of the OPEC oil cartel and 2 oil embargos as the Vietnam War was winding down.

Another sign that we are fighting falling prices are the rock-bottom interest rates. Interest rates rise in tandem with inflation, and conversely fall with declining prices. The 10-year Treasury Bond just dropped below 3 percent again. This St. Louis Fed graph highlighted by Krugman charts the relationship of interest rates with jobs.

“ It’s important to realize, by the way, that stagnant wages are NOT good for recovery; all they do is ensure that the burden of debt relative to income remains high,” said Krugman, “keeping demand and employment down. The situation cries out for aggressively expansionary monetary and fiscal policy. Instead, however, all the political push is in the opposite direction.”

The supply-side revolution was, and still is, a cover for cutting taxes. So-called Reaganomics didn’t cut government spending, yet sought to suppress the wages and salaries of the middle class in a number of ways. Tax exemptions allow U.S. Corporations to shelter their overseas profits from U.S. taxes until repatriated, for starters, thus encouraging them to export jobs overseas. And now Republicans are attempting to take away the collective bargaining rights of government unionized employees, just as they did for private industry in the 1980s and 90s.

All of this suppresses household incomes, without lessening household debt. So we are approaching a level of income inequality close to that of Mexico and other so-called Third World countries. Any long term solution to our budget deficit has to recognize that fact. Unless real incomes begin to rise again, there is no chance of paying off our debts—neither private nor public debts.

Harlan Green © 2011

It’s Basic Economics, Stupid!

Popular Economics Weekly

What was the reason for Fed Chairman Bernanke’s almost pathetic plea to understand real world economics, in his latest speech at the Atlanta IMF Conference? He said in essence that the Fed is caught between worries about inflation and an economy that is sputtering along. But in fact he was really calling for help!—that he needed help from Obama and Congress to keep economic growth going, because there is still a great danger of deflation than inflation.

If politicians want to obsess over the possibility of future inflation, in other words, then let them tackle the longer term entitlement problems—like Medicare, or foreign wars. But instead they are doing all the wrong things, as are the Europeans. They keep advocating drastic austerity measures while cutting taxes, when that will only depress growth further and expand the deficit (via less tax revenues), not shrink it.

Economic growth has slowed at the moment. But much of this is because of geopolitical uncertainty—the Arab Spring, Mideast oil, the euro bailouts of Greece, Portugal and Ireland, and maybe even our own debt ceiling problem.

But the Federal Reserve’s Beige Book report says most of the U.S. is still growing, retail sales are getting better, consumers and homeowners are paying down debt, and service sector activity in general that provides up to 70 percent of our growth is expanding faster.

Then why the obsession with inflation when it is just gasoline prices that are boosting the CPI index at the moment? Without gas prices the CPI has risen just 1.2 percent in a year. It is the classic battle between creditors and debtors that heats up during recessions. Creditors hate any inflation, since it devalues existing debt. And right now creditors—bankers and other holders of debt on Wall Street—seem to control the agenda. That is why we are hearing cries of austerity and budget cutting--all deflationary measures. Such policies drive down prices, all right, into deflationary spirals such as caused the Great Depression if done at the wrong time—like during this weak recovery.

The best weekly news was the jump in the Institute of Supply Management non-manufacturing (i.e., service-sector) index, which now makes up 70 percent of economic activity. The ISM reported broad month-to-month acceleration in the non-manufacturing economy. The report's composite headline index rose 1.8 points to 54.6 with strength centered where it should be, that is in new orders which rose more than four points to 56.8.

The ISM employment index also accelerated nicely, up 2.1 points to a 54.0 level that for this report is very strong. In other readings, deliveries lengthened, which is a sign of strength, and backlog orders rose at a healthy pace. Given that this report is based on a broad sampling of the nation's purchasers, says Econoday, it indicates that economic momentum is headed back up, albeit moderately.

One reason for what looks like a temporary slowdown, is that sales of combined North American-made vehicles and imports dropped to an annualized 11.8 million units from 13.2 million in April.  The North American component declined to 9.1 million from 10.1 million. 

The North American component includes Japanese brands assembled in the U.S. and parts shortages limited supply of many models significantly.  Lack of available Japanese brands pushed up related prices.  This may have convinced many car buyers to wait for the desired model to become available and/or for a lower price, according to analysts.

What is the help that Bernanke’s Fed needs? It can’t do all the heavy lifting, if more fiscal stimulus isn’t forthcoming. A good place to start is forgiving some of the $trillions in delinquent real estate debt incurred during the Great Recession. Real estate is hurting so much because it is estimated 25 percent of home loans are under water—i.e., have more loan than equity in their property. So the quickest way to bring down their debt load—which is holding back consumers spending—is to forgive some amount of the underwater mortgage principal, with some kind of loan modification.

The first quarter 2011 Federal Reserve so-called Flow of Funds report shows just how much is already “forgiven”, in some sense. Much of homeowners’ equity has been lost with so many foreclosures and short sales, of course. But homeowners are also paying down debt in record amounts.

The Fed estimated that the value of household real estate fell $339 billion in Q1 to $16.1 trillion in Q1 2011, from just under $16.5 trillion in Q4 2010. The value of household real estate has fallen $6.6 trillion from the peak - and is still falling in 2011.

In Q1 2011, household percent equity (of household real estate) declined to 38.1 percent as the value of real estate assets fell by $339 billion. A note by Calculated Risk says something less than one-third of households have no mortgage debt. So the approximately 50+ million households with mortgages have far less than 38.1 percent equity - and 10.9 million households have negative equity.

But banks are reluctant to modify loans unless urged by the White House, banking regulators, and/or Congress, even though it is also in their interest to take the delinquent mortgages off their books. And there has been no requirement that mortgage holders/servicers do so, even with the HAMP loan modification program.

Creditors—or rentiers in Europe—were also calling the tune at the beginning the Great Depression in the Hoover Administration. Roosevelt understood this, and instituted inflationary measures by increasing government spending, with regulations that controlled the banking speculation that caused the credit bubble—i.e., highly leveraged bank loans with no regard to risk. It took some inflation to get the economy growing again. In other words, it was the debtors turn to recover, which ultimately brought us out of the Great Depression.

The Roosevelt Administration actually refinanced more than 1 million homes under the Home Owners’ Loan Corporation from 1933-35, with bonds sold to the banks. It also bought many homes lost to foreclosure and rented them back, until they could be sold into the private market. Can we imagine what could be done today with that same political will? One million homeowners then would translate to at least 5 million today, when it is estimated there are no more than 8 million homes in various stages of delinquency. That is, if there is the political will to clean up the real estate mess.

Harlan Green © 2011

When is Inflation a Problem?—Part II

Financial FAQs

A recent column by MarketWatch columnist Rex Nutting shows us why inflation won’t be a problem for maybe years to come. U.S. businesses have become “world class” in squeezing the most from their existing workforce, rather than hiring more workers. This is in part because of the availability of technology to replace workers, but also a mentality that puts profits (and CEO salaries) first. CEO incomes now average more than 400 times the average worker’s salary with stock options and benefits, vs. just 40 times workers’ incomes in past decades.

And so labor costs continue to trend downward, which is why inflation is no problem. In 2010, for instance, the first full year of growth after the recession, U.S. total output increased 3.7 percent, reported the Bureau of Labor Statistics reported. But to produce all those extra goods and services, American workers put in just 0.1 percent more hours on the clock. And so labor productivity increased 3.6 percent.

What did we get for that extra effort, asks Rex Nutting? Just a little extra hay: Wages rose 2 percent, but most of that was inflated away. After adjusting for higher prices, real compensation rose just 0.3 percent. If you earned $1,000 a week in 2009, you got the equivalent of $1,003 in 2010, enough for an extra doughnut at the coffee shop.

What is making the deficit hawks nervous is that headline inflation—i.e., overall inflation including food and energy prices—has been steadily rising since July, 2010. This is using the Personal Consumption Expenditure price index, which is the best overall measure of domestic prices. But the core rate without food and energy prices hasn’t budged. Why? Because there aren’t enough consumers buying the products and services affected by food and energy prices—such as motor vehicles (though demand for vehicles is rising).

Much of what makes inflation hawks nervous has nothing to do with economic theory, or of common sense. The hawks theorize that if consumers have expectations that prices will increase in the future, they will spend more in the present, creating a self-fulfilling prophecy. It is true that when prices are rising, consumers buy more. But which comes first, the horse or cart?

It is only when consumers feel wealthy and their incomes are growing that they create more demand for goods and services, and so drive up prices. Conversely, during recessions when everyone feels less wealthy, consumers hold back driving prices lower. This is the feared Japanese deflationary cycle that has lasted more than 20 years, shrinking the size of Japan’s economy and its citizens’ life styles.

The U.S. has only experienced real deflation during the Great Depression (really 2 depressions back-to-back—1933-37, and 1938-39). And the Federal Reserve knows this. So by pumping more monies into banking reserves with QE2, and holding down interest rates, the Fed is attempting to keep prices within an acceptable range of inflation—1.5 to 2 percent.

Overall inflation trend is still trending downward, as we said last week. The core rate came in unchanged after edging up 0.1 percent in November. On a year-ago basis, headline PCE prices are up 1.2 percent, compared to 1.1 percent in November. Core inflation eased to 0.7 percent year-on-year versus 0.8 percent in November.

Businesses’ costs are the main driver of inflation, and labor is the main cost of doing business. Due to the rapid increase in productivity in 2010 and the pathetic increase in wages, the cost of the labor needed to produce a ton of steel or a loaf of bread fell by an average of 1.5 percent in 2010 after a 1.6 percent drop in 2009.

That is why inflation is still way below the Fed’s ‘implicit’ target range of 1.5 to 2 percent. It is also why the Fed wants to continue with QE2. Right now, the emphasis has to be on creating jobs, and keeping the inflation rate from falling further. For, falling prices mean lower profits for employers, which mean shedding jobs rather than adding them.

The decline in unit labor costs also means businesses aren’t being pressured to raise prices to maintain their profits. In fact, they can cut prices compared with a year earlier and still earn higher profits. They can even afford to give their hard-working employees an extra crumb as a reward.

Most people tend to think inflation comes from higher prices for oil or other commodities, as we said last week. But that’s wrong: Inflation isn’t an increase in a few prices, but rather it’s a general increase in almost all prices across the board. So why don’t we have an inflation problem? Because American businesses are world class at squeezing labor costs — that is, wages, says Mr. Nutting. Unfortunately, the rapid increase in productivity in the American workplace is also keeping millions of willing and able people on the unemployment lines.

Harlan Green © 2011

Where is the Inflation?

Popular Economics Weekly

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