July CPI Figures Highlight Deflation Risks

The Consumer Price Index (CPI), a broad measure of the prices paid by American consumers for a broad basket of goods and services, fell further into negative territory for the month of July. The data, released today by the Bureau of Labor Statistics, corroborates the assertion made by many - including myself - that deflation poses a more imminent threat to the economy than the widely assumed inflation threat. The inflation-phobes - of which there are many - are simply unable to fathom a future that Doesn't contain rampant inflation. This primarily has to do with a certain relationship which is falsely assumed true by the public, specifically:

1. Media headlines that have routinely contained figures in the hundreds of billions with respect to the size of Federal Reserve intervention and money-supply creation.
2. The widely accepted belief that If money is created, Then inflation will follow.

Such analysis completely ignores what is presently occurring in the economy in general, and the labor market in particular. It is common knowledge that labor costs (wages etc.) represent the largest single expense for the majority of companies. With record numbers of unemployed individuals today, competition in the labor market is fiercely intense. That competition results in workers accepting far lower wages; a reasonable trade-off considering the alternative. Thus, the largest expense that a company faces is shrinking. Lower wages beget less consumer spending and heightened price consciousness, triggering high levels of competition for attractively priced goods and services. And so the process continues, resulting in what economists refer to as deflation. Sphere: Related Content

Bank of England Sees Low Inflation Through 2010

The Bank of England (BOE) released it's quarterly report on inflation expectations today, which stated that the Bank expects inflation to remain in the 1-2% range over the coming two and a half years. What the headlines about this release didn't reveal is that, according to the inflation probability model provided by the BOE (Chart 5.4), the year 2010 will be characterized entirely be year over year percentage decreases in inflation. In fact, the Bank of England's models are forecasting some probability of the country experiencing negative inflation towards the end of 2010. Obviously, there is a difference between disinflation and outright deflation; however the notoriously flexible central bank models are grazing dangerously close to the deflationary realm.

From a macro standpoint, the report below tells us one very important thing: the Bank of England is expecting the next 18 months to be characterized by very slow, very weak growth. Any other assumption, when factored into an inflation probability model, would exert at least some upward pressure on the price of goods and services across the UK. As I've already pointed out, the BOE is expecting an entirely dis-inflationary 2010. For now, I remain firmly in the camp that perceives deflation to be the far greater threat than inflation.

BOE Q2 Inflation Prospects Sphere: Related Content

Bank of England Reserve Balance Update: July 2009

The Bank of England released it's monthly reserve balance report today, verifying that a literal explosion in the size of reserve balances has occurred. Back in April of 2009, the BOE reported total reserves at 71.3 Billion Pounds; by July that number had mushroomed to 152 Billion Pounds outstanding. Other selected figures of note from the release:

• the 12 month reserve balance growth rate stands at 442.3%
• the reserve balance grew 21.3%, Month to Month
• the BOE seems to have "moderated" it's expansion of reserve balances, leveling off at a smooth ~27 Billion Pounds per month; this creates a deceptive illusion in that the monthly growth rate of reserves has been in decline despite the absolute level of expansion remaining relatively the same.
• What UK recovery?

The situation in the UK is literally spiraling out of control. The American press seems to have taken little notice to this fact, choosing to focus instead on the less-worse job numbers, and lulled to sleep by the outrageous-yet-no-longer-explosive Federal Reserve balance sheet. As for the Bank of England, it appears that the decision has been made to avert deflation at any cost.

Alas however, inflation has historically been far more preferable than deflation - for the ruling class that is. We all know that inflation ravages the savers of the world; a category that does not include the governments of Western industrialized nations.

*InfoNgen facilitated this post's research

Bank of England Reserve Balances as of July2009 Sphere: Related Content

Government Statistics Lesson 1: The Boskin Commission

This is the first part of a series that we hope to continue somewhat regularly. Besides the fact that government manipulation of official statistics makes us mad, reminding us of George Orwell's 1984, the fact remains that investors eagerly await official government announcements about the economy and other things that affect our lives. However, nobody ever seems to discuss these issues; probably they are just not interesting enough to our reality TV saturated culture.

In 1995, the Senate Finance Committee appointed the Boskin Commission to study potential flaws in the government's measurement of the CPI. In short, the Commission determined that yes, in fact, we have been systematically Overstating inflation since the beginning of time, and that our methods of measurement were due for a change. In Commission-like fashion, this group of people issued a "final report", which was humorously entitled "Towards a More Accurate Measure of the Cost of Living". That report is hundreds of pages long, so instead we have provided below the three page Congress-style sheet that was ultimately presented to the US House of Representatives. Now, there are two reasons that the government would want to claim we have been Overstating inflation, or in other words, two reasons that the government would want to report lower inflation going forward. First, a whole swath of mandatory(that's right, there is mandatory spending;and it actually comprises the majority of the federal budget) government spending is indexed to the CPI, with Social Security topping the list. Lower "official" inflation was an instant money saver for Uncle Sam-alternatively it freed up more money to spend on other things - always a popular idea amongst politicians. The second, and more political reason, is that Wages are typically reported as "real wages" i.e adjusted for inflation. If you artificially lower your reported rate of inflation, then real wages will appear to grow, even if they are simply keeping up with the actual rate of inflation as experienced by consumers. Presidents love to brag about real wage growth during their Administration (we don't recall hearing that one during the past decade however...).

Boskin Commission Findings Sphere: Related Content

Worthwhile Reading: Alan Blinder on Inflation v Deflation

In Sunday's edition of the New York Times, Alan Blinder penned what we believe to be a worthwhile assessment of the prevailing wisdom, which states that a potent bout of inflation looms inevitably in the near future. Blinder injected the article with a dose of contrarian sentiment that has largely been absent from the public discourse over inflation(that would be self-evident though right?). The bit we most appreciated though was Blinder's exposure of what appears to be a logical "blind spot" on the part of the public and investment community. Namely, commentators have focused on the inflation risk that would arise if the Fed were unable to withdraw the banking system's excess reserves quickly enough. This line of reasoning ignores the fact that an equally likely event - the Fed withdraws reserves too quickly - would have deflationary consequences. Of course, as we see it, that is but one of the many logical fallacies that abound in the investment world. Sphere: Related Content

The New Economists and Inflation

One of the interesting side effects of the current recessionary environment is a newfound public attentiveness with regards to the economy, specifically within the realm of forecasting future events. Suddenly, a professional wedding cake maker(ice cream shop owner, florist, etc.)  is capable of forecasting annualized rates of inflation, and extrapolating the data out several years into the future. We would propose that this new legion of economic wizardry actually serve a distinct and useful purpose: They provide a readily accessible, highly reliable indicator from which one can apply a decidedly Contrarian strategy towards a number of predictions.

Typically, in order for the contrarian to feel confident about his inverse conclusions, there must exist a Strong Consensus about the future direction of the market price or economic statistic in question. Such a consensus, we believe, has developed within this new class of Economic Observers regarding the prospects for a severe inflation within the next year, two, or three. This sort of herd like thinking has proliferated for several reasons, namely logical foundations, media attention, and familiarity. To put it simply, it just seems logical to most folks that when Government spending measures top the $1Trillion mark, there must be some damage done to the currency, leading to inflation. Most significant we believe, is the average person's ignorance towards the concept of deflation, which serves to render his/her logical foundations utterly useless as he/she attempts to ponder the prospects for Inflation. Regardless of the basis for this conclusion however, we have detected a strong consensus in favor of an inevitable inflationary period. We however, will not be joining this crowd.

Sphere: Related Content