“I Can’t Eat an iPad”
Monday, March 21st, 2011
A little over a week ago, one of the Fed governors was in Queens, New York to make a presentation about the Federal Reserve and current economic situation of the area. The topic came around to rising prices, and he was asked "When was the last time, sir, that you went grocery shopping?" He started to explain about how there are prices that go down, especially technology goods like iPads. News reports say the crowd guffawed, and someone said “I can’t eat an iPad.”
There has been great concern about Fed statements that inflation is tame yet the public is seeing increases in gas and food prices regularly. In news reports, the phrase “core inflation” is often used. This measure excludes food and energy products, considered to be volatile, and leaves steadier products in the calculation. The fear is that volatile items create a “noise” that obscures the true inflation trends. The idea is that there can be inflation on food and energy, but policymakers only need to be concerned when those inflationary forces begin spreading to other goods and services. Otherwise, changes in food and energy prices may signal inflation problems when there is none on a longer term basis, the statistical equivalent of “crying wolf.” The core CPI does not have a good track record as recent research, and many others over the years have shown. As one veteran Wall Streeter once proclaimed, the core CPI only applies to “anorexic pedestrians. ”
The Fed may have a tough time claiming there is no inflation if these present trends continue. As the chart of our macroeconomic indicators show, inflation pressures are getting stronger. The producer price index (PPI), which measures prices paid at the manufacturer levels, is now running at an annualized rate of +11% over the last three months. For the past year, it is at +5.6%. The disparity with the consumer price index (CPI), which represents the prices of goods and services at the consumer level, is just barely over +2% on a year-year basis (the high end of what the Fed considers its target rate), but over the last three months it is running at +4.6%. (In January I wrote about the growing disparity between the CPI and PPI; the last time the relationship was similar, things played out quite badly.)
In terms of food inflation, the notable change has been in the last six months. Compared to last year, food is up +2.2%. On an annualized basis, however, the last six months are running at +3.8% and for the last three months at a +5.5%.
The money supply took another leap up recently, as seen in the chart of the St. Louis Adjusted Monetary Base.
Since the beginning of 2008, not just since TARP at the end of that year, or the stimulus at the beginning of 2009, the Fed has been lending at rates that are below inflation (chart from Dallas Federal Reserve).
One of the cures for this monetary problem is stronger economic growth, because that will create new goods and services that will absorb the extra money that has been created. That growth does not appear to be coming any time soon. (We will get a revised and final reading of Q4-2010 Gross Domestic Product at the end of this week; based on recent retail sales and import-export data, it may stay right where it is.) Whatever that figure will be, it is still bound to be lower than productivity growth. As long as productivity is higher than GDP, the employment situation will not improve.
Back on the inflation front, and the macroeconomic chart, the real concern is still wages. The higher inflation is eroding wages, and that erosion is increasing. The higher productivity of workers is not being seen in their paychecks, which is a multi-year problem that started well before this recession. The fact that it persists at this stage of the recovery is not a good sign, and is the cause of the growing concern with the Fed's insistence that inflation is tame. How much longer they will wait to move rates higher is anyone's guess, but the greatest probability seems to be toward the end of 2011.
One of the reasons for the concern about the Fed's move is what happens to the new financial instruments they are holding. The chart below (from Zerohedge.com) shows the vastly different makeup of their holdings. Among the worries is that as the Fed begins to unwind these positions (which would decrease the money supply), the value of their long-term instruments would decline. Because they have never held any long-term instruments to any great degree, they are in somewhat unchartered territory. One possibility that I have not found anyone talk or write about is what would happen if the Fed just held onto these instruments until their maturity many years from now, if no “right time” to sell them materializes. It does seem that they are walking on unchartered tightrope, to combine two metaphors.
Unfortunately, the attempts to fix the mortgage market have not worked. Foreclosure programs seem to have just delayed the inevitable. It's a reminder that the Fed's actions were to attempt to change the prices of goods made long ago (houses). When goods are financed, rather than purchased outright, the effects of their original pricing continue to affect current behavior, even if the pricing is no longer at those levels. When home prices were rising, the mortgages became smaller. When home prices decline, the mortgages can become larger than the value of the house. Had the homes been paid for, their prices would not enter into any of the Fed's decisions.
The next important data releases are this Friday's GDP revision, a major revision of the Federal Reserve's manufacturing data, and the national employment report a week later. The week of April 3 will be packed with numerous macroeconomic data releases. Keep an eye on the Institute for Supply Management Manufacturing Index (April 4) and their Non-manufacturing Index (April 6).