Is inflation out of control?

[turbo6bar]

Ok, the equity market says the Fed is done. Futures markets are discounting the likelihood of an August rate hike. We have a slowing economy and elevated levels of inflation (12 year highs). One can argue that 12 yr highs in inflation are not bad, because inflation has trended really low the past decade.

There are two problems I see:
1) Bernanke says a slowing economy will quell inflation. I think he is right to some extent, but I believe that contained inflation requires a collapsing US economy. Why? The inflation we are seeing is not contained to the US. It's a worldwide phenomenon.

2) If a slowing economy persists, Bernanke may have to reduce rates in 2007. Will this not make inflation worse yet?

It seems like the real key to inflation is moderating demand in developing countries (namely India and China). The only way WE (the US) can accomplish this with the tools at hand is collapse the US economy and subsequently the world economy.

So where am I wrong?

[john70t]

The millions of little US children dying of starvation part.
Other than that it's a valid strategy, except the the Euro/Yuan global dominance idea which may become permanent, as in centuries permanent.

[pwd72s]

Out of control inflation??? You must not have been around when Jimmy Carter was in the White House....

[RoninLB]

Many economists firmly believe that inflation is caused by excess liquidity. They even commented that the Chair's comment about a slowing economy slowing inflation is completely wrong and he knows better than to say that remark. His problem is recovering from Greenspan's huge increase in liquidity due to the possibility of a 2000 crash and disinflation scares.

The industrial key to containing their inflation is productivity increases which allow higher wages without raising prices.

Some have said that re appreciation is partially the results of re tax law changes a short time ago.

[RoninLB]

Originally posted by turbo6bar

Futures markets are discounting the likelihood of an August rate hike.

some say the futures mkts and high volitality in general is due to the flat yield curve. A player would have a better explain but the pros are having problems confirming their beliefs in the short term on direction in contrast to a firm belief that would happen with a steeper curve. There isn't any slack today.

[turbo6bar]

Originally posted by pwd72s
Out of control inflation??? You must not have been around when Jimmy Carter was in the White House....

Well, I was around, but not a player. I've read articles that contend inflation numbers would be much higher if we used pre-Clinton equations. It's certainly no match for inflation in the 80s, though.

The only important measure, I suppose, is are we keeping up with inflation, staying ahead, or falling behind? If S&P is up 8% in one year, and inflation is 6%...

I'm just bouncing some ideas. Most who have read my posts know I'm in the deflation camp, but it's good to consider all outcomes and plan according. I just can't tell if we are truly at a breaking point, or if this is just a speedbump. I have a high cash position, and inflation is my worst enemy.

I still believe that removing excess liquidity means a fall in the US economy. However, I'm not sure if the politicians and Bernanke are willing to let this go on for long. In which case, adding liquidity = reigniting inflation and several other issues.

[jyl]

Much of the current US inflation is externally generated. High growth in China/India/etc so upwards pressure on energy and commodity prices. Very low interest rates in Japan adding to liquidity. War, the military and political kinds, in Middle East driving up oil prices.

Thus changes we make internally, such as raising interest rates and depressing economic growth, have less impact on US inflation. Because of these external factors, I think we probably need a larger US slowdown to bring inflation down to 1%+ range.

I also recently read a study that concluded the current US economy, compared w/ the past US economies, requires more pain (this might have been measured in job loss, I can't recall) to produce a given level of economic slowdown. It wasn't a very deep analysis but still interesting.

On the related topic of what the Fed will do - Bernanke is focused on expectations of future inflation, in addition to or perhaps in place of, current inflation. So while the headlines focus on each month's CPI data, he is presumably looking at survey and market-based measures of future inflation expectations, as well as his models of future inflation.

I think this increases the risk that the Fed will not raise rates enough, and thereby fail to control inflation. Compared to a Fed that was focused on current inflation and thus would raise rates until CPI is knocked back to 1%; that Fed would have a higher risk of raising rates too much. Of course, in the end the Fed's #1 job is to control inflation so if they cease raising rates too soon, they'll have to resume raising.

This all makes me worry about a 2007 scenario in which the US economy is in a substantial slowdown or recession, but the Fed is actively raising (not lowering) rates.

That would be a pretty bad situation. Memories of 1970s stagflation, and just look at the 1970s stock market.

[red-beard]

I have no problems withy inflation. The guage on the end of my inflator tells me when to stop putting air in my tires. Have you guys tried this?

[turbo6bar]

the external inflation is worrisome. We could see an environment with flat/modest wage growth, while commodities and imported goods increase. Reports from Financial Times indicate pricing pressure in China is increasing. Product/commodity increases + wage increases means one source of cheap goods (and lower inflation in the US) goes bye-bye.

Complicating this is the fact liquidity is still high. As long as this nation has access to cheap capital, this up cycle could go on far longer than anyone expects, but like the housing market, extending the game only makes the hangover worse.

red, the gauge is useless when you already blew out the tires. I knew I shoulda never used retreads on my Porsche.

[jyl]

We've benefited from years of falling goods prices as US manufacturers shifted production from high cost to to low cost regions. At some point this benefit should shrink as this shift becomes complete. Not a lot of shirts, shoes, PCs, TVs, etc made in the US any more. Meanwhile, wages are rising in China, production is shifting to even lower-cost regions like Vietnam, but I don't think that'll produce the same cost decline.

[Porsche-O-Phile]

Take one look at housing prices and tell me inflation isn't a problem.

[turbo6bar]

Well, PoP, there's inflation and then there's INFLATION. This goes back to my point about wages lagging inflation. We have seen a massive growth in debt (particularly as tied to housing), and it's been a substitute for income growth. Corporate earnings as a percentage of GDP are high, while employee compensation, as a percentage of GDP has fallen. It would almost seem the middle class is getting the squeeze, but it's a quiet progression (ala boiling the frog). "Hey, we won't give you a pay raise, but you don't need it, buddy. Your house has gone up in value 78% over the last 4 years. Let me let you talk to my banker. He can get you a HELOC, and you can get that new bass boat you've been talking about." In this case, the bank is happy. The boat company is happy. The boss is happy. The employee is happy as long as he can pile up more debt. It's win-win for everyone, I think.

Thing is, I don't want to be a part of the squeeze, and in doing so, I must consider all possibilities. If inflation cannot be constrained, due to worldwide demand, how does one protect himself? Will Bernanke say "All ahead flank, basis points be damned," or will he say."How soon can you load my Chinook with sacks of cash?" Preparing for situation A is a lot different than situation B.

[GDSOB]

Originally posted by Porsche-O-Phile
Take one look at housing prices and tell me inflation isn't a problem.

Jeff, The problem you have with housing prices is you live in an area where demand exceeds supply. By alot. Natural market forces at work aggravated by speculators. Housing prices are adjusting downward, but may never reach the level of affordability you wish. Until we create more housing markets with perfect weather, ocean & mountains you are going to live in one of the most desirable areas of our country and have to pay for it.

Deal with it.

or move to someplace cheap.

like Ohio.

[jyl]

What to do about it?

On a macro-economy level, I think at some point the commodity price pressure reaches a stop. Some portion of soaring commodity prices is a speculative bubble, which will eventually burst. The biggest pension fund the country, CalPERS, is considering investing a portion of its funds in commodities. When huge, slow-moving money is getting in, is usually a sign that the smartest are getting out. As for the fundamental demand, China/India growth will eventually decelerate, perhaps helped along by a US slowdown/recession. The equilibrium price of copper probably isn't where it was 4 years ago, but it probably isn't where it is now either.

Same, I think, for energy (oil) price pressures. If the economy turns down, at some point you get demand destruction. Alternative energy sources will be developed, whether it be oil sands or solar or nuclear. And the speculative portion of the current price will eventually deflate.

Liquidity is also reversible. Whether it takes another +100bp, bank loans and securitized mortgages going bad, dunno. But eventually credit will become tight again.

The unknown, for me, is how much inflation and economic slowing/pain we get in the process, and for how long. I know I'm not smart enough to predict the path from here. All I hope to do is watch the signs and notice the directional turn when it happens.

On a personal level, I think the thing to do make your income grow, whether by advancing in your job, changing jobs, more education, etc. And tighten your belt. And, if you can, invest wisely. Maybe that means buying stocks when P/Es crash through 10X, shorting them down to there, picking up repossessed houses, who knows. But having cash and borrowing capacity is going to be a good thing in the coming year(s).

PoP, there was a point in the mid-1990s when you could buy LA houses out of repossession for good prices. I knew guys who accumulated several houses that way, and profited handsomely. Save like mad, polish up your credit, get a better-paying job, and I bet you'll get your chance - and not have to move to Ohio.

[fintstone]

Inflation is not a problem in the US at this point. Although housing has risen significantly in some areas....that is not a good indicator. Most folks are simply wrong...including the Fed who seems to think oil prices are inflationary, when in fact, they are just the opposite, and are deflationary.

[red-beard]

Housing inflation does not affect everyone the same way. If you own and have owned for a while and don't plan to move, then you are not affected. Most people fit in the catagory.

Also, the housing market will continue to go up in some areas and it will go down significantly in other.

[jyl]

fint, can you explain further? E.g. why are rising oil prices deflationary?

[fintstone]

Because it acts more like a tax since the majority of oil comes from outside the US...and the money does not go back into the US household pockets.

[jyl]

But are taxes really deflationary? Seems to me we've had periods of high tax rates and also high inflation. For example, in the 1970s income and capital gains tax rates were very high and yet, with the oil price shocks of the decade, we also had very high inflation.

Compare:
http://www.ctj.org/pdf/regcg.pdf - table of historical US tax rates
http://proft.50megs.com/inflation.html - chart of historical US inflation

I'm watching what companies do when confronted by high energy prices. Many of the companies I cover are raising prices wherever they can, with more urgency than I've seen in years, and the primary motivation is that rising oil (and commodity) prices are increasing their cost of goods. They've been doing everything they can to cut other costs - moving production offshore, freezing pension contributions, streamlining distribution networks, holding the line on wages, etc. But many of them are finding it harder to preserve their margins through those measures, so now they are raising prices. For example, packaged food companies are doing this as fast as they can.

Edit: I found and added the inflation chart above. I can't see any particular relationship between higher (lower) taxes and lower (higher) inflation. I realize the theory is that high taxes lead to lower demand and thus lower prices. I'd like to see the data that actually supports either theory (that taxes are deflationary, or that oil acts like a tax).

[RoninLB]

Discount all the price noise, including commodities markets, and common knowledge says growth rates affect inflation. Growth means added wealth. For instance does the debt add an over weighing of wealth?

Even the WSJ connects a slower GNP with lower inflation in many of their articles. So in a contrast faster growth stimulates inflation. If you want a booming economy you risk inflation so the idea says. [Inflation meaning the value of the dollar without noise.] From this point of view opinions are made on investment, etc. Differences in opinion made markets.

What if the idea of lower growth reducing inflation and visa versa is wrong ?

If the wrong idea is used to base opinions then it becomes more noise of a different gender.

If the right idea is used then maybe things become clearer ?

I ran with this above on my first reply.