Moderating Inflation? I Don't Think So...

A: Barry Ritholtz often argues about the flaws in the datasets that the fed uses to monitor inflation. These statistics, issued by the BLS/BEA/COMMERCE DEPT, has shown inflation as moderating here at home which allowed the fed to act aggressively in preventing the US economy from falling into a recession with their 1/2 point rate cut a few weeks ago. But I and many others out there have argued for some time that inflation IS out there, there is now a buildup of inflation in the pipeline, and to ignore food/energy in the so called CORE datasets is to turn your head away from reality! You want to see inflation? Look at what Dean Foods CEO said today about the current environment to get an idea about what it really is like out there!

First, why do I talk about this if this is a Manhattan real estate site? Here's why:

INFLATION RISKS ---> COMPANIES RAISE PRICES OF GOODS AS COSTS RISE ---> COST OF LIVING INCREASES ---> SPENDING POWER DIMINISHES ---> FED MUST RAISE RATES TO COMBAT INFLATION ---> AS RATES RISE, THE COST OF DEBT RISES ---> BOND YIELDS RISE TO REFLECT THIS MACRO ADJUSTMENT ---> LENDING RATES & CREDIT RATES RISE ---> AFFORDABILITY GOES DOWN

If you don't understand the macro effects of a high inflationary environment, then you probably will have a hard time connecting the dots to how it can ultimately trickle down to investment classes like stocks or housing. It's all connected.

THE FED WAS ABLE TO CUT RATES TO 'FORESTALL ADVERSE ECONOMIC EFFECTS' BECAUSE:

a) inflation data showed moderation (while some argue about the makeup of these models)
b) jobs data showed weakness indicating an adverse effect on US economy
c) housing woes continued to pose threat to overall economy

But I ask? HAS INFLATION REALLY MODERATED? Look at energy costs, look at overall housing prices in the past 5-6 years, look at food prices, look at health care costs, look at commodity prices showing whats in the pipeline! To say inflation is NOT a problem is utterly ridiculous! It's this train of thought that leads me to believe the fed is VERY CLOSE to being done with rate cuts, and that we are in a longer term trend of rising rates. I mean, since when is a fed funds target rate of 4.75% restrictive to economic growth?

Here is real world evidence of inflation via the CEO of Dean Foods:

"The third quarter has been particularly challenging as dairy commodity costs have risen sharply, hitting all time highs," said Chairman and CEO Gregg Engles. "This is by far the most difficult operating environment in the history of the company, reinforcing the importance of the long-term strategic initiatives we have underway."

The company, which makes products such as Silk soy milk and International Delight coffee creamer, said that increasing commodity costs have materially reduced profits. They also have hurt sales as customers react to higher prices

Now I understand this is one company and that we can't predict something as dynamic as 'inflation trends' from any one CEO. But this is just another example of how government statistics don't reflect what is going on in the real world. The fed loves to watch the CORE PCE as a measure of inflation, which measures prices paid by individuals for goods other than food and energy; here is that chart going back to the late 1980's:

Recall the inflation problem of the late 1980's, as indicated by Core PCE # above 4, and how the fed raised the fed funds rate (the same one they just cut to 4.75% two weeks ago) to just below 10% to combat runaway inflation. While I am not predicting such an extreme, I do think inflation in the pipeline is a problem. Its not on the surface yet and the fed is clearly taking a 'wait and see' attitude about this problem. If the problem doesn't go away, rates will HAVE to go up.

Is inflation out there? Do you think your cost of living has increased in the past 5 years OR no? Here are some others take on this incredibly confusing situation.

There's No Inflation: If You Ignore The Facts - (Newsweek via The Big Picture Link) -

Imagine that a cardiologist told you that aside from the irregular heartbeat, the stratospheric cholesterol count and a little blockage in your aorta, your core heart functions are just fine. That's precisely what the government's cardiologist - Ben Bernanke, chairman of the Federal Reserve - has just done. The central bank is supposed to make sure the economy grows fast enough to create jobs and make everybody richer, but not so fast that it produces inflation, which makes everybody poorer.

Catch that bit about "core inflation"? That's Fedspeak for: inflation is under control, unless you look at the costs of things that are going up.

Speechless on Core CPI - (The Big Picture) -

I wonder what people will be saying when the September CPI comes out. It will be substantially higher due to soaring energy and food prices this month. Oh, wait, that's not in the core. (Nevermind). Gee, I wonder why the Fed prefers Core PCE as an inflation measure -- instead of what is occurring in the real world?

Picking an Inflation Measure and Sticking With It - (Portfolio.com) -

The Fed has said, quite consistently, that the measure of inflation it cares about most is core inflation, as measured in nominal dollars, ex food and energy. You can argue with that decision, but once they've made that decision, I'm not a fan of suddenly deciding when food and energy prices rise that, oh deary me, they do matter for monetary-policy purposes after all.

CPI's Lie on Household Inflation Doesn't Wash - (Bloomberg) -

The U.S. consumer price index continues to be a testament to the art of economic spin. Since wages, Social Security cost-of-living increases and some agency budgets are tied to it, the government has a vested interest in keeping it as low as possible.

Yet your real cost of living -- what you keep after taxes, medical bills, college expenses and other household costs -- is probably much higher than the 2 percent annual rate the government reported in July, showing a slight decline.

The Llama of Lame - (Long or Short Capital) -

First of all, as far as I can tell food and energy are the only two items you should NEVER exclude from an inflation index. Tell your wife and kids they can have everything in the consumer basket except food and energy and you will quickly see that they are actually the two MOST important and indispensable factors in the CPI.

This will come back to bite you but not nearly as much as it bites us. The cheaper the dollar gets the more expensive all our imports get, inflation will rise faster than you can statistically manipulate it and when that happens expected inflation goes through the roof (which as you yourself have pointed out many times is by far the most serious threat to economic existence). Then the only way out will be interest rate increases as swift and severe as all the cuts have been.

Interesting food for thought from those that are on this side of the argument. I hope I'm wrong. One last thing, there is an argument that housing is deflating and is another example of how there are no inflation problems out there. There is one major item that is being left out of this affordability equation: RISING RATES! Housing has underwent an unsustainable rise in pricing over the past 5-6 years; over the past 3 years, rates have been rising offsetting any recent decrease in prices (prices go down, but cost of loan goes up). As home prices across the nation correct towards the norm, any affordability gained has been wiped out by a combination of rising rates and side effects of the recent re-pricing of risk / dysfunction in the secondary mortgage markets!

I wouldn't consider the housing correction as deflationary because the cost of living has not declined in lock step with pricing. Where I do see deflation is in consumer electronics, apparel and autos; hardly anything that I would consider as essential to daily living!

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