Food and Medical Costs Rising Despite "Deflation" Report

This goes to Core Inflation versus Headline inflation. The headline inflation is much higher – just go see the gasoline prices. The food commodities are reflecting a 25% rise in gasoline this year.

In general about Inflation:
Unfortunately, the media – even sophisticated ones including Bloomberg, is doing a poor job of connecting the Obama administrations spending and inflation.

There are four underlying issues that affect a currency and hence inflation in an economy:

a) Printing money: More dollars in the market ceteris paribus, the value of a dollar becomes lower.

b) Relative move UP of other currencies, especially the currencies that previously were intentionally managed (held low) to help exports into the US specifically.

c) Wage and raw material supply versus demand.

d) Inflation expectation.

The items (a) and (d) above are already in motion. Item (a) is partially reversible but item (d) is not – the Fox is in the hen house. Strangely, items (b) and (c) – though somewhat related – are generally ignored by the econoists and media. For example, China holding its Yuan low is one of the reasons the US saw extreme productivity gains over the past decade and hence the higher living standards. No one is accounting for a reversal in that which is coming. The Asian market is finally showing signs of developing a domestic demand. This can be clearly seen in China. This means, Chinese manufacturers will not find exporting as valuable as before leading to artificial shortage as they sell their products locally. When this happens, the Yuan does not need to be managed by the Government like today and will settle much higher than where it is right now. With the American addiction to Chinese exports and having to buy the exports at a higher cost will lead to raw materials and product inflation in the US – akin to the cost of a barrel of crude.

The credit problem is being solved by the Fed by flooding the market with liquidity with its programs which forces a ban to lend as it sees excess, unproductive capital on its balance sheet. In addition, it is buying Treasuries to put liquidity in the market. The credit freeze is thawing, but the next bubble has been unleashed. This bubble will heat up the economy and lead to wage inflation.

We will not juts see traditional Wage inflation, which is what the Fed is watching, but a secondary currency driven inflation and inflation driven by artificial shortage of products. This compounding of inflation will lead to double digit Core and hence Headline inflation.

In all this, we have not included the effect of the rising price of crude.

Hi Madwesh,

You bring up an excellent point, which is inflation as reported by the media does not really reflect how inflation feels at the grocery store or gas station.

I disagree, however, with wage inflation. With layoffs continuing, I don’t see wages increasing anytime soon.

Kimberly

Kim,

Whatever growth we see presently is not due to Stimulus – only $40 billion out of 787 billion has made it out. I am following the stimulus coming out, there is not an iota that has businesses yet – muncipalities have benefited not businesses.
What the businesses are benefitting from is the easy liquidity Fed (free money) has been pushing (combine low interest rates + dramatic rise in M1 money supply).

The growth is not due to exports to emerging markets or Europe – which remain very weak or relatively weak.

However, you see consumer spending is up (net of gasoline price increase) and inventories are low. Couple that with easy non – stimulus money floating around and you have a potent mix. In November & December, the stimulus money is going to trickle down to businesses. We could see a 4%+ GDP growth in Q4.

The unemployment is a measure which is backward looking – important but backward looking. The entire midwest from Texas to Dakotas and Minnesota is not seeing the kinds of problems California, New York, New Jersey and Florida see.

Through the same period when unemployment rose weekly, the consumer spending was up and the debt burden on credit cards reduced. Tells me, there is free money.

Hi Madwesh,

You make good points. I would like to see 4% GDP growth in Q4.

I’m not sure the growth in income is sustainable. According to the BEA, Disposable Personal Income increased $178 billion in May. All but $20 billion of this was a result of one-time tax rebates from the Economic Stimulus bill.

I just don’t see people returning to spending the way they did in 2007. Home equity is down, so they can’t use their house as an ATM. Around 9 million people are working part-time jobs because they can’t get full-time work. Banks are tightening credit. We are witnessing a shift in lifestyle. This means continued slow growth for the economy.

Kimberly

I believe you are thinking this too mathematically – while I know of no provisions of the “one time tax rebates” in the stimulus bill that you refer to, the answer I seek is with respect to the durable goods sustaining and consumer spending. Specifically, the flat panel TV sales dipped only two months through the recession.

Could it be that there is a significant mis-estimation? I will even conjecture that economists are using old models in a new economy and throwing the baby with the bathwater. I would another step and say that the economists still haven’t figured out the bounds of the service economy. Example: IBM’s Services business in 1997 was about $7 billion. It is now $44 billion and it grew even through the recession. See ISM indices that came out today for further evidence.

Again, the household balance sheet on an average are bad, but it is not true across the country. Example: Pennsylvania, did not go thru the problems. Pennsylvanians are not fixing their household balance sheets (Philly is the 4th largest MSA in the US and is not part of Case-Shiller – go figure!). If the “fixing the healthcare” fiasco had not been started by this administration, Philly market would have been hot by now. Pittsburgh real estate market grew 1% in the same 18 months where home prices were deflating in the 5 states. I could make a similar case for Texas and a bunch of other states. You might have seen that about 12% of US Fortune 1000 companies are now in Texas leaving New York and California behind (both around 9%). In 2010, as a percentage, Texas will continue this upward trend. Could it be that California and New York are no longer the bell-weather they were?

Hi Madwesh,

My point is that the tax credit is only for 2009 / 2010. By 2010, consumers will have adjusted to the new discretionary income, just as we did Bush’s tax cuts. It will not feel like extra cash, it will be taken for granted, and so not drive additional spending.

I agree with you about the growing importance of the service economy. Unfortunately, a large portion of that growth was financial services. I don’t see that as the engine for recovery in 2010.

Kimberly

Kim,

Consumers account for 70% of the US GDP. About 40% of the 70% is consumed by 20% of the US population. These 20% outspend the rest of the 80% and the spending by this 20% is not affected by home prices or the recession itself – they are affected by the stock market (which is where a fair amount of their wealth resides).

This is much more consistent with my comments above.

I learnt this today on Bloomberg where a well known head of research at a large Wall Street bank was speaking. This has a much better chance of explaining the situation. There was a fairly good discussion on wealth created and productively put away in 2002-2007 when generally it is believed that people were using their homes as banks.

Also regarding the stimulus. The 170 billion was in May 2008 not this past May. There was no one-time tax rebate in the stimulus bill passed in Feb – the CBO indicates as of yesterday only 65 billion of the 280 billion slated for 2009 has been committed so far. Only 1800 or the 18,000 projects identified for funding have been committed. There are 5000 or so projects in bid stage.

Hi Madwesh,

I stand semi-corrected. People on Social Security, etc, did receive $250 one-time payments, but they were not tax rebates. The payments did inflate DPI in May.

Kimberly