“Flation” remains one of the key debates of the day.
Some expect huge inflation. Others expect stagflation (a rediscovered buzzword) and still others hyperinflation (yes, some still hang their hats on that one), or even deflation.
Meanwhile, the Fed and other economists have a spotlight on inflation expectations (as if they matter, but they really don’t).
Let’s take a look at “flation”, where it shows up, and where it doesn’t.
Perfect Storm?
Gad Levanon, vice president, The Conference Board, emailed me yesterday stating “some of my blogs will be posted on the CNBC website.”
His new blog is “The US Faces a Perfect Economic Storm”
Levanon invited questions.
I had questions. I usually do. First let’s see what the “perfect storm” is all about.
In the weeks after the Federal Reserve raised interest rates in December, global financial markets trembled and inflation expectations, as measured by the bond market, declined significantly. On Feb. 9, market-based inflation expectation over the next five years fell to just 0.93 percent, the lowest level since the Great Recession.
This drop in inflation expectations fueled calls for halting the rate hikes, with a growing cohort of economists and market participants questioning the wisdom of raising rates in the first place.
Thus far, however, actual inflation numbers have refused to cooperate with the winter’s bleak expectations. Both major core inflation measures — core consumer price index (CPI) and core deflator of personal consumption expenditure (PCE), the measure favored by the Fed — have accelerated significantly in recent months; the 12-month growth rates of core CPI and core PCE now stand at 2.3 and 1.7 percent, respectively.
But is it really surprising that inflation is not remaining at its subdued rates of well below 2 percent? We don’t think so. The main story in the U.S. economy right now is that it is gradually running into supply constraints, which by definition implies price pressures in the labor market and later on in goods and services.
However, we should not be complacent about inflation risk, simply because there wasn’t much of it in recent years. In fact even later this year and in 2017 it could be a different story. If, as The Conference Board projects, the U.S. economy is still growing at around 2 percent in 2017, accelerating labor costs will start being passed on to the consumer. Meanwhile, the inflation-limiting effects of a strengthened dollar and lower oil prices will have mostly evaporated.
Many doubt that we should be worried about inflation with GDP growing at just 2 percent. But we argue that, when planning for 2017, it is completely justified to be more concerned. As we have been warning since 2014, the U.S. faces a perfect economic storm: Baby-boomer retirement is a generational tidal wave that combines with very weak gains in labor productivity to set up a situation of historically low growth on the supply side of the economy.
In Search of Supply Constraints
“The main story in the U.S. economy right now is that it is gradually running into supply constraints” said Levanon.
Do these charts represent supply constraint?
Merchant Wholesalers: Inventories to Sales Ratio
Total Business Sales Percent Change From Year Ago
Total Business Sales Detail
Harper Petersen Shipping Index
Supply Constraint or Oversupplied?
Somehow it seems we are massively oversupplied.
Retail sales were dismal (see Retail Sales -0.3%; Autos Down 4th Month, Plunge -2.1%)
Also note that Used Car Inventory Hits Record Level.
For more charts and commentary, please see Inventories and Sales: How Bad Are They? Study in Pictures
Questions and Comments for Levanon
- What about stock market and junk bond market bubbles? I seriously cannot understand the Fed and other economists never taking asset bubbles into consideration.
- Then what happens when those bubbles pop? Recession?
- And what about GDPNow at 0.1% and Auto sales dropping?
- Retail spending looks weak. Manufacturing is in a recession.
- Yep – oil prices going up – so will import prices.
- Exports? In a weakening global economy?
- It will not take much to tip this economy into a recession (assuming we are not already in recession – and I think we are).
- Fed prepared to hike with GDP at 0.1% and falling like a rock?
- Then again – these guys have never seen a recession in advance, and likely never will.
Those were my unanswered comments and questions to Levanon.
Perhaps those questions and comments hint at a “perfect storm” but for different reasons than inflation.
Regardless, there are few if any supply constraints.
Yield Curve
The 30-year long bond is a mere 33 basis points from a record low. The 10-year note is under 30 basis points away from a new low. Meanwhile, the short end of the curve has been rising since 2013 or 1014.
Had rates been higher, an inversion would have been likely.
The US treasury yield curve looks and acts like the concern is recession or deflation, not inflation. Why?
Three Possibilities
- Recession is here or on the horizon
- Central bank manipulations and negative yields make US treasuries attractive at what would otherwise be unattractive rates
- Both of the above
I sympathize with reasons one and three, but not two in isolation.
Price Inflation
For sure, there is decent-sized price inflation in healthcare, education, gasoline since the low earlier this year, housing, and rent.
We also see significant wage inflation in a number of states.
If wages and prices do rise, and the Fed hikes into recession, we have the dreaded stagflation scenario, albeit at much lower levels of concern.
Many promoting a stock market crash believe in hyperinflation.
We can sort this all out in a moment. First, I have a musical tribute.
Whole Lotta Flation Going On
Asset Bubble Inflation/Deflation
The key to where this is all headed depends on the answer to the question “Did the Fed sponsor more asset bubbles?”
If the answer is yes (and I believe it is), then another asset bust is coming up.
Asset bubble busts lead to asset level deflation, falling profits, rising unemployment, and likely falling prices.
Mike “Mish” Shedlock
Another question might be, considering the extraordinary measures the Fed took in the last crisis, instead of a bazooka the second time around, these apparatchiks are more likely to take a nuclear approach and drop money from B-52’s instead of helicopters. So, in the end, inflation,,,no,,,wanton destruction of the dollar is inevitable.
Inflate or die. What other options do they have? Does anyone really think the accumulated debt can ever really be paid back any other way. Certainly, these corporatist oligarchs aren’t interested in giving up their power by voluntarily bringing on default and a debt jubilee?
Or, I guess one could ask, how many nations have been destroyed by deflation and how many destroyed by devaluation down through history?
But if to prevent the bubble popping, the powers that be decide to drop money from helicopters, what then? I totally agree with your scenario mish if we assume the fed will just do nothing when the bubble starts to Pop. But what if they do “whatever it takes”?
I’ll answer the first question:
‘I seriously cannot understand the Fed and other economists never taking asset bubbles into consideration.’
When the extraction costs of oil surged towards and now over $100 a barrel:
OIL PRODUCERS NEED $100+ OIL
Steven Kopits from Douglas-Westwood said the productivity of new capital spending has fallen by a factor of five since 2000. “The vast majority of public oil and gas companies require oil prices of over $100 to achieve positive free cash flow under current capex and dividend programmes. Nearly half of the industry needs more than $120,” he said http://www.telegraph.co.uk/finance/newsbysector/energy/oilandgas/11024845/Oil-and-gas-company-debt-soars-to-danger-levels-to-cover-shortfall-in-cash.html
Growth stopped:
HIGH PRICED OIL DESTROYS GROWTH
According to the OECD Economics Department and the International Monetary Fund Research Department, a sustained $10 per barrel increase in oil prices from $25 to $35 would result in the OECD as a whole losing 0.4% of GDP in the first and second years of higher prices. http://www.iea.org/textbase/npsum/high_oil04sum.pdf
HOW HIGH OIL PRICES WILL PERMANENTLY CAP ECONOMIC GROWTH
For most of the last century, cheap oil powered global economic growth. But in the last decade, the price of oil production has quadrupled, and that shift will permanently shackle the growth potential of the world’s economies. http://www.bloomberg.com/news/articles/2012-09-23/how-high-oil-prices-will-permanently-cap-economic-growth
The Fed has been desperately scrambling to offset the end of growth with increasingly draconian policies since the run up in extract costs started at the turn of the century.
There are consequences to these policies.
Asset bubbles are one of them.
‘Then what happens when those bubbles pop? Recession?’
Far worse. The crisis is caused by the peaking of cheap to extract oil. Most of what is left is too expensive – it kills growth.
Therefore when the central banks start to push on a string the global economy will implode.
And that will be the end of civilization as we know it.
Billions will die.
The Fed knows this — why do you think they are moving heaven and earth and basically committing suicide in an effort to put off this end game?
if it was simply a recession then they should have let it happen a long time ago.
Mish pokes stick at dumb caged animal. I’m telling the SPCA.
As someone who is the grocery shopper in the h/h, I have seen substantial inflation over the last 5 years in increased prices and in reduced container sizes at the same price. My weekly grocery bill has doubled during this period. So have my rent and health care, all while my income has essentially remained the same. The methods used by the govt to calculate true inflation are bogus and laughable. There should be an understanding of what discretionary monies are left after paying for essentials; a truer measure of the decrease in the standard of living.
Shop at non union grocers. Businessmen are less greedy than unions.
Jack – andyb’s point is that prices have increased substantially. Union/non-union, it doesn’t matter. Prices have risen. That was his point.
Iron ore at 56 dollars, up from 45 dollars in october. Steel down 71 percent for the year with auto sales falling. Makes no sense except price manipulation.
Manipulation, perhaps, but inadvertently. It could be intentional, but doesn’t need to.
We are now at a point where virtually no form of actual productive work has any chance of paying even a fraction of what simply buying lottery tickets in the Fed-Ball does, and hoping Yellen pulls “the right” number out of her hat. The producers who’s products require Iron ore, used to be the big players in the market. As producers were in every commodity market.
But now, with every half literate Manhattanite and Londoner who can spell Hedge Fund correctly with some regularity, can without any effort at all obtain leverage to buy a thousand times the amount of Iron ore that has been turned into steel in all of history combined, the only signals being transmitted by price movement, is one of madness of crowds, and of hedgie A thinking he is outsmarting hedgie B.
It’s the inevitable result of handing the printing press to a bunch of idiot “macro-economists” that believe that the effect of China no longer buying ore, can be completely reversed by just handing enough money to yahoo A and halfwit B so that they can buy it instead.
So, what we are seeing in commodities markets, is not the effect of increased demand from productive supply chains. But simply the effect of spring weather and more sunlight making New Yorkers and Londoners more upbeat.
“The US treasury yield curve looks and acts like the concern is recession or deflation, not inflation. Why?
Three Possibilities”
No argument on your 3 … but no mention of the 800 pound gorilla in the room
The MASSIVE debt overhang
Until $trillions and $trillions of debt dealt with – via default / pay down / forgiveness – disinflation / deflationary winds will prevail.
I have long believed that Japan is the model for where the industrial world is heading. They demographically have an aging workforce with a decades old stagnated economy. The only caveat is they ban most immigration which slows their slide to deeper debt. The rest of the industrial nations hope to pile on more debt with massive immigration to avoid their fate. In the long run the results are the same, not enough people and productivity to maintain the worlds massive government.
What the world needs now is a new word. I offer “flatflation”, the proposition that inflation will wander in a narrow range of positive and negative numbers.
“… accelerating labor costs will start being passed on to the consumer.”
Accelerating labor costs will be passed on to labor, as they consume.
Good luck passing on to consumer … the debt laden consumer will respond with weak tepid demand.
There is a “supply constraint” if you are a Keynesian loony who believes a)that demand is “insufficient” and that the only problem is lack of purchasing power (read: “print money”/”run deficits”) and b) that bubbles cannot ever exist, because there’s no such thing as capital misallocation in Keynes-land.
The deflation is coming out of Asia and it effects profit margins on products sold here. Ask any business person or consumer if their cost of living has increased in the past few years and the answer from everyone is YES! We run online retail websites and have watched our shipping costs explode over the past four years. Our cost of packing materials, cost of goods and advertising have all risen to unsustainable levels. In addition, our profit margins have dropped substantially because of sites like Amazon (that destroy margins), the Asians opening warehouses in California so they can dump product directly in the U.S. with low margins, the free shipping paid for by the US Postal service so that companies like Alibaba, Dhgate and Amazon China stores can easily compete in the U.S. markets.
Increase the cost of doing business and destroy the profit margins at the same time and what you have is a rush to the bottom and a depression for retail vendors.
The real inflation is here, but the Fed doesn’t want to acknowledge it because it’s not politically correct to raise rates and stick it to the status quo.
There is a millionaire deflation in Illinois. Read the other day that 3,000 of them have left the state in the last year, a 2% decline.
The state where the governors make the license plates is the #1 loser:
http://www.governing.com/topics/mgmt/gov-states-losing-population-census.html
Texas is gaining the most population.
Correction. 3,000 millionaires have left Chicago.
http://www.zerohedge.com/news/2016-04-12/rich-flee-crime-infested-hell-hole-chicago-amid-racial-strife-civil-unrest
CPI deflation would be such a blessing for shoppers. If only bankers would let go of that nonsensical Phillips Curve already, and allow shoppers to have affordable prices at the store.
If only bankers would stop printing asset bubbles in an effort to trick private industry into building unproductive Keynesian pyramids, then voters would not be asked to bail out bank loans every few years.
And this is what central banks do when growth ends …. but as we can see… this form of growth has its limits…. the limits are realized when every person, corporation and country are supersaturated with debt..
The moment is approaching.
With plenty of punch, central bankers wait in vain for the world to drink
Central bankers usually worry about when to remove the punch bowl of cheap finance but when they gather in Washington, D.C. this week they will face a different problem: how to force the world to drink.
Amid a flood of cheap money and a historic experiment with negative interest rates, households, corporations and banks in the developed world have turned their backs on borrowing. Credit growth has flat-lined and an array of metrics indicate the world has become a more cautious place, potentially upending whatever bang for the buck central banks might expect.
In the U.S. households are paying down mortgages instead of borrowing against homes to fund consumption, altering behavior that arguably helped fuel the 2007 financial crisis but that also contributed to economic growth. A Chicago Federal Reserve Bank composite index of household, bank and corporate leverage has been below average for nearly four years.
European and U.S. companies are socking away cash and the Bank of Japan’s descent into negative rates has yet to boost consumption, corporate investment, or even faith in an economic rebound.
Even as global liquidity expands, the appetite for it remains moribund.
“You can’t create demand from thin air. What’s needed is to create an environment in which companies and households feel confident to spend,” said a senior Japanese policymaker directly involved in Group of 20 negotiations that will continue in Washington this week.
“There’s a growing sense globally that monetary policy alone cannot cure all problems.”
More http://www.reuters.com/article/us-imf-g20-cenbank-analysis-idUSKCN0XB0AN