Smackdown: Fleckenstein vs Yardeni

Interesting smackdown between Bill Fleckenstein and Ed "Y2K" Yardeni:"

"Even if the Fed can’t strip the inflation measurement of all
items going up in price, it has a built-in excuse, provided recently by
economist Ed Yardeni: One must decide whether prices are going up because of
"excess demand" or supply disruptions. As Yardeni wrote in his morning piece
April 11: "Raising interest rates when supply shocks may be the main reason for
higher commodity prices could be a mistake, especially when there is no evidence
that core-inflation rates are rising too."

Got that?

His explanation:
"Rising commodity prices resulting from supply disruptions — rather than driven
by demand — may take the steam out of the global boom, and slow U.S. consumer
spending and overall economic growth

See? Rising prices will correct
themselves if they’re due to supply disruption, an argument that he leans
toward. (Rising prices couldn’t possibly come from too much
money-printing, could they?) The Fed need do nothing. Thus, I believe
(for not just this reason, but others that I have articulated) that only one
more rate hike remains in the Fed’s quiver.

That said, I still think we
could see data that would persuade the Fed not to even give us that much.
If there is a nasty sell-off into earnings season, if we do in fact see some
negative economic data, coupled with problems in the real-estate market (none of
which would shock me), the Fed might be inclined to stand down on May 10. Either
way, the rally that we get when the Fed decides it’s done will be the last one
before serious downside action occurs.

Good stuff!


Does the Fed really ‘know’ what’s going on?
Bill Fleckenstein
MSN Contrarian Chronicles,  4/17/2006

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  1. Bynocerus commented on Apr 21

    The term permabear get’s thrown around a lot these days, and used on people who have only been bearish since the tech collapse. But, Fleck qualifies for permabear if there ever was one. Reading his articles, I wonder if he won’t be happy till we bump into each other at the soup kitchen a few years from now, getting our lukewarm cabbage broth and stale bread.

    At the same time, I’m paying a lot more attention to Fleck lately, due in part to my own portfolio. I trade both ways with my fun money, but the IRA money stays long/short till it doesn’t. What is especially frustrating is that I am at the same place in my NDX index funds as I was on January 3. As you showed in your charts a few days back, all your money was made in the first week, but if you’re indexed to the Naz, all your $$$ was made in the by Thursday.

  2. KirkH commented on Apr 21

    I’d like to hear some thoughts about Kurzweil’s new book and it’s chapter on the future of economics. Basically he says accelerating change leads to accelerating deflation.

    Would the Greeenspang hangover be worse if they’ve had to inflate to keep ahead of an exponential growth of deflationary pressures instead of the typical linear view?

  3. david commented on Apr 21

    Hi Barry, Some of the Fed Gov should wake up and smell the roses. Record profits for big business and the average guy is getting killed by inflation. It is everywhere. In food, gas, clothing, health care, drugs etc. Oil is at $75 and climbing and the stock market ignores this and many other red flags. Its different this time. Greed is at an all time high. Common sense is at an all time low.

  4. vfoster commented on Apr 21

    i think the answer is no, the fed doesn’t know what’s going on. even if they did, why would they indicate they are near the end of tightening? they just gave the hedge fund community the green light to pile into the commodities. now they are at the mercy of the market and probably don’t know what to do..

    does anyone think this excess liquidity is being intensified by bush’s supply-side policies (i do)? it would seem to me that in the case when a president is a supply-sider, the fed would need to err on the side of tighter policy.. David’s point of the widening class structure raises the issue.. supply-side policy is inherently inflationary and we know inflation hits the classes much differently.
    what amuses (or scares) me is that the democrats have no idea how to present this argument to the american people.. they all want to blame XOM when they should be blaming Bush and Congress

  5. zanzibar commented on Apr 21

    This inflation debate is nuts. Just look at growth rates in quantity of money and credit. And doesn’t anyone buy gas, health care insurance, kid’s tuitions and heating??

  6. marty commented on Apr 21

    1. in defense of fleckenstein, he’s a witty, and unlike most market guys, he’s very much an independent thinker. the cheerleaders can’t understand the sell off in broadcom today, for example… can any of the cheerleaders spell 9 TIMES SALES…

    2. deflation is impossible in america as long as the feds print money and the “urge to splurge” remains strong. in fact, if economic or social times get bad in america the unjapan like response will be to spend our way out of the funk. doesn’t sound too deflationary to me…

  7. john commented on Apr 22

    This year 19 million flat screen TVs will be purchased as opposed to 1.4 million last year. I can’t think of anything that is more “must have” than a 40+ inch flat screen television.

    When that number reverses I’ll start thinking about cabbage soup and stale bread.

    There is no inflation. There is no inflation because it costs far less to make a flat screen than the old style yet a flat screen sells at a premium to the old style. Sometimes that premium is in excess of 10 times. That, according to my old engineering books, is an exponent.

    Consequently if both the old style and the flat screen are profitable in the marketplace then it is obvious that the producers have the flexibility to “add price” and get their ask when it comes to flat screen.

    In the (near) future the flat screen will come down to probably a third or maybe even a quarter of today’s price. This will also be reflected in the production cost of the flat screens – i.e. that too will become more efficient and the profit margin will be maintained because the lower price will attract far more buyers.

    As far as fuel is concerned – an automatic pencil made in China and sold here in Staples has to travel a hellofa long way to get to the market yet still only costs about fifteen cents (12 in Wallyworld). Do the math. There is no inflation. When I was a kid, pencils (the old fashioned wood and lead ones) cost about 7 cents apiece. Since I can get about 4 times the use out of an automatic pencil the difference is significant. Again, do the math (4 x 7 = 28) – there is no inflation and, at least when it comes to pencils, there seems to be deflation.

    So in actuality given the productivity gains in pencils at least, producers could increase the price by 13 cents (due to fuel cost rises) and still sell you a better instrument than you had years ago. Since the energy cost of the 15 cent pencil is probably about a third of the total (or 5 cents), energy would have to go up a bunch more in order to bring that pencil’s cost into line with historical valuations. Then there would have to be still marginally higher costs added to permit it to contribute to inflation.

    As far as health care insurance and kid’s tuitions? These are independant of energy costs and reflect desirements of the population. Heating however is another “pencil theory.” That is – it is cheaper today to heat 1 square foot of your house than it was 50 years ago regardless of the price of fuel up to and probably including $100 oil. At least to the temperatures desired by the occupants. Does that mean that everyone can afford it? Probably not but not everyone could afford coal for the boiler 50 years ago either so not much has changed.

    There is no inflation. So why are they raising interest rates? Because the morons have to do something to stay employed. They lower them and they raise them and that’s what they do for a living. Has anyone thought of that?

    I’m not an economist – just a trader – and I have to say this is the hardest work I’ve ever done. But it keeps me sharp and staying sharp is the same as staying young.

  8. Barry Ritholtz commented on Apr 22


    You are confusing economies of scale in the process of manufacturing technology with inflation.

    The two are independent and unrelated. One is due to macro economic forces, while the other is a function of how new products achieve consumer acceptance.

    You can read “Crossing the Chasm” by Moore for the details, but technology-adoption life cycle looks something like a bell curve, and consists of different consumer types:

    early adopters,
    early majority adopters,
    late majority adopters, and

    It is the nature of technology (and most items manufactured with new or innovative processes) to start out expensive. The cost per unit is high, as you are selling these products to a small contingent of innovators. The full cost of R&D, development and fabrication is born by a small group of buyers (innovators). Hence, the 1st large flat screens were $20k, and sold a few 1000 per year.

    The next group is the early adopters, and they got to pay $8-10k for flat screens, as more volume brought the price down. The early majority adopters paid about $4-5000 two years ago. That is now morphing to
    the late majority adopters, who are paying between $2-4000.

    As to inflation, well, we can agree to disagree: You think there is none; I think that the evidence for inflation — price increases in energy, food, insurance, industrial metals, health care, education, commodities, housing, yield, precious metals, etc. is self explanatory to the rest of us.

    But I would advise you to rethink your understanding of how consumer pricing models work — they are independent of macro economic issues.

    Otherwise, you would only conclude that there can never be inflation cause items like flat panels — and RAM, flash memory, digital cameras mp3 players, PCs, etc. always come down in price.

  9. Ned commented on Apr 22

    John and Barry—nice posts-intelligent discourse–reason I like this blog so much. Just got my last winter gas heating bill in the mail and anyone who claims no inflation is welcome to pay it for me. It is a doozy.

  10. me commented on Apr 22

    Just look at Intel and gold to see if Flick knows what he is talking about

  11. john commented on Apr 22

    OK – let’s try it again – but first let’s have a commonly agreed to definition – I’ll go first – according to –

    “A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services.”

    What part of “persistent increase” or “persistent decline” did I not address? I said – pencils are cheaper today than they were 50 years ago. (They are also more consistent in manufacture, better quality, far more plentiful, are found in many different colors and come a lot farther to get to me than they did then).

    Pencils are less expensive – there is no “persistent increase”. I can buy more pencil for my money today – thus – no “persistent decline”. There certainly isn’t a shortage of pencils.

    There is also no shortage of oil. There might be someday but not today. There is certainly no gas lines anywhere so somehow the oil is getting through. I also believe that $3 gasoline is the breaking point after which people’s salaries will be increased or people will stop driving.

    I happen to agree that $75 oil is probably not very good for anyone but I’m not prepared to accept it as anything more than a momentary blip. And, certainly, raising interest rates will not solve that problem. Nor can raising interest rates possibly solve the problems that $75 oil will cause downstream. (Ned: I regret that your heating bill is so high – but that is just the cost for heating your house – not a sign of inflation. It can’t be inflationary because it doesn’t fit the definition).

    My point is simple – the Fed will continue to raise rates until they don’t. At which time they will lower them. That’s their job and people do their jobs or they are fired. Is it meaningless – yes – I’m put in mind more of Johathon Swift’s writings than Mr. Moore’s.

    Barry I really enjoy this site. Sorry to turn these comments into a forum – it’s your house do with it as you will.

  12. zanzibar commented on Apr 22

    “persistent decline in the purchasing power of money” – John

    What do you think has happened to the purchasing power of USD over the last 100 years? Increased or decreased?

    What is the growth rate of money and credit relative to GDP growth rate?

    IMO, the Fed has been increasing both the cost and quantity of money.

  13. john commented on Apr 22

    “What do you think has happened to the purchasing power of USD over the last 100 years? Increased or decreased?” asked zanzibar.

    I don’t know if that is an easy thing to answer. While it might be true that in 1929 terms the dollar is only worth 2 cents I don’t know how you can prove the statement either way.

    Here’s why – sure there are a lot more of them today than ever before – but they buy far more today than they ever did before. There’s hardly anything from 1929 that I buy today with the exception of fresh dairy, vegetables, and fruits. And they are actually cheaper today on a labor-hour adjusted basis than they were in ’29. No inflation there – prices are less and availability is greater.

    Central banks strive for 2 to 3% inflation. It is absolutely necessary to keep the shell game going. And before we start talking about the credit crisis let’s be sure we know what the credit was used for. For example how much was used to buy real property, which, while it might lose value in the near term, will over the life-span of many millions of loans actually appreciate in value? I’d warrant over half of the total is in this category. How much has gone to buying college educations for the kids and ourselves which, while causing some discomfort early on actually pays for itself many times over in most instances? Another 10 percent maybe? The fact that vehicles bought on credit now days last longer than the loans is a good thing – it means they become productive in their lifetime. Especially so if they are sold and refinanced again. (Think about that for a minute – a recycling miracle). If you sweep all of that off the books because they might be considered productive loans then what are you left with? If you are not replacing your refridgerator every couple of years and if the last one you bought actually uses less energy how can you calculate that loan as a loss?

    That’s why I argue the way I do. It is too difficult to compare the present to some time in the past – too many things are different. Just because we still use something called a dollar doesn’t mean a thing when it is an part of an amalgamation of all currencies throughout the globe. How do you measure inflation when most US companies profits are calculated in foreign currencies because tax policy makes it favorable to do so?

    Anyway I don’t necessarily want the last word but I’m not going to reply any longer in this thread – I’m sure we’ll take up this discussion again and soon.

    Again – thanks Barry for allowing such a robust discussion.

  14. D. commented on Apr 22

    When I think of inflation, I think of my consumer goods basket price now vs. a few years ago TO STAY IN THE SAME SOCIAL BRACKET.

    My monthly costs for all the same goods and services are up 10% over last year.

    It’s true that I could find cheaper products than 5-10 yrs ago. I could also avoid cell phones, the cable, fast internet an a load of unnecessary items.

    But the reality is that when you add up all these products together even if each of them decline in price individually, the basket is more expensive today than it was 5-10 yrs ago. We need more stuff to stay in the same social bracket!

    Yes, some things have gone down in price. I can buy a quality suit for the same price as I did 10-15 years ago.

    Yes I could go to Wal Mart and find all kinds of things that cost less.

    But a few years ago I bought stainless steel cutlery which rusted the second time in the dishwasher.

    I bought a replacement toaster oven which lasted 1 year while the other one lasted 15.

    Every time I buy something today, no matter what the price is, there’s some kind of problem with it. Who knows what’s good or not anymore? If I see Made in China, I now avoid it and I’ve started to notice others doing it also.

    As for the flat screens, the companies producing them are far from breaking even on them. They’re currently operating on cash flow. And prices will be coming down because the competition is fierce. New plants are being built without concern for profits. There is so much money looking for investments that all kinds of capacity is getting built.

    Neil Young has the best line for what is happening:

    They cut the forest down to build a piece of crap! Piece of crap! Went back to the store They gave me four more The guy told me at the door it was a piece of crap Piece of crap! – Neil Young

  15. Barry Ritholtz commented on Apr 23

    One last thought on the subject of inflation and prices: regardless of inflation, as products become cheaper/faster/easier to produce, they move further downstream on the consumer scale of luxuries versus necessities. This ends up rasing everyone’s material standards of living (I’ll leave the philosophical issues for another post!)

    Consider indoor plumbing: It was a luxury that started with Royalty, who apparently did not care for the chamber pots they had been using; Now its owned by everyone in this country (the chamber pot explains the phrase “He’s so poor, he doesn’t have a pot to piss in”)

    So too, with other goods — from automobiles on down. Remember when VCRs, answering machines and then mobile phones were the province of the well heeled? Even that phrase — well heeled — refers to expensive quality clothing, versus those who had holes in their shoes. You can buy decent (if not stylish) kicks today for $10.

    PCs are almost ubiquitous amongst the masses; so too are iPods; Blackberrys/Palms, DVRs, etc all will be so too in less than 20 years — maybe even les than 10 yrs.

    Its the same with Plasmas.

    But again, this is not a function of inflation; Rather it is a direct correllary to how the laws of supply and demand work. A hot product invites lots of competition, all of whom wnat to jump on the bandwagon and make money. They eventually create a glut (see semi conductors for a clasic example), driving prices down to the point where nearly every economic strata can afford them.

    Material standards of living improve, and hence, Captialism vanquishes communism.

    But it does not mean that there is no inflation . . .

  16. trader75 commented on Apr 23

    The best juxtaposition I have heard came from Paul McCulley: capitalism is deflationary, but democracy is inflationary.

    The function of free-market competition is to steadily diminish profit margins over time, through competitive efficiency gains in logistics, technology, processes etc. that are then passed on to consumers.

    This is the “stuff keeps getting cheaper” phenomenon that fuels a rise in the material standard of living for consumers. But at the same time, this competitive tendency of capitalism is deflationary, and potentially detrimental, from a worker standpoint.

    Consider how much labor goes into the production of an automobile. Over time, that labor component gets smaller and smaller as automated processes become more efficient. We are moving towards a time and place where two or three highly trained individuals will be able to do the work of two or three hundred workers in the old days. This will be great for anyone who wants to purchase a high quality automobile for, say, $6,000… but not so great for all those who no longer have a job on the factory floor.

    So that’s the trade-off: the deflationary aspects of capitalism benefit us as consumers, but hurt us as workers, because the efficiency gains passed on to consumers are extracted from workers.

    As 40 inch plasmas get cheaper and what not, the average working wage should also decline. Imagine the average joe’s situation a few decades from now. Maybe he only makes 25K a year in 2006 dollars… but on the other hand, his 10 foot plasmatron was $100, his car only cost $2K and his 250 terabyte iPod was just $19.95.

    The other side of the falling cost of stuff is falling real wages. So is the consumer / worker of the future a winner or a loser? Not really easy to say either way.

    And because capitalism is inherently deflationary–and because the deflationary process routinely creates vocal losers–we have the inflationary democratic process to balance things out. The more that things become unbalanced in terms of who wins and who loses, the more incentive politicians have to try and redistribute the wealth.

    The other wildcard factor here is the inherently uneven distribution of technology gains. Most people in western society favor meritocracies in theory, but reject meritocracies in practice. The results are too jarring. Plus there is always the nagging question of who hit it big on legitimate means vs who is just corrupt.

    At any rate, I think the overall picture makes more sense if we remember this a multi-variable model–capitalism deflationary, democracy inflationary–and take human tendencies into account on an individual and societal level.

    I think the shit is gonna hit the fan like we ain’t never seen pretty soon, but maybe that’s just me.

  17. Isaac Greten commented on Apr 24

    This discussion reminds me of a paper I read as an econ major about the history of economic development- this fellow put together a pretty cool data set on laborers in Europe and backed out their wages in ounces of silver, and compared that to the price of bread over the period from the 1200s up to the 1800s. The punchline? All the economic shifts over that period resulted in essentially no improvement in the standard of living for European laborers.

    Yeah, go ahead and bitch about the data set, see if you can come up with anything better:

  18. Roger commented on May 9

    What I’m surprised at is I didn’t see any discussion about goods vs. services in the dialogue above.
    Sure, pencils, electronics, and cans of beans have tended to get cheaper across the decades. Louis Rukeyser’s “Book of Lists” gave some 50 year price change lists that really surprised me, and certainly confirmed this trend.

    On the other hand, how about services? I think folks went to the doctor a century ago, though they didn’t go as MUCH as we do today.

    If memory serves, the dollar depreciated ROUGHLY 90% (a dollar became worth a dime or so) last century. To me THAT spells inflation – period.

    Since today it is easy to argue that a higher and higher proportion of our wealth will be spent on services (i.e. music online suddenly makes “music” consumption a SERVICE instead of buying a piece of metal or plastic (a good). That does NOT bode well for the long term inflationary outlook.

    With real wages in the US being crimped by global competition (jobs seen as merely commodities, provided by a global marketplace — peoples’ well being is no longer a major consideration in corporate America), one has to wonder how the standard of living can keep rising in the 21st century at the pace it has in the 80’s and 90’s.

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