There’s No Inflation — Except for Necessities

Barron’s Alan Abelson weighs in on one of of our regularly and favored subjects: There is no inflation, except for all those pesky things going up in price (a/k/a/ inflation ex-inflation):

THERE’S NO INFLATION — EXCEPT FOR SUCH NECESSITIES of daily sustenance as food, gasoline and The Wall Street Journal (which, in case you were too busy having a jolly time at the beach to notice when it was disclosed, next month will fetch $1.50 a copy rather than the current buck). But those are obviously exceptions that prove the point, for none constitutes a component of core inflation, so, in the larger economic scheme of things, how significant can any of them be?

Once again last week, confronted by a disquieting indication that inflation is alive and virulent — namely, that the producer-price index shot up 0.9% in May — the Émile Coué chorus in the Street rushed to reassure the investing masses by singing their anthem of everything gets better every day, citing the much more demure 0.2% rise in core producer prices as incontrovertible evidence. And, we’re pleased to say, the masses were sufficiently reassured to shrug off the downbeat data and send the market bounding ahead.

And, of course, fresh fuel for the bulls came the very next morning as that same Coué chorus — or should we more properly call them "core-ists" — seized on release of the consumer-price index as confirmation that all’s well on the inflation front. What better proof, they exulted, than the miserly 0.1% uptick in the CPI — once you take out pesky items like food and energy. As for the 0.7% rise in the CPI when food and energy are included, "pshaw," they scoffed, that’s just the "headline number"!

For the life of us, we must confess, we don’t quite understand why "headline" is a pejorative. Do those contemptuous of us benighted souls who award it more serious notice laugh and sneer when a banner headline in their daily proclaims, "War Is Declared" or "World’s Tallest Building Collapses" or "Mets Win"?

We’ve no objection, of course, to anything that makes people happy, even if it’s a patently ersatz invention of the Federal Reserve conceived in the ’70s when that august body was desperate to find a semantic antidote to the heaving inflation of the time. So at the behest of the then cantankerous chairman, Arthur Burns, it tossed out first energy and then food from the standard calculation of inflation. The result, lo and behold!, was "core inflation," which has served nicely over the years to dim the perception of inflation and buoy spirits on Wall Street, if not in the real world whose inhabitants have to cope best they can with rising prices. (Please don’t accuse us of being anti-semantic; our source is the redoubtable Steve Roach, who was one of the economic-spear carriers at the Fed back then.)

And we’re also aware that the price of certain commodities has plummeted. DRAM prices, as we noted some weeks back, have suffered a huge markdown. Moreover, the Journal reports that a gram of cocaine, which sold for around $200 barely a decade ago, can be bought these days for as little as $20 (which perhaps tells you more about the no-inflation crew’s recreational habits than the legitimacy of their overall analysis).

Bur for ordinary folks like us who don’t dabble in DRAMS or do coke, such instances of lower prices might as well be snippets of fluff. The stuff, essential and not so essential both, we must fork over our hard-earned dough to acquire has been getting inexorably more costly for quite a spell now. And to judge by the action in the commodities markets — wheat at an 11-year high, crude at a nine-month peak, etc. after sad etc. — we might as well grimace and bear it, and draw what solace we can from the knowledge that core inflation is so meek.

Not much more to add to that . . .

UPDATE June 16, 2007 9:22am

The NYT’s Floyd Norris weighs in on the same subject in a blog post: Inflation Soars — But Wall Steet Ignores It:

Share prices are soaring today, on the good news that the core
consumer price index was up just 0.1 percent in May. Economists are
ignoring the fact that the overall C.P.I was up 0.7 percent.

The core figure leaves out food and energy, and since that is the
rate the Federal Reserve watches, traders think there is little risk of
a Fed move to tighten. The theory is that food and energy numbers can
be volatile and thus misleading.

The trouble with only watching the core rate is that real people eat
and also use energy. And changes in those prices are important over
long periods of time.

Over the past three months, the total consumer price index has risen
at a high annual rate of 7 percent, while the core rate is advancing at
the small rate of 1.6 percent.

To be sure, three months is a short period. But four years is not.
Over that period, the overall CPI is up at an annual rate of 3.15
percent, a full percentage point more than the core rate. Food is up at
a 3.1 percent rate, a 13 year high for that measure. And energy costs
have risen at a 12.9 percent annual rate.


Norris also notes that recently, China was
a net seller ($941 million) of Treasury bonds. "One month does not make a trend, but if China is getting hesitant
about adding to its Treasury portfolio, interest rates could be headed
up even if the Fed does want to ignore the actual inflation rate."


I wonder if there is any correlation between our interest rates and that little factoid . . .


Perils of Going Public
Barron’s, June 18, 2007

Inflation Soars — But Wall Steet Ignores It
Floyd Norris
NYT, June 15, 2007,  11:39 am

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What's been said:

Discussions found on the web:
  1. Adam Kotsko commented on Jun 16

    So wait — does “core inflation” have any intrinsic meaning at all, or is it just “inflation minus key necessities”?

  2. DookieHole commented on Jun 16

    What number does the government use to calculated COLA’s?

  3. Barry Ritholtz commented on Jun 16

    Food and energy are dropped from the core rate because they are volatile from month to month and will cause understatements and overstatements in inflation estimates based on month to month price changes.

    However, I understand wanting to remove an unusual spike (I.E., Post-Katrina gas surge).

    But 5 years ago, Oil was $18; Its now $68; Milk was $2 a gallon; now, its now heading to $5. Medical costs have gone up relentlessly between 10-15% / yr.

    If you want to remove the monthly volatility, you can drop the outliers (like the Cleveland Fed does), or use a moving average, or look at the year-over-year numbers.

    All three methods reveal that (non-volatile) inflation is MUCH higher than the reported core.

    There’s data smoothing, and then there’s inflation ex-inflation. The core rate is looking more and more like an exercise in hiding the true state of price stability.

  4. Winston Munn commented on Jun 16

    A better term for core inflation would be a variation on EBITDA – IBITDA: Inflation Before Interest rate inceases, Tax increases, Daily necessity increases, and Anything else that goes up in price.

  5. ferd mertz commented on Jun 16

    the comment about cheap coke seems appropriate in that wall st. behavior of this decade appears manic-depressive mirroring that of a coke addict. maybe timing moves involve understanding when the toot stash runs out or the effects wear off.

  6. dblwyo commented on Jun 16

    Barry – in effect what you’re saying is that core should be re-defined to include energy and pehraps food; as well as perhaps a re-weighting on services, healthcare, etc. A good argument but it requires that the ‘regime’ has changed on energy and that we can recognize it. I just completed a looksee at CPI and CPIx back to ’79 where the headline number oscillates around the core but basically always returns to it. It’s not clear that that’s NOT happening now as well.

    If it were my job I’d be very leery at making changes on recent data when the results not well defined, clear and the multi-decade history argues the other way. And on the other side, while energy, are indeed climbing and look from IEA numbers to expect a clear long-term supply-demand imbalance, that the economy isn’t absorbing these ‘shocks’ w/o embedding them into general inflation.

    That’s a difficult question and deserves some explanation. Marc Faber – a fellow CNBC guest – just guest-hosted the Asia show and made the point that the $ measured against assets has shown a a clear decline. Perhaps that’s the indicator(s) to look at to start to resolve the conundrum ?

  7. Winston Munn commented on Jun 16

    Why would the Federal Reserve minutes show concern for inflation when core inflation seems so contained?

    Maybe there is more Fed understanding of cause and effect than they are willing to admit.

    Consider these observations from Minyanville:
    “A rise in prices is an outcome that can be activated by three causal factors: a decrease in the supply of goods on the market, a collective social movement towards less saving and more spending, or an increase in the supply of money and credit (Rothbard, 1962). A price-based measure of inflation is an outcomes measure; it provides no information about the factors that influence price behavior.

    Total U.S. debt is 3.5 times GDP, a level never seen before. The second highest level was 2.9 times in 1929. Total U.S. financial debt (excludes consumer debt) is 2.1 times GDP, the highest ever.”

    These debts must be serviced. When there is nothing left to build, when slowing economic activity precludes business expansions, when manufacturing is replaced by services, the only option left to service debt is a financial solution, which is speculative and risky in nature, and must be repeated to service the newly acquired debt at higher risk than before.

    However, one doesn’t always win these bets.

    Bear Stearns seems to be in the process of learning this economic lesson – monetary inflation is great until you are the last greater fool.

  8. John Badalian commented on Jun 16

    Dear Barry:

    Please let’s not forget the use of hedonics in inflation statisitics as well as questions raised as to just how much money is being injected into the system? Your friend James Grant has quipped that unless our productivity is just so mindblogging, inflation has to show up somewhere. Yes, I DID take my medication this morning, but I still want to know what happened to M-3!

    Barry, the people at the top of the food chain are running this show, and they’ve done quite nicely over the last couple of decades. It works swimmingly for them, and for the time being, the BRICs, the rest of the Asian Rim, and even the EU. Except that many good & independent thinkers (e.g, you, Grant, Nick Taleb, Volcker, etc. etc.) are raising more & more well-grounded questions rearding the increasingly feculent nature of American economic statistics.

  9. Bob A commented on Jun 16

    Might I add that the way things have been going of late, couldn’t one reasonably conjure that events such as last weeks ‘interest rate scare’ and the earlier ‘subprime scare’ were simply well planned marketing events orchestrated with the utmost secrecy and deliberation in very exclusive offices on Madison Ave and Wall Street?

  10. Eclectic commented on Jun 16

    On Norris and China:


    China pegs the yuan to USD for good reason… so that their U.S. importing partners won’t have to be distracted with hedging the currency and can just keep the containerized freight units sailin’ the Seven Seas, and rollin’ across ‘Merca.

    Were it more necessary for them to avoid having their partners hedge the yuan in euros or yen, then they’d peg it in them.

    Lately the rest of the world hasn’t minded the peg too badly, kind of like you might not be too troubled with the notion of picking up manna dropped from Heaven or free China-produced goodies. But, it won’t always be that way.

    We’ve been there… we’ve done that, with the yen, the pound and former European currencies.

    USD *is* the currency of Communist China, and they’d no more wish to run rates in the U.S. up than they’d want to depreciate the value of their own holdings in Treasuries.

    Too, they’d run the dollar up, and thus the yuan as well (and oil way-the-ass-up over and beyond the risk premium highs of today in USD)… helping to kill off remaining U.S. exporting jobs (more trade pressure on China from Congress) and potentially causing a recession in the U.S. (although the U.S. consumer would have to be dragged out of the shops kicking and screaming, fighting tooth and nail), thus shooting their own export trade and domestic jobs in the foot.

    Maybe way down the road, after a long concentrated improvement in China’s domestic consumer d-e-m-a-n-d could absorb that kind of independence from the dollar, but not now. They need U.S. consumerism, and they need it in dollars.

    I do think Madam Wu enjoys puttin’ the voo-doo on Bush and Paulson:

    …almost as much as they enjoyed snowing Snow about the same issues.

    After all, what’s a little interest rate jolt among friends?… just to keep everybody in the U.S. on their tippy toes and off China’s toes.

    No, Barringo… maybe you’re temporarily sniffin’ inflation, but my guess is that de-flation is still the merry-go-round world-wide risk, and it comes from the bottomless pit of labor in China and throughout other countries of the developing Third World.

    My inmate lives another day, and they may have issued him another tube of toothpaste.

  11. Karl Smith commented on Jun 16

    Whats wrong with the Core?

    As often is the case the real question is – what are we trying to measure.

    For the FED what they want to know is roughly how well increases in the money supply are being aborbed by economic growth

    As I’m sure you’ve heard ad nausem “inflation” is everywhere and always a monetary phenomenon. Except of course when its not.

    One area in which its not is when we are talking about goods that are subject to large supply shocks. The disruption of an oil producing facility or a frost in Florida raises the real costs of gasoline and oranges.

    Its not simply that their price is rising because there is too much money out there, they have become in fact more scarce. Perhaps, even more importantly, our oil and orange generating capacity has not changed.

    There are fewer oranges this period but there is no particular reason to think their will be fewer oranges in the future.

    Now the rise of China and India put a bit of a wrinkle in that. Its not that there is less oil for example but there are more people using it. Oil in terms of other goods is becoming systematiclly more scarce.

    Does this warrant focusing on oil when making monetary decisions, I would think not. But it does mean examining the core rate more closely for any sign of bleeding over.

    I think the FED is doing that and its the correct approach.

  12. blam commented on Jun 16

    I am thinking Ravi Batra has presented the best overall summary of what’s up in America.

    His theory is that debt expansion is the only way an economy can grow when wages lag productivity. The increase in excess business profit (record high margins)as a result of the wage gap leads to excess business expansion and supply (and productivity), in the face of stagnant demand as a result of lagging wages. The only way to mop up excess supply is for gov’t and consumers to borrow-to-spend.
    It follows that excess business profits lead to stock price bubbles.

    At some point, credit induced expansion peaks and the whole enchildada collapses.

    Read it for yourself in the book by Ravi Batra “Greenspan’s Fraud – How two decades if his policies have undermined the global economy.”

  13. Steve commented on Jun 16

    Well said, Karl.

    And I don’t mind people noting the headline YoY inflation rate, but this hand wringing over a monthly change is ridiculous. Last fall, when the monthly headline number was negative, was Abelson screaming that we’re in a deflationary spiral and the Fed needs to cut rates.

  14. Eclectic commented on Jun 16

    Karl Smith… You are correct.

    The dynamic problems of supply and demand you represent are often cured randomly and technologically.

    They do not derive from monetary inflation, per se, but are the real fluctuations of unit price of a given commodity in real terms against other commodities also in units, and not just in currency units.

    In other words, generally, the units of one commodity exchangeable for another are quite stable over long periods, and although the units of labor (via productivity) needed to obtain them are reduced over time, the relative inputs of labor needed for acquiring all commodities are reduced evenly.

    For example, your discussion of increased oil demand in China makes units of oil more costly in terms of units of lumber, cotton, corn and other commodity units, including units of l-a-b-o-r.

    The unit costs of these items, over time, work to cause a sort of permanent equilibrium to exist between those unit prices and the unit prices of oil… all other things held equal.

    The purpose of the central banks of the world is to facilitate that orderly adjustment, and not to misunderstand their purpose to be to stimulate economic output. They can do no such thing and only force the reorganization of currency unit values when they try to stimulate local GDP.

    Expansive monetarism can NOT stimulate, and it can NOT recover an economy from a recession (even a depression). It can only facilitate the capacity for economic expansion when that capacity exists, but it most certainly can constrain it, even if it does exist.

    As I see it, all central banks of the world misconceptualize their missions as much as the U.S. Fed does its own.

    The problem is structual, because the central banks are charged with multiple responsibilities that they can not address effectively, because they may actually conflict with each other.

  15. Uncle Jack commented on Jun 16

    $1.50 ???

    H.otel S.ierra Batman, I wasn’t even willing to pay $1.00 and now you’re telling me the WSJ is $1.50 ?

    Don’t forget they recently shrank the size of that thing.


  16. WatchingTheSagaUnfold commented on Jun 16

    Any chance for a Disney theme park in Iraq in the next decade? Yeah, you might think that is absurd, but why not? I think we are seeing a regression to a bored planet, overloaded with too much awareness of ourselves and how we pretty much are serfs to the rich, like always.

  17. michael schumacher commented on Jun 18

    THere’s already a disney theme park in Iraq….it’s called fantasyland.


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