My spasmodic inflation report...

Any minute now. Just keep holding the snipe bag.

Inflation (yawn) Watch, ...  

Maybe the Great Gold Unload last Monday was an indicator, but it's getting even harder to make a case for runaway (or even ambulatory) inflation in the US and most of the developed world.

But the bigger story behind McDonald’s falling margins is that weak demand, driven by high unemployment in much of the world, means that McDonald’s feels no real ability to raise its prices, even as many of its costs are stable or rising. The reason for falling margins, said Thompson, “is because consumers are very sensitive to price. So we don’t have the inflationary environment or the consumer sentiment environment to go out and take the kind of price increases that historically we did.”
It’s no one thing driving it; rather, it is a mix of things reflecting the overall economic environment: Cash-strapped consumers buying more value items off the dollar menu for which margins are low than premium products; fixed costs like management salaries, equipment depreciation, and rents that are stable to rising; and an inability to hike prices without seeing customers flee.
“We do believe this is not a structural kind of change,” Thompson continued. “We think that it is based  upon the economy at this point.”
In other words, what McDonald’s shows is one of the central realities shaping the economy: As long as growth remains depressed and unemployment high, whether in the United States or around the world, inflation probably isn’t the thing that policymakers need to stay awake at night worrying about. [More]

That doesn't mean any end to econopocalytic predictions from those who disagree with our monetary policy. I hear the phrase, "when, not if" in virtually every economic speech to ag audiences. But if "when" is a really, really long time from now, doesn't "if" become more applicable?

I am becoming suspicious that the "hardened" fear of inflation will last much longer than we can imagine. Inflation hawks, like hard-right politicians (significant overlap there, I would suggest), do not have tools for changing their minds. Consequently there cannot be rational, useful debate on actions that could change our approach to our economic problems.

Given the simplicity of the argument, the real questions is who they are trying to convince or, to put it differently, who are the ones who have opposing views on the inflation / unemployment outlook and monetary policy. I see two set of voices that are critical of the current central bank actions. First, there are those scared of inflation, or as Evanst put it, those who are afraid of "unlocking the long-ago-vanquished inflation demons from the dungeon". Given how low inflation has now be for decades and how anchored inflation expectations are, it is difficult to understand where those fears are coming from. The second argument might sound more rational:  if you want inflation to be around 2% in the long-term and given that we know that inflation will be higher one day when the recovery gets stronger, it might be ok to see inflation below target for a significant period of time (while the recovery is weak). But this argument depends on the slope of the Philips Curve. In a world where the Philips Curve is very flat (as it is for all these countries), it is very unlike that any fast reduction in unemployment will bring any significant inflation in the future. Therefore the fear of inflation when the recovery is strong, is not supported by the data either.
The panel discussion left me with a sense that over the years we have developed an unfounded fear of inflation and a very asymmetric view on what is admissible: being below the target is ok, being above cannot even be discussed as an option. And it was refreshing to see voting members of the monetary policy committees of the US Fed, Bank of England and Riksbank saying this explicitly -- it was just the ECB that was missing. [More]

I had thought by now I would be more leery of expecting a future of low inflation, but it seems the response of too many thought leaders virtually guarantees it.

What does "high" mean?...

Record prices in many commodities like sugar and copper feed our availability bias to conclude we are experiencing unprecedented costs. Actually, we are close to where we started over a century ago. But have we shifted long term downtrends for commodities?  This graph gives me pause.

Statistically, most commodities are now so far away from their former downward trend that it makes it very probable that the old trend has changed – that there is in fact a Paradigm Shift – perhaps the most important economic event since the Industrial Revolution. [More]

The instinctive or at lease, accepted response is to smell inflation but as I have pointed out before, it is very hard to have inflation if wages cannot grow - consumption simply shifts because there is only so much money in consumers' hands. With 9% unemployment wage pressure is tough to imagine.  This is pretty much what recent data suggest.


What is striking is the very long term decline has been essentially erased in the last few years. I'm not sure this is a paradigm shift, since energy uses and sources are in high flux. But if it isn't - think about where prices would revert to on the above chart!

Some inflation stings more...

Farmers need to be aware that mere numbers do not convey the way people experience price increases. In fact, the New York Fed has discovered food and gas price jumps get up our noses more so than other increases, despite the absolute costs.

In sum, our research shows that expectations of higher nominal wage growth or concerns about increased growth of nominal government debt are unlikely to be behind the recent increase in short-term inflation expectations reported in the Michigan Survey. Instead, we suggest that this rise in inflation expectations reflects two factors: (1) sharp expected increases in food and especially gasoline prices and (2) the use of a survey question (“prices in general”) that results in reported expectations being more sensitive to these types of price change. An important open question concerns the extent to which households act on their expectations of overall inflation as well as on their expectations of specific price changes. As noted earlier, one significant area in which inflation expectations may influence consumer behavior is in the wage negotiation process, but thus far neither the “prices in general” nor the “rate of inflation” measure appears to be feeding into increases in expected future wage growth. We hope to return to this open question in a future post. [More]

The good news (sorta) is due to still-slack labor demand general inflation is constrained. Without wage increases consumption must fall forcing prices back down.

For inflation expectations to begin spiraling upwards, price increases must be sustainable. And for price increases to be sustainable, they must be matched by wage increases; otherwise real purchasing power falls, consumption pulls back, and the economy weakens until prices adjust downward. Given the state of the American labour market, there is very little upward wage pressure, and therefore very little risk of a wage-price inflation spiral. [More]

But when people start lifting their inflation expectations - which then alters their spending patterns - it is more often due to the perceptions formed by filling the tank and shopping for food.


This is why our sector may be subject to more and perhaps disproportionate criticism about prices.

Why our "10%" brag is mostly spin...

I've been irritated for years about the constant hammering that - thanks to us - consumers only spend 10% of their income on food.

First of all it uses AVERAGE income, which most economists think distorts the picture since nearly 2/3 of Americans earn LESS than average income.

Second, food prices are not determined for the most part by subsidized corn, wheat, etc. and when the are they are in the wrong way: dairy, sugar.

Finally, the poor (who farmers don't like to talk about much) face the problem of inelastic demand.

The financial restraints on lower-income consumers mean they have less flexibility when food and energy prices climb. Families making $15,000 to $20,000 a year use 19 percent of their after-tax income for food and those earning $20,000 to $30,000 typically use 18 percent, compared with 8 percent for families earning more than $70,000 annually, according to the Labor Department's 2009 Consumer Expenditures Survey, released October 2010. [More]

Income inequality is getting worse, so these extremes will be widening. At this rate, farmers will be talking about how lucky consumers making over $200,000 are to have our farm program, while not looking at the other 80%.

While these inequalities are not the fault of agriculture, exploiting them deceptively for self-promotion is - as my father would put it - sharp practice.

We really, really need to know more about who we serve. And care a little more.

We are the fuel...

If it has not been made abundantly clear to farmers how they are linked to the popular uprisings exploding (and I don't think that is hyperbole) across the Mideast, let me belabor the point.

It's about commodity prices and food, as much as dictatorship.

Of course, prices rose during the Egyptian protests only to fall back as it became clear that Mr Mubarak would depart without significant civil unrest. The same thing could happen this time around. But as the popular uprising gains momentum and moves across borders, bigger issues may loom. Iran is home to a restive opposition movement—and over 10% of the world's proven oil reserves. And if China were to catch the fever for democracy? It's difficult to know how that might impact the global economy. China makes up a much larger share of global activity than it did in 1989.
Amid all the uncertainty, one thing does seem clear: events have a way of building on themselves. The combination of high unemployment and rising commodity prices has fueled dissatisfaction across the Middle East. The resulting unrest is influencing commodity prices. And that, in turn, may make life more difficult for marginal households in other countries, setting the stage for still more political upheaval.
One watches and hopes for the best. But leaders of more stable countries need to be working hard to make sure they're prepared for the economic impacts of something less than that. [More]

In short, it looks to me that the unpredicted rise in food commodities has been so abrupt and injurious to so many, that political triggers have been tripped. The corrupt political regimes there barely coped with a semi-stable global economy. They have no capability of addressing a real challenge, and that is now baldly apparent to their people. For example, they don't even have the political skill to address the public with the spin and persuasion we routinely expect.

In Sayf-Al-Islam's rambling speech last night on Libyan State television, he blamed the current unpleasantness in his country on, as near as I can determine, crazed African LSD addicts. 

This isn't going down as well as Sayf had intended, and Libya seems less stable than 24 hours earlier.  Indeed, Sayf's off-the-cuff remarks managed to make Hosni Mubarak's three speeches seem like a model of professionalism, which I would not have thought was possible a week ago.  

Indeed, it is striking how utterly incompetent leaders in Tunisia, Egypt, and Libya have been at managing their media message.  Speeches are announced, then never delivered on time, and then delivered with production values that woulds embarrass a public access channel in the U.S.  It's like political leaders in the region have discovered blogs just as the young people has moved on to Twitter or something.  [Er, no, that's the United States--ed.]  Oh, right. 

Having just finished a week of intense media whoring, methinks that one problem is that most of these leaders have simply fallen out of practice (if they were ever in practice) at personally using the media to assuage discontent.  I've been on enough shows on enough different media platforms to appreciate that there is an art, or at least a tradecraft, to presenting a convincing message in the mediasphere.  Authoritarian leaders in the Middle East are quite adept at playing internal factions off one another.  That's a different skill set than trying to craft a coherent and compelling media message to calm street protestors no longer intimidated by internal security forces. [More]

He-Who-Must-Not-Be-Spelled provided an equally bizarre public performance last night. This is the backdrop grain traders are trying to game. Meanwhile, we are moaning about why we didn't hold onto our crops.

Thank goodness, we didn't. Like ethanol plants which will run out of $4 corn contracted in Dec 2009, the food industry is just beginning to adjust to higher input prices. This volatility takes some time to be felt, but it does impact the system.

3. The current 12-month inflation rate for finished consumer foods in January of 3.8% is only slightly higher than the 3% average over the last ten years, and is lower than six of the months over the last year, e.g. 4% for November, 4.6% for September, 5.7% May, 6.6% March, etc.

4. The average inflation rate for finished consumer foods over the last 12 months of 3.9% is lower than the 6.7% average from 2007-2008. 

MP: Perhaps this explains some of the disconnect between all of the news reports about rising wholesale and commodity food prices globally, but no signs yet of rising consumer food inflation (1.5% CPI food inflation through December 2010).   [More]

As demand and supply (in that order, I think) of meat forces prices higher, US consumers may be some of the last to become restive about food prices. Nonetheless, I believe it will come, and the obvious targets will be ethanol and farm subsidies.

And if the protests in the Midwest are mildly successful or even sufficiently disruptive, I would not rule out food-price rallies in Washington.

Gold and inflation...

One of the favorite indicators of inflation hawks has been gold prices. But as Scott Sumner points out, gold is a case unto itself.

Again, I don’t doubt that there are individual investors fooled by news stories of massive monetary base increases and huge deficits, who think that high inflation is just around the corner.  Not many average investors know that the same thing happened 15 years earlier in Japan, with no inflationary consequences.  But I believe the best point estimate of the market’s consensus inflation forecast comes from the CPI futures market, as well as the TIPS spreads in the T-bond market. [More]

As he explains in the cited post, demand from India and China, along with decreasing production means the global gold market is not dominated by inflation fears here in the US, but by much larger forces. In fact, my suspicion is as newly, albeit moderately,  affluent citizens in developing economies look for somewhere to stash extra moola, they stay pretty close to tangible wealth, not unlike our own forebears who bit on dollars to see if they were real gold.  It will be a while before they trust arcane investments like say REITs or swaps.

A more powerful mover of inflation in the US would be oil prices.  And speaking of which, the rally continues.

Benchmark oil settled up $1.19 at $89.19 a barrel on the New York Mercantile Exchange. It's the second time in less than a month that oil has reached the level where it was in the fall of 2008. There are widespread expectations that the price will hit $90 a barrel by year's end and head toward $100 a barrel by next spring when traders begin looking ahead to the summer driving season. [More]

Still, I think we have passed a tipping point on oil being able to dominate our economy. Higher prices would not have the effect we have previously endured as Americans are getting better at curtailing use on their own.  And it's not like we have full employment with people being paid to commute vast distances just to get the bodies.

Nonetheless, I'm filling every tank up right now.

The Inflation Watch (yawn)...

Nope - all quiet on the monetary front.

[More]

More seriously, it is important to remember that there is a very real penalty to betting on inflation year after year. "Just-you-waiters" may place themselves in costly positions by ignoring reality to hold onto their now several-years-old hysterical warnings.

For example, it is really hard to imagine interest rates being forced up by wage pressure with 9+% unemployment. Tell me when that is going to drop and then I'll believe.

The bad news is the power of money to earn a return passively.  Sooner or later, investors will have to take a chance.

Even lower...

I have looked into long-term mortgages to restructure debt and improve our farm transition and our retirement.  While looking at some historically low offers on interest rates, believe it or not, I think they could go even lower.  At the very worst, I don't think there is a huge rush in order not to miss rates touching bottom and bouncing up. To buttress my case:

First, this bit of research from the Fed.

A recent study by the Federal Reserve (The Depth of Negative Equity and Mortgage Default Decisions by Bhutta, Dokko and Shan) investigated the question: at what point do underwater homeowners “strategically default” on their mortgages? Surprisingly, it found that the average borrower doesn’t walk away from his home until negative equity reaches a very high level, -62%. But the fascinating thing was that there was something that could trigger underwater borrowers to default much, much earlier – and that something was an interest rate rise.
With a quarter of US mortgages underwater, and likely to stay that way for some time, the Fed must follow its own research if it wants to prevent a cascade of defaults. Hence, expect US interest rates to stay ultra low for an ultra long time. [More]

Second, the strong likelihood that stimulus measures are over, and austerity is the political flavor of the month.  This will seriously slow or stop the economic recovery right in its tracks, I believe.

From Alec Phillips at Goldman Sachs (no link):

Congress looks increasingly unlikely to extend ay more fiscal aid to state governments, despite ongoing shortfalls in state revenues, and they have already let several other items lapse. We are therefore removing from our estimates an assumption of further fiscal stimulus beyond the policies in law (including this week’s unemployment extension), though we continue to expect extension of most of the expiring 2001/2003 tax cuts. This adds almost a full percentage point to the drag on growth from Q4 2010 to Q4 2011 to what we had already estimated.

[More]

This seems likely to me with unemployment stagnant and demand dismal.
Third, there are more calls for Fed action in the face of fiscal anticipated pro-cyclical action to stimulate demand and get credit flowing.  And Bernanke is keeping them in mind.

Bernanke outlined the further actions he had in mind: cutting the interest rate paid on bank reserves, strengthening the Fed's promise to keep short-term interest rates low for the foreseeable future, or buying enough mortgage securities to replace those that are paid off. If the economy appeared at serious risk of returning to recession, the Fed would consider large-scale purchases of Treasury bonds or mortgage-related securities. [More]

Finally, Fed inflation expectations continue to hint of near-deflation for forseeable future.

 As a follow up to my recent post on the Cleveland Fed's update on its expected inflation series, I have graphed below the expected inflation curve.  This curve plots the average expected inflation rate at various yearly horizons using the Cleveland Fed data. This figure makes clear that inflation expectations are headed down across all horizons. [More]

As always, I am not advocating mimicking my actions, just letting you know how I see it. Place your own bets. I have been hearing from inflation hawks (with reasonable arguments) for nearly two years warning of skyrocketing interest rates only to watch them tumble to an effective less-than-zero for most savers (rolled over a CD lately?)

All the trends in our recent economy have taken longer to reverse than we expected from history or theory.  I'm not sure why, but from the stock market to house prices, it seems even when unsustainable trends emerge, they wear out the patience of those who just know they can't continue.

Hyperinflation Warning!!...

Just kidding.

The cost of living in the U.S. unexpectedly dropped in April for the first time in more than a year, reinforcing forecasts that the Federal Reserve will keep interest rates near zero for much of 2010.
The 0.1 percent fall in the consumer price index was the first decrease since March 2009, figures from the Labor Department showed today in Washington. Excluding food and fuel, the so-called core rate was unchanged, capping the smallest 12- month gain in four decades.
Retailers such as Wal-Mart Stores Inc. are cutting prices to bolster sales as customers face almost 10 percent unemployment and rising foreclosures. The European debt crisis, which has pushed up the value of the dollar and may restrain global growth, will probably further depress prices at a time when inflation is already running below Fed policy makers’ projections.
“There simply isn’t any kind of price pressure of any consequence,” said David Resler, chief economist at Nomura Securities International Inc. in New York, who accurately forecast the decline. “This puts the Fed firmly in place for the foreseeable future.” [More]

I probably shouldn't ping on this too much, but virtually all Deficit Doomsday scenarios depend on a plummeting dollar and runaway prices for their scariness.  What seems to keep happening is the US economy manages to look slightly less ugly than the other choices, and the scare talk may actually reinforce the flight to US-denominated safety.

This doesn't mean inflation isn't a threat, but it sure isn't going to catch us by surprise.

Watching the wrong chart...

Many folks upset at the "trilions and trillions" of dollars in liquidity pumped into the global economy to replace consumer demand are poised in breathless anticipation of inflation or even hyper-inflation.  Every day I become more convinced they are looking at the wrong numbers.

Indeed, even the most vigilant inflation hawk, would be hard pressed to show much evidence of consumer inflation - a rise in the price of goods and services.

But meanwhile, asset inflation is brisk indeed.  Consider stocks, for one.

The CHART OF THE DAY displays a price-earnings ratio for the Standard & Poor’s 500 Index that’s based on average profits for the past decade, as compiled by Yale University Professor Robert Shiller. Grice used the data to reach his conclusion, outlined in a report today.
Shiller’s cyclically adjusted ratio stood at more than 20 times earnings this quarter as the S&P 500 headed for a fourth straight quarterly gain, the longest winning streak since 2007. The index rose 5.2 percent through yesterday.
“The risk is there -- as it always is -- but the returns aren’t,” Grice wrote. The Shiller P/E is within the highest of five ranges since 1881, when his calculations begin, the report said. When the S&P 500 was similarly expensive, returns averaged 1.7 percent a year for the next decade, according to Grice. The comparable figure for the lowest range was 11 percent.
Stocks also cost too much relative to “intrinsic value,” based on his projections for earnings and asset values. He made that judgment after analyzing shares of non-financial companies in the FTSE World Index, a benchmark for developed markets. 

 [More]

Another closer to home data point is farmland. I think it qualifies because the returns (rents) are not keeping pace with values.  In other words, the p/e is creeping upward.

Why do we have this new kind of inflation?

I have a very simple answer to this question: Follow the money. Whether an economy generates asset price inflation or consumer price inflation depends on the details of to whom cash flows. In particular, cash flows to the relatively wealthy lead to asset price inflation, while cash-flows to the relatively poor lead to consumer price inflation.
Why? In Keynesian terms, poorer people have a higher marginal propensity to consume. The relatively poor include people who are cash-flow constrained — that is they cannot purchase what they wish to purchase for lack of green, so their marginal dollar gets immediately applied to the shopping list. Also, poorer people may be different, there may be a correlation between poverty and disorganization, lack of impulse control, inability to defer gratification etc. Think of Greg Mankiw's Spenders/Savers model.
Except when the world seems very risky, no one holds cash for very long. Poorer people disproportionately use their cash to purchase goods, while richer people disproportionately "save" by purchasing financial assets. If the supply of both goods and financial assets is not perfectly elastic, then increases in demand will be associated with increases in price. If relative demand for goods and financial assets is a function of the distribution of cash, what price changes occur will be a function of who gets what. [1] [More]

This is an indicator of income distribution.  Until most consumers get income increases, I can't see consumer inflation picking up steam, which means there will be less reason to raise interest rates and also more reasons to invest in non-monetary assets like land and stocks.

In short, we may have a positive feedback loop set up that will baffle policy makers and investors for some time to come.

Inflated worries...

Several separate pieces of information coalesced in my sinus-packed head today about a nearly inchoate fear I feel running through much of the farm economy.

Inflation is coming! Alas, Babylon!

I'm not the only only one who seems to be hearing this either. John Roach, whose newsletter I find to be one of the calmer voices in the ag marketing advice arena, offered this comment yesterday morning.

During our recent seminars we encouraged farmers to sell more of their 2010 crops than normal and pieces of distant years’ crops. Farmers’ largest concern voiced about making sales, was their worry about inflation.

Quite frankly we think farmers are too worried about inflation. The greater worry should be over production driving crop prices down not inflation driving inputs up. How many times in your history of farming has inflation been the reason profits have turned to losses on the farm? For many it has really happened only once…..in 2008.

We believe the bigger concern about profits on the farm should be, “I worry that strong profitability and a positive grain outlook has brought increasing amounts of capital to agricultural production around the world.” Capital investments are increasing acreage in South America and increasing yields in the former Soviet Union countries. We are headed toward surplus supplies as fast as Mother Nature will allow. Every farmer in the world is working as hard as he or she can spending more money than ever to create those surpluses.

We am not trying to get anybody to rush out and sell everything. Quite the contrary, our thought is spacing out sales over the spring Sell Signals will be the right approach this spring as it has been for the vast majority of the past 30 years. But, too many farmers are telling me they are afraid to make 2010 sales let alone anything beyond because they are so worried about inflation.

In fact, we often hear warnings about excess liquidity due to all the government stimulus flooding the markets for everything and driving prices skyward. And we keep hearing them, and have for years now - good times and bad.

So where is it?

From the BLS report on the Consumer Price Index this morning:

On On a seasonally adjusted basis, the January Consumer Price Index for All Urban Consumers (CPI-U) rose 0.2 percent ...


The index for all items less food and energy fell 0.1 percent in January. This decline was largely the result of decreases in the indexes for shelter, new vehicles, and airline fares.

Owners' equivalent rent (OER) declined 0.1% in January, and is declining at about a 1% annualized rate. OER has declined for five consecutive months (a record) and is important because it is the largest component of CPI.


Based on reports of falling rents - and a near record high apartment vacancy rate, OER will probably decline for some time, keeping core CPI low and possibly negative this year. Also - falling rents will push up the price-to-rent ratio, and put additional pressure on house prices.[More - apologies for total excerpt]

Even more dramatically:

[Source]

Some evidence exists to support a credible position that deflation remains a significant threat.

I have written frequently about the odds of both, and usually favor inflation, but maybe the better expenditure of time would be to actually try to envision what inflation might look like, regardless of how/when it arrives.

Suppose the CPI is announced at 5%.  Does this mean everything we buy is 5% higher?  I think that is the flaw in our expectations - we are fooled by overall numbers, when inflation occurs in different goods and services at different rates.

So given how the CPI is calculated, YOUR inflation rate could be another number altogether.  For instance, for Jan and I, several CPI components don't affect us much:

• housing costs (mortgage paid off)
• higher education (kids through college)
• food (only the two of us, big garden)
• transportation (I drive a 4 yr old Vibe, for Pete's sake)

and so on.  On the whole those who consume less see less inflation - duh. [Notable flaw in this argument: medical care costs, especially drugs - for four more years, anyway]

So even if the did revisit '70s type inflation, it may not be as bad for us as many younger families, for example. But we would and will, I believe, see asset inflation - like farmland and machinery.

In fact, I think what is happening is folks are captivated by One Big Thing they remember from Econ 101, best expressed by Milton Friedman's phrase "too much money chasing too few goods".  Only we don't have too few goods and services and could easily come up with more by importing or hiring a few laid off workers or utilizing slack capacity.

[Source]

Even more important is all those billion of "excess" liquidity aren't showing up in the money supply.

[Source]

In fact, this money is piling up in banks with skittish leadership too afraid to lend even as loan demand weakens.

[Same source]

As more banks fail, and bank officials grow more nervous about new regulation and reserve requirements, I don't see that wealth leaving their vaults very soon.  In fact, agriculture may be one of the few sectors with "decent" access to funds for borrowing.

But my current overriding reason for discounting the chance of inflation that could inflict serious damage on my finances is everybody is talking about it and has likely already shifted markets to make it less likely.  When more folks adopt a blase attitude about the outlook for inflation - then we'll have the pieces in place for its emergence.