Last week, headlines and pundits were hot and bothered about the potential for the Federal Reserve to fall behind the curve on inflation. While my on-going assumption is that the Fed will indeed chose much higher inflation rather than risk ending the economic recovery with higher rates, I think the current hand-wringing by some is premature. In fact, it seems more the result of either boredom with the Fed’s business as usual policy stance and/or the anxiety on the part of some stock market bears looking for any kind of catalyst to shake the market out of its low volatility slumber.
I was so surprised at all the hand-wringing over a “business as usual” policy statement that I rolled the tape on the press conference. I was wondering what I missed, I actually listened to the conference call a second time (yes, it was painful). The experience made me even more convinced the market over-reacted just as much as it did when Yellen carelessly suggested rates might increase earlier than the late 2015 market projection.
Recent inflation numbers apparently increased expectations that the Fed might show a more hawkish tone. This is reflected best in the first question of the press conference from Steve Liesman of CNBC:
“Is every reason to expect, Madam Chair, that the PCE inflation rate, which is followed by the Fed, looks likely to exceed your 2016 consensus forecast next week? Does this suggest that the Federal Reserve is behind the curve on inflation? And what tolerance is there for higher inflation at the Federal Reserve? And if it’s above the 2 percent target, then how is that not kind of blowing through a target the same way you blew through the six and a half percent unemployment target in that they become these soft targets?”
This was a leading question, especially considering that Yellen made it very plain in her introduction that the inflation readings remain benign. Moreover, long-term expectations for inflation remain tame (also see the Fed’s latest projections). Most importantly, the year-over-year change in the PCE, the Personal Consumption Expenditure, reached the 2.0% target in early 2012 only to quickly plunge from there. Not only might it be premature to project a 2% reading for next week’s release, but there is nothing to suggest that this time is different. The Federal Reserve has the least control over the non-core prices of food and energy, so the escalation of violence and turmoil in Iraq is definitely not the kind of event that the Fed would try to offset with monetary policy.
The Fed still can’t tease the market into sustaining pre-recession inflation levels…
Source: St. Louis Federal Reserve
Perhap’s Yellen’s poor response ignited the flames of disappointment. Yellen did not address PCE directly and instead talked about the noise in the Consumer Price Index (CPI) while reiterating the Fed’s standard guidance on inflation:
“So, I think recent readings on, for example, the CPI index have been a bit on the high side, but I think it’s–the data that we’re seeing is noisy. I think it’s important to remember that broadly speaking, inflation is evolving in line with the committee’s expectations. The committee it has expected a gradual return in inflation toward its 2 percent objective. And I think the recent evidence we have seen, abstracting from the noise, suggests that we are moving back gradually over time toward our 2 percent objective and I see things roughly in line with where we expected inflation to be.”
Ironically, Yellen could have just pointed to the longer-term trend in the CPI. This view dominates any shorter-term noise….
The overall trend on CPI continues to point downward
Source: St. Louis Federal Reserve
The most bizarre part of the buzz on the Fed’s supposed willingness to ignore inflation is that Yellen re-affirmed, re-emphasized that the Fed is all about meeting its price target. It will not tolerate deviations in EITHER direction for long:
“…we would not willingly see a prolonged period in which inflation persistently runs below our objective or above our objective and that remains true. So that hasn’t changed at all in terms of the committee’s tolerance for permanent deviations from our objective.”
This was Yellen’s response to Liesman asking about the Fed’s tolerance for higher-than-target inflation.
I feel irony in my skepticism about a Fed ignoring a budding inflation threat: this is the core scenario that has kept me long-term in the gold (GLD) and silver (SLV) trades. My thesis/assumption back in 2009/2010 was that the Federal Reserve would be extremely reluctant to tighten policy even as the economy strengthened out of fear that rate hikes would quickly kill the economy. By the time the Fed was ready to hike rates, the “inflation genie” would already be out the bottle. Granted, I am not nearly as rabid about this view, especially since I have come to appreciate the deep entrenchment of the lingering post-recession deflationist psychology in the economy.
So, overall, I am very skeptical that this episode is the long-awaited lift-off of inflation and a lagging Fed. I actually think the Fed is right to look through the current “warming” in inflation readings, and I think it will find vindication just as the Bank of England did during a similar episode under former Governor Mervyn King. When the Fed asks “what inflation”, I find myself surprisingly agreeing for now…
To me, the data do not support the notion that broad-based inflation is taking hold in the economy. We do not even have wage pressures, not to mention all the slack that remains in the economy as evidenced in part by extremely low levels of housing production. Just do a web search or read mainstream financial magazines to see anecdotally how many people are still worried about the sustainability of the so far very weak housing recovery. I find it hard to believe we will get strong inflation with all this weakness and deflationary fears. On the commodity side, copper and iron ore have experienced major price declines in recent months that also fly in the face of any kind of sustained inflationary pressure in the economy.
Full disclosure: long GLD, SLV.
On February 7th, The Monetary Policy Committee (MPC) of the Bank of England (BoE) decided to leave interest rates at the rock bottom rate of 0.5%. In doing so, the MPC acknowledged that it was assuming that the current stubbornly high inflation would eventually return to the target 2%. The MPC is expecting productivity gains and the reduction in external price pressures to do the trick.
“Inflation has remained stubbornly above the 2% target. Despite subdued pay growth, weak productivity has meant no corresponding fall in domestic cost pressures. And increases in university tuition fees and domestic energy bills, largely resulting from administrative decisions rather than market forces, have added to inflation more recently. CPI inflation is likely to rise further in the near term and may remain above the 2% target for the next two years, in part reflecting a persistent inflationary impact both from administered and regulated prices and the recent decline in sterling. But inflation is expected to fall back to around the target thereafter, as a gradual revival in productivity growth dampens increases in domestic costs and external price pressures fade.”
I took particular interest in the claim that external price pressures will fade. To do so, the global economy would have to remain weak. If so, then it is unlikely that growth in the UK will fare much better, even at the projected “slow but sustained” pace. The other possibility is that the British pound or sterling – CurrencyShares British Pound Sterling Trust (FXB) – appreciates enough that external prices go back down. If so, then Mervyn King’s hopes of rebalancing the economy with a reduction in demand for imports and an increase in exports surely will not be realized.
Adding to this conundrum for the UK economy is the stubborn persistence of weak economic growth (mainly flat) along with strong employment growth. The UK economy is getting less and less productive and thus less and less capable of offsetting inflationary pressures. This is a dynamic that I will be watching ever more closely given the BoE projects a two-year horizon over which the economy will continue to suffer high inflation and weak economic growth (aka stagflation). The implication for the currency is mixed, and I continue to expect “more of the same” for the pound.
On June 14th, the United States Department of Agriculture (USDA) released its 2011 cost estimates for raising children in the U.S. (see “A Child Born in 2011 Will Cost $234,900 to Raise According to USDA Report“). According to this report, the average cost of raising a child in the U.S. rose 3.5% from 2010 and rose 22.5% from 1960 (in 2011 dollars), the first year these data were collected. (Note the USDA cautions that its methodology has changed over the years so comparisons between now and 1960 are not “precisely comparable). The share of expenditures has changed dramatically in certain categories like child care and education, food, and health care. The following chart is from the end of the publication (click image for a larger view), and it demonstrates the big differences in how children are raised now versus 50 years ago:
The amount families spend on children varies greatly based on household income, so these averages hide even more interesting stories. For example:
“A family earning less than $59,410 per year can expect to spend a total of $169,080 (in 2011 dollars) on a child from birth through high school. Similarly, middle-income parents with an income between $59,410 and $102,870 can expect to spend $234,900; and a family earning more than $102,870 can expect to spend $389,670.”
It is clear from the report that the costs increase according to income because of choices families make. Thus, it is not quite accurate to say child-rearing gets more expensive with income. Instead, families tend to choose to spend more on their children the more income at their disposal.
Read/download the full report here.
James Hamilton posted a quick study of the impact of oil prices on car sales in “Oil prices and the U.S. economy” in EconBrowser. Hamilton demonstrates from recent history that once the economy has made an adjustment to high oil prices, a subsequent price run will not impact the economy until it reaches new highs. In other words, oil prices must force the economy (consumers and businesses) to make new adjustments before a significantly negative impact occurs. Auto sales already greatly favor more fuel efficient vehicles, thus blunting the traditional drag on the auto sector as consumers shun bigger, gas guzzlers.
Oil’s relative share of consumer expenditures is another factor to consider. Amazingly, energy’s overall share of consumption has declined as gas prices have soared in recent months.
For more detail and data see “Oil prices and the U.S. economy“
Several times on these pages, I have “celebrated” various confirmations of reflation as indicated by the soaring salaries of CEOs, largely through stock-based compensation. On October 10th, the New York Times printed the results of a study that confirmed what many of us already knew from informal observation: the wages of U.S. workers have fallen at a faster rate than they did during the recession. This “deflation” is working in the exact reverse of the trend for those who who hire these workers and run their companies! From “Recession Officially Over, U.S. Incomes Kept Falling” (NY Times via CNBC):
“Between June 2009, when the recession officially ended, and June 2011, inflation-adjusted median household income fell 6.7 percent, to $49,909, according to a study by two former Census Bureau officials. During the recession — from December 2007 to June 2009 — household income fell 3.2 percent.”
This is a sobering statistic that has potentially dire implications for the economy in general. Compare this situation to that in China where an on-going study in the New York Times concludes that China’s government has propped up its banks and large corporations at the expense of Chinese workers (see “As Its Economy Sprints Ahead, China’s People Are Left Behind.”):
“Under an economic system that favors state-run banks and companies over wage earners, the government keeps the interest rate on savings accounts so artificially low that it cannot keep pace with China’s rising inflation. At the same time, other factors in which the government plays a role — a weak social safety net, depressed wages and soaring home prices — create a hoarding impulse that compels many people to keep saving anyway, against an uncertain future.
Indeed, economists say this nation’s decade of remarkable economic growth, led by exports and government investment in big projects like China’s high-speed rail network, has to a great extent been underwritten by the household savings — not the spending — of the country’s 1.3 billion people.
This system, which some experts refer to as state capitalism, depends on the transfer of wealth from Chinese households to state-run banks, government-backed corporations and the affluent few who are well enough connected to benefit from the arrangement.”
Neither system, in the U.S. or China, appear stable to me. With China dependent on the income (or rising debt) of U.S. workers to keep its exports alive, these systems of increasing inequity actually start to look increasingly unstable. I will be monitoring these processes even more closely going forward. They are certainly deflationary, not inflationary.
The spotlight is shining bright these days on executive pay. I have cited several stories regarding the tremendous increases in executive pay that occurred in 2010 that resoundingly reversed (and then some) stagnation and sometimes declines in executive pay in 2009. (See for example, “Pay rises 13% for CEOs at Canada’s top 100 public companies” and “CEOs recover all the pay they lost during the recession” or review articles under the category “Salaries“).
This weekend, I noted two state-based stories on executive pay that demonstrated how dramatic a turn-around has occurred in the pay for specific executives.
In “Lucrative paydays for corporate chiefs“, the Atlanta-Journal Constitution reports:
“Here’s one measure of just how good it was: $232.9 million.
That’s the total compensation that the chief executives at Georgia’s 25 most-valuable public companies took home last year, according to The Atlanta Journal-Constitution’s review of the annual disclosures required by the Securities and Exchange Commission…
Here’s another measure of just how lucrative 2010 was: 29 percent. That’s the average pay raise the 25 executives saw last year.”
In “Arizona CEO’s median compensation surged 48% in 2010“, The Arizona Republic reports:
“Sparked by rising profits and rebounding stock prices, the median compensation for chief executive officers and chairmen at Arizona-based public companies surged 48 percent in 2010, hitting a statewide record of $1.54 million.
Plus, hefty pay packages were shared more broadly by other top officials at 43 corporations based in the state. Some 74 senior executives below the CEO level earned at least $750,000, up from 63 who earned that much the year before.”
In both cases, compensation swelled partially thanks to a strong rebound in the stock market, meaning that corporate executives have greatly benefited from the reflation generated by economic stimulus and/or monetary easing. As I have mentioned in previous posts, strong corporate profits have supported all forms of equity-based wealth and effectively beat back the ghosts of deflation in 2010.
Of course, the huge irony is that poor employment reports and stagnating personal income data tell a different story. For example, after Friday’s awful jobs report and the on-going dire news coming from the housing market, you would be excused for assuming the entire country had dipped back into a poverty-stricken recession. Such is definitely not the case for the big winners of 2010.
Nightly Business Report produced a short video segment describing China’s inflation woes (transcript included) called “China’s Inflation Battle.” The commentator identifies China’s RMB¥ 4 trillion stimulus program (about $585B USD at the time) as the original source of the inflation and takes us to Pengshui, 1000 miles from Beijing, to see some of the examples of how inflation is impacting the lives of the average Chinese person.
The most interesting quote came from Associate Professor Patrick Chovanec of Tsinghua University, School of Economics and Management:
“When you see over 50 percent growth in the money supply, the question isn’t, why is there inflation? The question is, why isn’t there more inflation? Why haven’t we seen it sooner? The reason is because a lot of that money didn’t go into a consumption boom. It went into an investment boom.”
It is a scary thought to think inflation problems could (will?) get even worse once the Chinese figure out how to make use of all this massive investment.
America’s CEOs have been rewarded for performance that has driven corporate profits to record levels.
“The typical pay package for the head of a company in the Standard & Poor’s 500 was $9 million in 2010, according to an analysis by The Associated Press using data provided by Equilar, an executive compensation research firm. That was 24 percent higher than a year earlier, reversing two years of declines.”
“Executives were showered with more pay of all types — salaries, bonuses, stock, options and perks. The biggest gains came in cash bonuses: Two-thirds of executives got a bigger one than they had in 2009, some more than three times as big.”
This situation presents an odd dichotomy. The housing market remains moribund and likely double-dipped, the unemployment rate and jobless situation has shown little improvement in many, many months. Yet, corporate profits and CEO pay could not be better. Even as the Federal Reserve seeks to keep monetary policy loose and accomodative, I suspect the current momentum will continue as companies continue to make hay with what they’ve got: more jobless profits…
As is said when the Fed prints money, it has to go somewhere. We have found one more resting spot for that fresh cash!
And now for a different perspective…
In CNBC article “Data Double Take: Inflation for Majority of Economy at Record Lows“, David Rosenberg, chief economist & strategist at Gluskin Sheff, argues that inflation is not a threat in the U.S. because the service sector’s rate of inflation is at historic lows. Moreover, companies in the service sector have no pricing power and workers are unable to earn higher wages. These arguments all run counter to other findings demonstrating that CPI from any angle is pointing to inflation in the near future.
The most interesting claim in the article is that the Federal Reserve’s printing press is, in effect, churning out fresh dollars at no cost:
“The Fed may be printing money, but it’s not multiplying through the economy like it once did. That’s because banks are not using it to extend credit, said the economist. Also, our economy has generally become more resistant to the Fed’s reflation powers because of productivity gains from technology and globalization, the doves say.
‘The money multiplier has been broken for quite some time, and recently it is going lower,’ said Brian Kelly, of Brian Kelly Capital, citing money supply data that for every $1 pumped into the economy only 76 cents is being created. ‘In effect, monetary policy has been losing its potency for 30 years. What the Fed is doing now is stepping on the gas while the tires spin in the mud.'”
I would love to see more data on that because over those same 30 years the Federal Reserve’s monetary accommodations have been credited with creating shallow recessions before 2008, averting a complete financial meltdown in the last recession, and, most recently, driving stocks on a 30% rally since late summer of 2010. Of course, easy money from the Federal Reserve has also been blamed for assisting and outright creating the our triple bubbles in tech stocks, housing, and credit.
It seems that one’s inflation expectations often hinge on the imagination: either you believe the generally accepted inflation data as indicative of a tame future inflation outlook, or you look at specific (even pervasive) examples of inflationary pressures as warnings of what is to come. I have clearly been in the latter camp.
The Institute for Fiscal Studies (IFS) released a study on March 21 noting that the recession and recovery period in the United Kingdom from 2008-2011 marked “…the first time that incomes have fallen over a three-year period since the three years from 1990 to 1993, and the biggest three year drop in real living standards since 1980-83.” Real household incomes fell a total of 1.6% over this time whereas in “normal” periods the typical UK household experiences an average income gain of 1.6% per year.
Inflation racing ahead of wage gains was cited as one of the most important factor contributing to this historic decline. Lower interest rates for savings had a large impact on the standard of living for retirees.
Deflation on earning power and inflation in the cost of household purchases has placed a double squeeze on UK residents. In this context it is interesting to note Bank of England governor Mervyn King lamentations during last month’s conference call to defended monetary policy in the latest Inflation Report. King partially defended the on-going accomodative monetary policy in the face of inflation stubbornly above the inflation target of 2%. King asserted that the recession was going to reduce the standard of living either through deflation of wages (impact from the economy) or the increased prices of purchased goods (impact from monetary policy). In his view, this adjustment appears inevitable. However, this recent study by the IFS seems to suggest that in trying to choose the “least bad” option, the UK may end up stuck swallowing both bad options.
While Federal Reserve Chairman Ben Bernanke comfortably dismisses rising food prices as a transient phenomenon that has not perturbed inflation expectations, many of America’s poor are finding that food inflation (something I have called “agflation” in the past) is the pest that refuses to leave. In “Rising food prices could drive up rates of hunger“, John Sepulvado of CNN Radio paints a poignant portrait of America’s growing population of hungry poor.
The statistics are staggering but the personal tales of struggle are even more potent. Here is a description of the current life of Wendy Madison of Opelika (emphasis mine):
“…there was a 10-year period where her family was doing well, before her husband Joseph had a massive heart attack. She says her family’s biggest mistake is they failed to plan for such hard times, and didn’t save.
Now, their family of three depends on a little more than $1,000 dollars in disability pay, along with $294.00 in food stamp benefits per month — the equivalent of a dollar per meal. Madison says her food stamp benefits have not increased despite rising food prices. An increase in benefits have been denied repeatedly — leaving the Madisons ‘begging for food while going hungry.’
‘It makes you feel useless,’ Madison says, ‘like your government is waiting for you to die so they don’t have to help you anymore.'”
Regardless of your position on Federal assistance programs, stories such as these are stark reminders that inflation is very real for a significant portion of our country. Another way to think about the issue is that despite all the money the Federal Reserve has printed through QE1 and QE2, very little has yet to get to the people in the most dire need of it, whether through jobs, higher wages, and/or assistance. Yet, this same printing is very likely exacerbating the upward pressure on the items that consume large portions of the budgets of the poor: food and energy.
Steve Hansen at “Global Economic Intersection” presents a compelling case arguing that food prices should be included measures of core inflation (the Consumer Price Index, or CPI). Hansen simply looks at the history of the core CPI excluding food and energy versus CPI for food only versus CPI for energy only and comes to the easy conclusion that “…there is strong correlation between food price increases and the overall Consumer Price Index (CPI)…with only rare periods of exception.”
His closing remarks on the topic are a vivid reminder of one of the many reasons I care so much about “Inflation Watch”:
“Inflation is a very personal enemy for most Americans who live paycheck to paycheck. When your paycheck does not get larger, and the prices go up – you must cut something out of your life. And when Fed Chairman Bernanke says inflation is low – you know that he is addressing the segment of the population which does not live paycheck to paycheck.”
Suddenly, former Federal Reserve chairman Alan Greenspan knows inflation. In fact, he now sees inflation as a real danger. Greenspan discussed a variety of economic topics with a crew from CNBC. I was quite intrigued, and VERY surprised, at his commentary on inflation and even gold. It is as if retirement has brought on an inflationary epiphany. Stepping away from the printing presses of currency has delivered some remarkable clarity…somehow.
Here are some highlights that were of most interest to me (bold emphasis mine):
- Inflation premiums are building up in the “out years”, but none of these indicators (TIPS, out year treasury yields) will tell you when inflation is about to take hold, and certainly not when the bond markets are going to move.
- In 1979, 10-year treasuries were yielding 9% and all the indicators told prognosticators that yields had peaked because the U.S. was not an inflationary economy – over the next 4-5 months, yields went up 400 basis points.
- Greenspan has always been somewhat skeptical of the output gap – the stagflation of the 1970s proved that “it is not an infallible indicator.”
- The general assumption about measures of core inflation is that food and energy fluctuate, but have no trend. That is incorrect.
- Rising incomes have shifted diets toward more protein, requiring more wheat crops while at the same time we are running out of arable land. This will create a long-term uptrend in food prices.
- Concerns over the security of oil supplies will also put oil prices on an upward trend.
- Over the counter derivatives (futures) have encouraged more storage of oil above ground in developed nations, providing a buffer. Otherwise, oil would be even higher right now.
Greenspan’s commentary on gold perhaps hearkened back to his pre-Fed days when he wrote “Gold and Economic Freedom” back in 1966. The quotes below come from CNBC’s transcript of the larger interview. He made these comments after pointing out that both the euro and the U.S. dollar are flawed fiat currencies (imagine what could have happened in currency markets if Greenspan made such an observation while he was Chairman!).
“What the price of gold is saying, is that there elements within the marketplace that feel very uncomfortable with respect to what is going on generally, and its not an accident that you’re finding that central banks are going in to buy gold and one of the reasons is gold is historically one of the rare media of exchange that doesn’t require any collateral or backing, counter signatures, gold is universally acceptable as a means of payment.”
“I’m not saying we can or should go back on the gold standard, that would be extremely difficult, and it would require such cast changes that this society has made no indication that it wants to do that, but I do think to get a sense of the stability of the system, watching the price of gold is not too bad.”
The overall discussion begged the obvious questions on monetary policy. It is not clear to me whether Greenspan’s characterization of existing inflationary pressures compels any changes, especially given these underlying forces are out of the Fed’s control.
Disclosure: author is long TIP and TBT
Gavyn Davies at the Financial Times writes a good review and critique of William Dudley’s recent speech at New York University’s Stern School of Business, New York City titled “Prospects for the Economy and Monetary Policy.”
Davies notes that Dudley, President and Chief Executive Officer of the Federal Reserve Bank of New York, remains laser focused on the output gap and unemployment in the U.S. and relies on them to provide a buffer of comfort versus inflation. Dudley is not worried about other signals of inflationary pressures, like rising commodity prices driven by demand, as long as inflation expectations remain contained. We have shown numerous examples in these pages of how these expectations are actually tilting toward inflation. It remains unclear when the Federal Reserve will also notice.
For more details see “The Fed doves have not caved in.”
A contraction in credit has served as a firm pillar of support for those who still fear deflation is the biggest threat to the U.S. economy. It seems even that pillar is slowly but surely weakening. In “Behind a Rise in Auto Sales, Easier Credit“, the New York Times reveals that loosening credit standards and increased lending have helped boost auto sales over the past year. Michael E. Maroone, the president of AutoNation, is cited as claiming that increased credit was the most important driver of auto sales last year. The statistics from this detailed article are a vivid reminder of how fast consumer borrowing can recover under the right conditions.
Consider these statistics quoted from the article:
- Sales of new cars rose 11 percent, to around 11.4 million, in 2010 and are off to an even stronger start this year.
- More than 859,000 new cars were sold to consumers with a so-called subprime credit rating in 2010, a nearly 60 percent increase from the year before.
- [The packaged consumer loan] market stood at $36 billion in 2008, during the throes of the crisis, but by 2010 it had bounced back to almost $58 billion. Bankers and analysts project that could rise by as much as 15 percent in 2011.
- Over all, lending to subprime borrowers has risen to about 38 percent of the auto finance market, although it is still well below its precrisis highs when it made up nearly half of all loans.
As the NYTimes notes, “…the gradual expansion of credit in virtually every area except real estate is an important sign that the American economy is returning to health.” So while an obsession with housing statistics can mire one in deflationary blues, so many other corners of the economy are flashing much different signals.
CNBC’s Lori Ann LaRocco interviewed Diane Swonk, Chief Economist at Mesirow Financial, about the status of the economy.
Swonk noted that most of her clients are worried about inflation. However, she sees inflation as a two-sided coin. On one side, inflation is squeezing producers, but companies that deal with consumers cannot pass on price increases:
“I remind [my clients] of how little pass through inflation that we have experienced in the last decade.
When I ask them how much they have passed along to consumers and you see a fairly substantial break. There are those who can pass along some of the increase in costs if their clients are other businesses. Those who deal with consumers can’t pass along the increases as easily or are paying the price in volume if they do.”
Swonk also notes that rising oil prices will be destructive for all economies. In particular, higher oil prices will further increase food prices and magnify the suffering of poorer nations, leading to yet more social unrest.
Corporate profit margins have hit record levels, but it seems inflationary pressures are waiting in the wings to send those margins back toward the mean. Zero Hedge summarizes the latest Philly Fed report, pointing out that prices paid less prices received has not been higher since 1979.
- businesses try to increase prices, can’t, and see their margins cut;
- businesses do raise prices, people buy less, and revenue gets hit.
The stubbornly high unemployment rate has convinced many that resistance to price increases is a foregone conclusion. However, I would like to layer on a more nuanced scenario here. Given that increasing employment is the Federal Reserve’s stated goal of its latest quantitative easing program, we should assume that the Fed’s response to either of the above scenarios will be more quantitative easing. If profits or revenues fall, companies will not hire more workers in response. If anything, companies will fire more workers. In other words, even with inflationary pressures building in the economy, especially in scenario #2, the Federal Reserve could actually find more reason to continue adding to those pressures. We may not get a self-reinforcing negative feedback loop, but it will feel close!
The Bank of England already faces this conundrum of accomodative monetary policies even in the face of stubbornly high inflation – but governor Mervyn King has found a lot of comfort in the United Kingdom’s current output gap and a conveniently tame outlook for inflation.
So, what if quantitative easing actually works and increases employment? Well, there should be a lot of increased prices waiting to eat into those newly minted paychecks.
It seems everywhere we look, inflationary pressures are inescapable. Corporate margins may be the last canary in the coal mine…
Looks like Singapore is now feeling some inflation pressure. The small island nation raised its inflation forecast for 2011 and may be forced to raise interest rates.
Bloomberg reports in “Singapore Raises 2011 Inflation Forecast to 3%-4% After Record Expansion“:
“Consumer prices may climb as much as 4 percent this year while exports may rise 10 percent, the trade ministry said today. The economy expanded a revised 14.5 percent in 2010, with gross domestic product growing an annualized 3.9 percent in the three months to Dec. 31 from the previous quarter, it said.”
Bloomberg also quotes Ravi Menon, the permanent secretary at the trade ministry:
“The key macroeconomic challenge this year will not be growth but dealing with emerging cost pressures…At this juncture, we expect these pressures to be relatively contained although there may be some pockets of tightness that we should continue to be watchful for.”
Inflation may be scheduling an autumn arrival in the U.S. The New York Times reports in “Companies Raise Prices as Commodity Costs Jump” that businesses across the economy are chomping at the bit to raise prices soon:
“A package of Oscar Mayer cold cuts. A pair of Nine West boots. A Whirlpool washing machine.
By the fall, people will most likely be paying more for each of them, as rising prices hit most consumer goods, say retailers, food companies and manufacturers of consumer products…
…Many big companies, including Kraft, Polo Ralph Lauren and Hanes, say they cannot hold off any longer and must raise prices to protect some profits.”
While such talk has come later in the economic cycle than we expected, its arrival should be taken seriously. The NYT article quotes analysts who take the other side of the story, for example claiming that consumers will not pay the higher prices. However, with corporate profits at historic levels despite extremely high unemployment, we should not underestimate the inflationary pressures that could stick once companies feel compelled to finally pass on their higher costs to consumers.