Thanks to improvements in crop production, monetary tightening, a slowdown in economic growth rates, and currency appreciation, the trend now appears to be heading down for core and headline inflation in Asia. Different countries are wrestling with different problems, but, overall, economists and analysts quoted in “Food Inflation Begins to Moderate in Asia” seem to be getting optimistic about the prospects for inflation.
The article includes some statistics on the huge difference in price trends on various food items in India:
“The cost of bananas in New Delhi is up 50 percent over the year, while paneer – a form of cottage cheese – has risen 26 percent to 145 rupees per kg.
Yet other food prices are falling. Staples such as tomatoes and potatoes, which peaked earlier in the year at levels that caused great stress to poorer families, have seen prices moderate in recent weeks.”
(Originally appeared in “One-Twenty Two“)
First, Bernanke made it clear he thinks gold is not a good indicator of inflation expectations. Now, the Federal Reserve Bank of San Francisco has produced research that could convince the Fed to insulate itself from the inflation expectations of average Americans in “Household Inflation Expectations and the Price of Oil: It’s Déjà Vu All Over Again” by Bharat Trehan (thanks to Bill Fleckenstein for calling this article to my attention).
Household inflation expectations have risen to 4.5% from 3% at the end of 2010. Fortunately for the Federal Reserve, its empirical research seems to show that household expectations have become inaccurate and irrelevant for monetary policy:
“This Economic Letter argues that the jump in household inflation expectations is a reaction to the recent energy and food price shocks, following a pattern observed after the oil and commodity price shocks in 2008. The data reveal that households are unusually sensitive to changes in these prices and tend to respond by revising their inflation expectations by more than historical relationships warrant. Since commodity price shocks have occurred relatively often in recent years, this excessive sensitivity has meant that household inflation expectations have performed quite badly as forecasts of future inflation.”
Trehan admits that the University of Michigan’s Survey Research Center shows that households had been pretty good indicators of future inflation from the 1970s to 2000. However, over the past several years, the increased volatility in the prices of food and energy have misled consumers to anticipate more future inflation than is warranted given low levels of existing core inflation:
“The recent jump in the Thomson Reuters/University of Michigan measure of household inflation expectations appears to be related to increases in the prices of energy and food, similar to the jump observed in 2008. The size of this response to noncore inflation cannot be justified in terms of the historical relationships in the data. This disproportionate response is probably the reason why household inflation expectations have not done well as forecasts of future inflation in recent years, a period of volatile food and energy inflation. The poor forecasting performance argues against reacting strongly to the recent increases in household inflation expectations.”
Moreover, recent increases in inflation expectations are not justified by changes in monetary policy. Trehan speculates that…
“It’s also possible that households’ sensitivity to noncore inflation goes up following substantial, sharp increases in the price of energy and food items, such as those that occurred in the 1970s and over the past few years…This similarity to the 1970s is unsettling because it suggests that consumers are not accounting for the ways monetary policy has changed over this period.”
I assume this claim means that the Federal Reserve’s monetary policies have improved since the 1970s. In my opinion, we have seen even less reason to trust in the Federal Reserve’s policies to the extent that these policies “fix” economic problems in such a way to help set up the next crisis. These crises build while the Federal Reserve tends to reassure that it has everything under control and/or there is nothing happening to cause concern.
I would challenge the historical record and related regressions to suggest we need to consider whether the structural underpinnings of inflation are changing in ways that the Federal Reserve will be slow to recognize. Whether the Federal Reserve can do anything about these changes is another question.
I typically ignore most of the inflation numbers reported by the government, but I could not resist reading Calafia Beach Pundit’s latest piece titled “Consumer price inflation is heating up.” Calafia takes a look at the CPI from all angles, month-over-month, year-over-year, rate of change, and even non-seasonally adjusted (which is the basis for payments to TIPS). Calafia convincingly demonstrates that all arrows are pointing upward for inflation. He even concluded that China’s current struggles with inflation will be America’s future inflation problem:
“The ongoing rise in China’s inflation rate is making headlines today, but U.S. inflation is not too far behind, as this chart shows. It’s not surprising that inflation should be moving higher both in China and the U.S., since China has essentially outsourced its monetary policy to the U.S. Federal Reserve by pegging the yuan to the dollar. Chinese inflation is somewhat more volatile than ours, and that is also not surprising since its economy is smaller and less burdened by long-term supply and labor contracts. If China has an inflation problem, then so does the U.S. It will just take longer for the problem to become obvious in the U.S.”
This piece is a must-read.
Disclosure: author is long TIPS
The Swiss National Bank (SNB) announced its latest monetary policy today with the very provocative title “Swiss National Bank maintains its expansionary monetary policy.”
“The Swiss National Bank (SNB) is maintaining its expansionary monetary policy. It is leaving the target range for the three-month Libor rate unchanged at 0.0–0.75%, and intends to keep the Libor within the lower part of the target range at around 0.25%.”
The SNB goes on to outline economic conditions around the globe highlighting the strengths and weaknesses. Interestingly, the Swiss economy has done relatively well despite the record strength in its currency. Specific areas of weakness are tourism and exports, both highly dependent on relative exchange rates.
On balance, the SNB found it necessary to increase its near-term inflation forecast a bit. The SNB also again acknowledged that it cannot maintain its current expansionary monetary policy given its expectation that inflation will exceed its upper limit of 2% by 2013. With its currency too strong for comfort, the SNB is clearly trying to wait as long as possible before moving to head off these higher than desired inflation levels. It is a dilemma more and more central banks will feel as the U.S. dollar continues to sink against every major currency.
From the monetary policy statement:
The recent acceleration in the franc’s strength, especially against the U.S. dollar, is a continuation of a longer-term trend. The franc is now trading at record levels against the U.S. dollar.
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.
The tagline for Inflation Watch is “Watching for potential inflation here, there and everywhere.” We borrowed this from money manager Bill Fleckenstein.
Apparently, there is at least one other person forecasting a time when inflation is “everywhere.” CNBC interviewed Arun Motianey, director of fixed income strategy at Roubini’s RBG Capital and a protege of economic professor Nouriel Roubini:
“We’re heading into a world of inflation because we are highly indebted and we are indebted here in the US economy in the household sector and in the financial sector…It’s going to be inflation everywhere and it’s going to happen really through the weakness of the US dollar…Then inflation in those other parts of the world that are expecting appreciating currencies, they’re going to inflate as well because that’s the way you ultimately correct this [economic slowdown].”
Motianey asserts that this inflation is required to avoid the apparently worse alternative of deflation.