Posts filed under “Inflation”
The link to John Melloy’s post in our early reads caused a bit of a stir. Sure John Williams is a bit controversial, but he has been hammering on the “Official Data Understates Inflation” for decades now.
Sometimes, it helps to shift your perspective ever so slightly to get a better view on things. The chart below, which only looks at price rises greater than +/- 5%, will do that. (Mad props to Invictus for the chart work)
It is clearly the high-frequency items – primarily food and fuel – are creating most of the angst (Household insurance at 8.5% is one of my peeves).
But we typically don’t buy motorcycles, major household appliances, computers, or televisions on a weekly or monthly basis, and they have been deflating hard. (See Hackonomics take down of Hedonics as to why)
YoY Changes in Price Index Categories (+/- 5%)
Note: We get fresh numbers Friday, so this is an early glimpse of where we are . . .
Peter T Treadway, PhD
Historical Analytics LLC
April 11, 2011
LESSONS FROM THE PAST – THE GERMAN HYPERINFLATION
“On the afternoon of July 31st, 1914, the Reichsbank, on its own initiative, suspended the conversion of notes, which in the previous days had come, in great quantities, to its branches to be exchanged for gold. On August 4th the conversion of notes was suspended by law, with effect as from July 31 st… in the two weeks from July 24th to August 7th the quantity of Reichsbank notes in circulation increased by more than two milliard marks. Thus was initiated a monetary inflation that was without precedent in history.”
From The Economics of Inflation – A Study of Currency Depreciation in Post War Germany, Constantino Bresciani-Turroni, p 23.
The above quote is from a book written in 1931 which has now achieved cult status. I have been researching the German hyperinflation period post WWI in order to get some idea as to how to survive investment-wise were such a hyperinflation to befall the US.
Germany During and After WWI – A Lesson in Monetary Inflation
The argument can be made that the German experience is not relevant for the US. Germany after all was the loser in major war and was severely punished in terms of reparations and territorial concessions by the victors. But there just might be some relevance especially when we are evaluating QE2, the expansive US budget deficit and today’s inflationary international monetary system. In fact, the German hyperinflation of 1921-1923 had its roots in massive money printing and debt financing that began when WWI started in 1914. Investment-wise, it’s better to be a citizen of country that is on the winning side of a war. But had Germany won that war, the country would still have been in dire economic straits.
Most investors today are vaguely aware of the German hyperinflation of 1921-1923. They’ve probably seen the parabolic graph showing German prices going to levels best expressed in exponential terms at the end of the period. They’ve all heard stories of people carrying huge amounts of currency in wheelbarrows just to buy routine items. They probably think that German holders of fixed income securities were wiped out by this incredible hyperinflation as their investments became effectively worthless.
This perception would be slightly off. In fact, by 1921 most of German fixed income holders who had patriotically bought government bonds, mortgages etc during the war were already wiped out largely by the high inflation that cranked up in 1914 and accelerated into the hyperinflationary period beginning in 1921.
Rogoff and Reinhart in This Time Is Different refer to “default by inflation” as the default method of choice for countries which have over borrowed in their own currency. WWI Germany fit that description. Today the US along with Japan and the euro countries have been borrowing in their own currency with wild abandon. Rogoff and Reinhart define hyperinflation as over 500% per annum. The list of countries that have experienced this extreme version of inflation is longer than you might think. But Rogoff and Reinhart also have compiled a list of countries that have experienced 20%-40% inflation and have therefore in real terms defaulted on debt denominated in their own currency. That list unfortunately is a very long one. A bondholder doesn’t need hyperinflation to go broke. A few years of (unanticipated) 20%-40% inflation will do just fine in terms of seeing his or her investment become worthless in real terms.
From 1914-1921 Germany suffered from accelerating but “only” high inflation. In 1914 when the war began the Reichsbank suspended convertibility of the mark into gold and Germany was taken off the gold standard. (The word “Reich” was still innocent then.) Britain and France also suspended the gold standard. The onset of WWI marked the end of the classic gold standard that had worked so well and had produced near zero inflation for the prior thirty-five years. (The attempt to revive the gold standard in the mid 1920s ultimately proved to be a deflationary fiasco. Like Humpty Dumpty there was no putting the gold standard back together again. But that’s another story.)
To repeat, the German inflationary process began in 1914 when the war began and not in 1918 when it ended. The hyperinflation phase in 1921-1923 was the culmination of this process. German inflation increased steadily from 1914 on as did the depreciation of the mark against the dollar on foreign exchanges. The war was long, costly and financed by massive money printing and borrowing from a clueless if patriotic public. That wasn’t the plan in 1914. The war was supposed to be short, Germany was supposed to win and, as in the Franco-Prussian War of 1871, the hapless losers would pay an indemnity. (The French unfortunately for Germany had a similar plan.) Consequently, the war was financed in Germany not by an increase in taxes but by borrowing and massive money printing. This was a deliberate decision and, like today, there were some people who understood what was happening and opposed it.
The German stock exchange was closed and did not reopen until December 1917. In fact most of the world’s major stock exchanges closed when the war started in the summer of 1914. New York and Paris reopened in December 1914, London in January 1915. Unlike investors who were citizens of their opponents, German investors thus were basically ignorant as to the value of their equity holdings for most of the war. Even when the exchange reopened, in the following years German investors had a hard time evaluating their shares in real terms because of the inflation. Many an investor thought he or she had made money in paper marks when in fact in real terms they were suffering substantial loses in real terms.
A few numbers from Bresciani-Turroni might be helpful. He had several choices in measuring the inflation, i.e., domestic price data, gold as the reference point or the dollar/market exchange rate. He used all three. The different measures did not always move in exact lockstep in the short run but in the long run they paint the same picture of accelerating inflation and economic ruin. All numbers quoted here are as Bresciani-Turroni presented them and are not always totally consistent from period to period but are indicative nonetheless.
Tons of talk and pixels being spilled over the imminent inflation threat. It bears an eerie resemblance to what we heard from the likes of Jerry Bowyer and Art Laffer two years ago. I’d fade it now, exactly as I suggested back then (here and here, the latter piece co-authored with Bonddad): Exhibit A —…Read More
Visualizing Economics looks at what happens to the classic Case Shiller housing graph when you adjust for size, quality, etc. My longstanding view has been that the bubble was in credit, and the credit bubble caused the overall housing boom and bust, as well as select regional bubbles. > click for ginormous version Source: Visualizing…Read More
Back in 2005, I posted this table on Cheap Gas vs other items; it contained the following table: > Other “Refined” Products Compared with Gasoline Product Unit Cost Price per Gallon Lipton Ice Tea $1.19/16 oz $9.52 per gallon Ocean Spray $1.25/16 oz $10.00 per gallon Gatorade $1.59 /20 oz $10.17 per gallon Diet Snapple…Read More
Following the record low data in New Home Sales yesterday, we looked at a 50 year chart of that plumbed the depths of that data series. Today, I want to expand upon that and look at a 120 year chart of real vs. nominal home prices, via Visualizing Economics. There are a few noteworthy items…Read More
William C. Dudley, President and Chief Executive Officer
Remarks at New York University’s Stern School of Business, New York City
It is a pleasure to have the opportunity to speak here today. My remarks will focus primarily on two areas. First, what is the outlook for economic activity, employment and inflation? In particular, what are the areas of vulnerability that we should be most concerned about? Second, what does the outlook imply for monetary policy? As always, what I will say reflects my own views and opinions, not necessarily those of the Federal Open Market Committee (FOMC) or the Federal Reserve System.
In my talk, I’ll argue that the economic outlook has improved considerably. Despite this, we are still very far away from achieving our dual mandate of maximum sustainable employment and price stability. Faster progress toward these objectives would be very welcome and need not require an early change in the stance of monetary policy.
However, I’ll also focus on some issues with respect to inflation that will merit careful monitoring. In particular, we need to keep a close watch on how households and businesses respond to commodity price pressures. The key issue here is whether the rise in commodity prices will unduly push up inflation expectations.
Inflation expectations are well-anchored today and we intend to keep it that way. A sustained rise in medium-term inflation expectations would represent a threat to our price stability mandate and would not be tolerated.
Turning first to the economic outlook, the situation looks considerably brighter than six months ago. On the activity side, a wide range of indicators show a broadening and strengthening of demand and production. For example, on the demand side, real personal consumption expenditures rose at a 4.1 percent annual rate during the fourth quarter. This compares with only a 2.2 percent annual rate during the first three quarters of 2010
(Chart 1). Orders and production are following suit. For example, the Institute of Supply Management index of new orders for manufacturers climbed to 67.8 in January, the highest level since January of 2004 (Chart 2).
The revival in activity, in turn, has been accompanied by improving consumer and business confidence. For example, the University of Michigan consumer sentiment index rose to 77.5 in February, up from 68.9 six months earlier (Chart 3).
Indeed, the 2.8 percent annualized growth rate of real gross domestic product (GDP) in the fourth quarter may understate the economy’s forward momentum. That is because real GDP growth in the quarter was held back by a sharp slowing in the pace of inventory accumulation. The revival in demand, production and confidence strongly suggests that we may be much closer to establishing a virtuous circle in which rising demand generates more rapid income and employment growth, which in turn bolsters confidence and leads to further increases in spending. The only major missing piece of the puzzle is the absence of strong payroll employment growth. We will need to see sustained strong employment growth in order to be certain that this virtuous circle has become firmly established.
With respect to the labor market, there are conflicting signals. On one hand, the unemployment rate has fallen sharply over the past two months, dropping to 9.0 percent from 9.8 percent two months earlier (Chart 4). This is the biggest two-month drop in the unemployment rate since November of 1958. On the other hand, payroll employment gains have remained very modest—rising by only 83,000 per month over the last three months (Chart 5). Such modest payroll growth is not consistent with a sustained drop in the unemployment rate.
The true story doubtless lies somewhere in between—but probably more on the side of the household survey that tracks unemployment. That is because measured payroll employment growth in January was probably temporarily depressed by unusually bad winter weather. Although some of the recent decline in unemployment is due to a drop in the number of people actively seeking work, the household survey does show a pick-up in hiring. Other labor market indicators, such as initial claims and the employment components of the ISM surveys for manufacturing and nonmanufacturing, have also shown improvement recently
(Chart 6 and Chart 7), which suggests that the weakness in payroll growth is the outlier.
Although there is uncertainty over the timing and speed of the labor market recovery, I do expect that payroll employment growth will increase considerably more rapidly in the coming months. We should welcome this. A substantial pickup is needed. Even if we were to generate growth of 300,000 jobs per month, we would still likely have considerable slack in the labor market at the end of 2012.
In monitoring employment trends, we also need to recognize that the data are likely to be quite noisy on a month-to-month basis. This is particularly the case during the winter months, when weather can play an important role. Recall, for example, the aftermath of the blizzard of 1996 in the Northeast when the February payroll employment count was originally reported as rising by 705,000 workers. It will be important not to overreact to monthly data but to focus on the underlying trend.
So why is the economy finally showing more signs of life? In my view, the improvement reflects three developments. First, household and financial institution balance sheets continue to improve. On the household side, the saving rate, which moved up sharply in 2008 and 2009, appears to have stabilized in the 5 percent to 6 percent range. Meanwhile, debt service burdens have fallen sharply to levels that prevailed during the mid-1990s. Debt service has been pushed lower by a combination of debt repayment, refinancing at lower interest rates and debt write-offs (Chart 8). Financial institutions have strengthened their balance sheets by retaining earnings and by issuing equity. For many larger institutions, a release of loan loss reserves has been important in supporting earnings. Credit availability has improved somewhat as very tight standards start to loosen (Chart 9). As a result, some measures of bank credit are beginning to expand again
Second, monetary policy and fiscal policy have provided support to the recovery. On the monetary policy side, the unusually low level of short-term interest rates and the Federal Reserve’s large-scale asset purchase programs (LSAPs) have fostered a sharp improvement in financial market conditions. Since August 2010, for example, when market participants began to anticipate that the Federal Reserve would initiate another LSAP, U.S. equity prices have risen sharply and credit spreads have narrowed (Chart 11 and Chart 12). Long-term interest rates have moved higher after initially declining, but this does not appear troublesome as it primarily reflects the brightening economic outlook.
On the fiscal side, the economy has been supported by the shift in policy toward near-term accommodation. In particular, the temporary reduction in payroll taxes is providing substantial support to real disposable income and consumption. This could have a particularly strong impact on growth during the first part of the year.
Third, growth abroad—especially among emerging market economies—has been strong and this has led to an increase in the demand for U.S.-made goods and services. Over the four quarters of 2010 real exports rose 9.2 percent (Chart 13). After a disappointing performance earlier in the year, U.S. net exports surged in the fourth quarter (Chart 14).
The firming in economic activity, in short, is due both to natural healing and past and present policy support.
In this regard, it important to emphasize that we did expect growth to strengthen. We provided additional monetary policy stimulus via the asset purchase program in order to help ensure the recovery did regain momentum. A stronger recovery with more rapid progress toward our dual mandate objectives is what we have been seeking. This is welcome and not a reason to reverse course.
We also have to be careful not to be overly optimistic about the growth outlook. The coast is not completely clear—the healing process in the aftermath of the crisis takes time and there are still several areas of vulnerability and weakness. In particular, housing activity remains unusually weak and home prices have begun to soften again in many parts of the country (Chart 15 and
Chart 16). State and local government finances remain under stress, and this is likely to lead to further fiscal consolidation and job losses in this sector that will offset at least a part of the federal fiscal stimulus (Chart 17). And we cannot rule out the possibility of further shocks from abroad, whether in the form of stress in sovereign debt markets or geopolitical events. Higher oil prices act as a tax on disposable income, and the situation in the Middle East remains uncertain and dynamic. Also, we cannot ignore the risks stemming from the longer-term fiscal challenges that we face in the United States.
But in the near-term, the most immediate domestic problems may recede rather than become more prevalent. On the housing side, stronger employment growth should lead to increased household formation, which should provide more support to housing demand. And anxieties about the large overhang of unsold homes represented by the foreclosure pipeline may overstate the magnitude of the excess supply of housing. Families that have lost their homes through foreclosures are likely to seek new homes as their income permits, even though many may re-enter the housing market as renters rather than buyers. On the state and local side, a rising economy should boost sales and income tax revenue and help narrow near-term fiscal shortfalls.1
Moreover, although we do need to remain ever-watchful for signs that low interest rates could foster a buildup of financial excesses or bubbles that might pose a medium-term risk to both full employment and price stability, risk premia on U.S. financial assets do not appear unduly compressed at this juncture.
On the inflation side of the ledger, there are some signs that core inflation is now stabilizing. However, both headline and core inflation remain below levels consistent with our dual mandate objectives—which most members of the FOMC consider to be 2 percent or a bit less on the personal consumption expenditures (PCE) measure.
Recent evidence shows that the large amount of slack in the economy has contributed to disinflation over the past couple of years. This can be seen in the steady decline in core inflation between mid-2008 and the end of 2010. As shown in Chart 18, core PCE inflation in December had risen at just 0.7 percent on a year-over-year basis, down from 2.5 percent in mid-2008. Slack in our economy is still very large, and this will continue to be a factor that acts to dampen price pressures.
Nevertheless, there are several reasons why we need to be careful about inflation even in an environment of ample spare capacity. First, commodity prices have been rising rapidly (Chart 19). This has already increased headline inflation relative to core inflation, and the commodity price changes that have already taken place will almost certainly continue to push the headline rate on year-over-year basis higher over the next few months. Second, some of this pressure could feed into core inflation. Third, medium-term inflation expectations have recently risen back to levels consistent with our dual mandate objectives (Chart 20). If medium-term inflation expectations were to move significantly higher from here on a sustained basis, that would pose a risk to inflation and, thus, would have important implications for monetary policy.
First the Fed, now the B of E: Spencer Dale, the Bank of England’s Chief Economist, is joining hawkish bankers Andrew Sentance and Martin Weale. The three have voted for an interest-rate increase. The debate is (of couse) over inflation, and like the Fed, the B of E is now threatened with splitting into two camps:…Read More
Today’s must read MSM piece is the WSJ discussion of Inflation: “The pace of consumer price increases in the U.S. is quickening after being dormant for months. But a tug of war between the prices of goods and the prices of services, playing out beneath the surface, could keep inflation from becoming the worry it…Read More