deflation

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Decent Numbers

The end of the week brought a flurry of economic reports, none were surprising and all were supportive of the notion that economic growth is steady, but not spectacular.

Retail sales rose a decent, but not terrific, 0.6% in December. This is off a little from November’s 0.8%, but is still within the realm of sufficiency. For the year as a whole sales were up 6.6% which, again, is better than we have seen recently, but not breathtakingly good. The key point to take away is that consumers are returning to the stores, which means that the consumption component of GDP will continue to tick along. This is critical since it amounts to about 70% of the entire economy. One thing to follow closely is the level of auto sales. Car makers are experiencing a revival at the moment and car sales skewed the overall retail sales figures. Take them out and sales grew more slowly at 0.5% in December. This is the opposite of the skew in November, when a swing in auto sales actually reduced the total rather than added to it. The point being that auto sales are trending up but have, as they always do, a very bumpy trajectory around that trend line. In any given month auto sales can muddy the overall view quite a bit. Hence the need to back them out in order to understand the basic trends.

A similar problem exists in the Consumer Price Index. We saw a big jump in prices in December, CPI rose 0.5%, compared to 0.1% in November. But before we all start to jump on the impending inflation band wagon, let’s back out fuel prices: when we do that December “jump” is eliminated and we drop back to the same 0.1% we had in November. So the recent rise in oil prices has skewed the data. Should we be concerned? Not yet. Fuel and food prices are notorious for jumping around. They can often hide the real trend in inflation and so we need to look at prices both with and without them. The so-called core inflation rate, which excludes food and fuel prices, is low and very stable. It is the basic trend we refer to when we talk about disinflation. For the whole year 2010 core inflation was a very low 0.8% compared with 2009’s 1.8%. So at a base level prices have shown a decreasing rather than increasing trend over the last twelve months. Even the entire CPI including the more volatile items trended down: it rose 1.5% for the entire year compared with 2.7% in 2009.

So inflation is not a problem at the moment.

But those fuel and food prices could become troublesome in 2011 and beyond as worldwide demand stays ahead of production. This is likely to be especially true in raw material prices, so we should expect commodity prices to rise more rapidly than other prices. Food too looks to be a problem. The US just downgraded its forecast crop yields, a move that immediately sent food futures rising. Longer term this is more a problem of infrastructure than capacity: food availability and prices in many poorer countries is more a function of bad transportation than it is of capacity to produce. Africa in particular suffers from this problem. Then again there is the distortion in world prices caused by the pervasive subsidization of food prices in wealthy countries. Many rich countries are loath to cut those subsidies and expose their farms to worldwide competition. High sugar prices in the US are a notorious example of the consequences of such subsidies. At the same time, by giving agriculture so much welfare both the US and Europe end up producing too much food. This excess gets dumped on the world markets where it depresses prices and forces local producers in places like Africa out of production. So one of the largest causes of periodic famine in Africa is not the local infrastructure or practice, which are both bad, but the ongoing subsidy to American and European farmers. Which makes a mockery of the usual subsequent “gifts” of food from those places. The gifts turn out to be drawn from an excess that caused the famine the gifts are supposed to ameliorate.

Other data released today shows that industrial production jumped 0.8% in December. Once again we need to dig beneath the surface. When we do we find that it was utility output adding an extra bounce to the increase. December was a cold month for much of the country and so utilities were generating extra power. Take that bump out and production grew at a lesser rate or about 0.3%. For the entire year 2010, industrial production rose 5.9%, not a bad recovery, but not a boom. This increase in production pushed capacity utilization rates up as well, to 76.0%, an increase of 0.6%. But this level of utilization is still way below the average – by between 4.5% and 5.0% – for the thirty years ended in 2009. So the economy is still flush with spare capacity in need of use before we arrive at a period of new expansion.

One last report worth talking about is the University of Michigan consumer sentiment index for early January. This shows a slight decrease in optimism, driven apparently by that jump in oil prices I mentioned above. The decline in optimism is not huge, but were food and fuel prices to keep up steady increases it may be sufficient to dampen consumption later in the spring or early summer.

So there you have it. A fairly routine round up of the data.

None of it is a surprise. None of disturbs the overall outlook. None of it is great cause for alarm.

Which is good. We could all do with a little hum drum news as we continue to dig out of the mess caused by great recession.

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Obama: WTF?

OK. I am sorry for the expletive. But really.

First we read Obama is wondering out aloud whether our high unemployment is structural and thus insoluble to ordinary policy making. Then we hear he is freezing Federal worker pay in order to cut into the deficit.

What next? Social Security privatization? The abandonment of unemployment assistance?

How much more to the right can he shift?

This is absurd. No wonder his support amongst Democrats is wilting. He is jumping ship faster than anyone I can remember.

First: discussions about structural unemployment are the preserve of those who see the economy exclusively through a supply side lens. It is they, not us, who think the economy has suddenly become hidebound and thus impervious to government nudging and intervention. The facts, of course, belie their position, but why let facts intrude into a well oiled ideological argument? The simple matter is that the evidence to support an argument that our unemployment problem is predominantly one of structural issues is non existent. There are none of the normal telltale signs: rapid wage increases in understaffed industries and no labor shortages in parts of the country where business cannot grow because it cannot hire fast enough. Put this another way: if any of you know of such problems, please write to the government and let them know. None of the usual reports have any such problems in them. The best way to describe structural unemployment is simply to say it is the level below which further growth in employment produces inflation.

Please, if you locate high inflation let me know also. Setting aside the volatile stuff like fuel and food, prices are still trending down. Not up. And before you argue that we should include those volatile prices, let me remind you that they were dropping like stones last year, so to be consistent you would have to have been screaming about deflation back then. We eliminate them for a reason: we want to track the long term trend, and get rid of seasonal ups and downs.

So, without shortages, wage increases, inflation, and any other sign, where is this structural problem?

Perhaps – just perhaps – it is in the inability of workers to move from one area of the country where there is no work, to another where there is work. This immobility could be due to home prices and the fact that a worker’s home is worth less than the mortgage. So the worker cannot afford to move, even if there is no local work. And yes there may be a skill mismatch between the workforce and the work available. But all the data on those problems indicates that they are but a small part of the larger issue.

No. Our unemployment problem is cyclical. It stems from a lack of demand and an unwillingness on the part of businesses to hire given their expectation of continued lack of demand.

That Obama is debating this issue tells me he continues to be clueless. It also tells me that his advisors are ideologically not sympathetic to the workers and middle class who put him in power. There are sensible and credible things we can do to reduce unemployment, but if the powers that be deem it an insoluble problem we will never get such policies aired. I despair sometimes for America and its apparent death wish.

Second: that pay freeze. Pure dross. Pure pandering to the Republicans. Pure rubbish. It has no worthwhile impact on the deficit. It makes the pay gap between government and private workers worse. It reduces government efficiency by demotivating workers. It is ridiculous, inhumane, and stupid.

I am ashamed that it is now come to pass that Obama has crumpled up before the onslaught of the right wingers. Once more he has let workers down monumentally.

One last thing: will he fight for an extension of unemployment benefits? They expire this week. Let’s watch to see where he lands on that one.

This is not pretty. Then again what more do we expect?

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What Inflation?

If there is one economic factor that the experts on Wall Street have consistently been wrong about, it is inflation. Ever since the great intervention in the economy after the Lehman implosion these analysts have been explaining that the consequent huge increase in the money supply would inevitable – inevitably – produce a sharp increase in inflation. This line of reasoning has been taken up by the right wing echo chamber and is now approaching full blown cacophony.

For two straight years we have been lectured by these orthodox economists and their various political hanger-on that the policies of the Fed and our neo-socialist government will do nothing but untold harm to our economy. Those policies will, they say, lead not to economic health, but to economic ruin brought on by the debasement of the dollar and an associated, uncontrolled, burst of inflation. It is this prospect, so they say, that is preventing businesses from investing, and is undermining consumer confidence.

Government is the problem.

Where have we heard that before?

Those of us who argue differently are dismissed as crazy interventionists who don’t realize the consequences of this supposedly reckless monetary regime.

Well.

Let’s look at the facts.

Inflation, when we take away the volatile stuff like food and fuel, has steadily chugged down a disinflationary path. The experts have been wrong in their forecasts for twenty-four months and counting. It is this adjusted, or core, measure of inflation that we look at to understand the trend of prices within the economy. Food and fuel prices jump about all over the place and tend to mask the underlying trend. This is not to say that those jumps are not real, but that they do not signify anything of deeper meaning within the overall price structure of the economy.

And what is today’s news about consumer prices?

The unadjusted Consumer Price Index rose just 0.2% in October. Core inflation was flat for the third month in a row, and has risen only 0.6% over the last year. This is the lowest level of core inflation ever reported. The trend line is still downward. We are perilously close to deflation and getting closer each passing month.

In other words the facts completely refute the imminent inflation disaster argument. Utterly and totally refute it.

Not that I expect it to go away. Those who fan fears of inflation do so on the basis of two things:

  1. An ideological dilike of government intervention in the economy
  2. A misreading of the economic situation

The ideology is well known and often drives otherwise sensible people to hold odd and anti-socail policy positions. The second is less well known, but is more pernicious since is based upon wrong headed economic theory.

So, to make my case once again: We are stuck in an odd economic situation. The normal outcomes from an expansionary monetary policy, assuming strong employment and demand, could be upward pressure on prices. That assumes the economy fails to expand in real terms in response to the change in money supply. But. These are not normal times. In fact we are so far from normal that we may not return there for a decade or more. We have an economy with a very large gap between its capacity or potential and its actual level of activity. We are going through a steady reduction in debt, and that implies a loss of cash for spending. We have very weak employment to go with this weak demand. Flooding money into this kind of economy may reduce interest rates enough to stimulate activity, but it will not shift prices.

Think about this from a practical business point of view. In the face of weak demand for your products, it makes no sense to raise prices. It makes sense to cut them.

If enough businesses cut enough prices we enter deflation.

If demand for the stuff needed to make consumer goods is sufficiently weak, those prices will drop too. And that includes wages.

The only reason that commodity prices are jumping about at the moment is that many emerging economies are growing well. It is not a reflection of overly strong demand in the developed economies.

So the experts are absolutely wrong. Inflation is nowhere in sight. Those folks who signed the letter published in the Wall Street Journal two days ago were urging the Fed to back away from its “inflation inducing” policies. Their point of view is thoroughly debunked by today’s news.

Will we see them change their mind in view of the new facts?

Of course not. Why let facts get in the way?

Fact based policy making is so yesterday.

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The Dark Ages Are Back

Here we go. The Dark Ages are upon us. I realize that post modernists have a hard time with the concept of the Dark Ages, but I don’t. They were dark, and filled with a willful ignorance born of an ideological and religious zealotry. Intellectual discourse was suppressed to make way for the only truth – in Europe this was Roman Catholicism. The authoritarian church burned and otherwise disposed of anything that was not within their narrow view of the world. This included the entire corpus of ancient Greek thought which was only rediscovered a thousand years later when Europeans ventured into the middle east and came across the great seats of learning in the Arabian world.

And now, with us?

We have forgotten all the learning of the 1930’s. The Fed is lambasted for doing what it is supposed to do. And the Republicans have now launched an attack on its very reason for being. This is ugly. We are trying to be ignorant. We are trying to expunge alternative ideas. We are falling prey to dumb thinking dressed as cleverness.

Not only is it difficult to press for an all out Keynesian response to the crisis, even though it is the only proven solution that doesn’t consign millions of our citizens to abject poverty, but it has now become difficult to engage anyone seriously about the alternatives. Apparently the forces of free market ideologues are making a stand, and will not concede their error. They prefer to sink America as long as they sink Obama too.

Setting aside the question as to whether Obama deserves to survive. This is nihilism at its very worst. Read your Nietzsche quickly.

So obsessed are the Republicans with ousting Obama that they would gladly advocate policies that undermine the economy. Thus they attack the Fed for daring to undertake QE2: it might succeed and thus bail out Obama. They have now begun a campaign to alter the Fed’s official mandate to strip it of the goal of bolstering employment. Right now the Fed has a dual mandate: keep inflation low, and, at the same time, maintain full employment – which is generally thought to mean an unemployment rate of about 5.0%.

Yes. You read that correctly.

The GOP wants to take the Fed’s unemployment franchise away and force it to focus simply on inflation. According to Senator Corker from Tennessee this would simplify things for the Fed. It would also mean it could not follow policies like QE2 which are designed to stimulate the economy.

I will not defend the Fed’s success or failure. In my view they have failed terribly: they have not kept full employment and they have allowed inflation to drop below their target range. Unemployment is too high and inflation too low according to the Fed’s own targets. The Fed is also the regulator responsible for the mortgage market. I need say no more on that topic.

Nonetheless the GOP attack is extraordinary for its recklessness and total abandonment of the nation’s unemployed. It is vicious. It is deliberate. It is tantamount to plunging us back decades in terms of economic thinking.

The notion that it is Congress alone that should combat unemployment is laughable. Corker knows full well that his party have stalled, gutted, and undermined every single attempt to help the unemployed. His party offered not one plan to stimulate the economy. Other, that is, the failed policy of cutting taxes.

This astonishing attack on our economy has only that one goal: to unseat Obama.

So not only is Keynesian fiscal policy not to be deployed to help our situation. Nor is Friedmanite monetary policy. What’s left? the Bible? Hope, wing, and a prayer?

These zealots are committed to the institution of a modern version of the Dark Ages in which we are cleansed of our ideological errors and are forced to live only by the one good book. The Palin wing, of course don’t even allow books, but that’s anther question.

Is America this stupid?

Yes.

Even erstwhile sophisticated analysts like David Brooks get tangled up in the right wing backlash against modern thought. His column today sent poor old Paul Krugman into fits. I see why. It was replete with a revisionist and totally false history. Brooks accused left of center economists of being model bound and beholden to uber-ratuonalist thinking. Nothing could be farther from the truth: it was the right wing Chicago school who developed the rational model of economics. They did it to unseat the more real world and pragmatic Keynesian mode of thought. Brooks is accusing the left of the sins of the right. Yet he gets published. He either is completely ignorant of modern economic thought, or he is deliberately lying about it. Both explanations of his column are odious.

So here we are.

The next phase of the great war has begun. We are plunging rapidly into an intellectual void. The dumber the leader the better. The more outrageous the lie the more easily it is believed. Dialog is expunged and looked at as unnecessary. The cultural wars began as a push from the right to re-assert discredited values or to impose supposedly “family” values on those who dared to think differently. The fear of difference was stoked from being a marginal oddity into the central mass of right wing political ideology.

Nothing is allowed to get in the way of the radical transformation the right wants to impose on middle America.

And that crusade to take us all back to the Dark Ages has now focused on the Fed.

Yesterday I picked up my copy of Gibbon. His conclusion at the end of his epic history was that the decline and fall of Rome was driven by four great forces: the passage of time that undermined the empire’s original vitality; the empire’s abuse of its environment; the rise of Christianity and the concurrent invasion of the barbarians; and above all its eventual loss of civil internal discourse.

And after that decline and fall, Europe was plunged by those same forces into the thousand years of ignorance and poverty we call the Dark Ages.

This sounds all too familiar.

The analogy is stark.

The next two years will be brutal.

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Bernanke Takes a Beating

Poor old Ben, I feel bad for him. Today’s Wall Street Journal carries an open letter from a long list of right wing leaning economists and other sundry analysts urging him to stop all this QE2 nonsense and get back to the proper course of reducing regulation, helping big business, and thinking of nifty ways to reduce taxes.

Well they don’t quite go that far, but you get my drift. They talk in proper terms: “… we think improvements in tax, spending and regulatory policies must take precedence in a national growth program, not further monetary stimulus.”

This is standard right wing fare and nothing new. And I mean nothing new. Not new in this crisis, and not new at any time in the past three decades.

The problem they believe is that “The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed‰Ûªs objective of promoting employment.”

This sounds awful.

Debasement of the currency? Oh, horrors!

Increased inflation? Oh, double horrors!

The end of the earth is nigh because Ben Bernanke, Republican appointee and conservative though he may be, is pushing an agenda that will result in a debased currency and run away inflation.

And what is this evil policy?

Monetary policy.

Plain and simple. Old fashioned monetary policy. Albeit with a twist: instead of intervening in the market to reduce short term rates, the Fed has resorted to buying longer maturity assets. How dare they!

All that money will inevitably create inflation and send the dollar plunging. There will be a tidal wave of debasement, hyperinflation, and civilization will end – at least at the Harvard Club. Egad. Whatever next? Deficit spending? Apocalypse pending.

Setting aside my constant commentary that I don’t see where this inflation will come from – the inflation rate is miniscule and shrinking fast. There seems to be a problem here. What other policy, pray tell, is the Fed supposed to follow in the face of high unemployment and zero interest rates? There isn’t one. It only has one policy option. And let me repeat: it’s called monetary policy. The kind you would find advocated in the text books these people teach from. Indeed one of the signatories is none other than John Taylor the author of his eponymous rule the Fed uses to determine what interest rates should be. Last I looked that rate, according to the Taylor rule, was -5.0%. Which is not possible by any other route than QE2.

I look forward to a forthcoming revision from Professor Taylor. Along with an apology for having created so evidently a stupid rule.

Let’s just be clear about QE2: it may not work because adding boatloads of cash to an economy awash with cash seems like a long shot. Especially when no one wants to invest that cash in the US. So a great deal of that cash will spill over into the global economy where it will annoy people like the Germans, Japanese, and Chinese all of whom are trying to avoid dealing with their own economic imbalances. They don’t want the dollar to fall because that decline would force them to address issues in their various domestic economies. Like reducing their exports and making more stuff for their own populations. Annoying these folks is not a bad thing when our own survival is at stake.

Further, even were it to work, QE2 looks as if it is too small to drive the economy off the rocks by itself. It needs to be complemented by fiscal policy. Which is not going to happen.

Thus the risk of inflation is practically zero. We have an economy stuck in a glut of over capacity. It is suffering rapidly declining core inflation and appears headed towards deflation. Our problems are not at all those suggested by the signatories. The private sector is stuck. There is little sign that it will improve much, if at all, from where it is now. There is one and only one way out: the government.

Therein lies the rub.

The signatories hate the notion – with a near religious commitment – that the government can do anything to help save the economy. So they want to stifle the Fed. It is a “quasi” arm of the government. So it must be stopped before it succeeds else then ideological basis for the right wing collapses.

It doesn’t matter that ordinary people have a huge stake in the success or failure of policy. Or that the policies put forward by the likes of the signatories are exactly those that caused the crisis.

No not at all.

We the people merely exist to support corporate profit making and a sound currency. Even if that means being unemployed. It’s the American way.

Any intelligent observer of the request for more support for business might ask: what should we do to help businesses invest? After all businesses a knee deep in cash and are not currently investing. What else do they need?

Bernanke answers that by lowering rates in order to induce spending.

The right wingers don’t want to go that route. They want to boost profits by giving out tax breaks. This is despite the fact that profits are good and cash flows sufficient. They want us to believe that throwing more breaks to business will somehow set them in motion.

Why? If they are not in motion now?

So I repeat: the problem is not a supply side problem. It is a demand side problem. People are not buying. So businesses are being cautious. Throwing all the cash in the world onto business balance sheets won’t change a darned thing.

One last gripe: the policy Bernanke is pursuing is straightforward monetary policy with that twist I mentioned. It is monetarism. As in Friedman, doyen of the right. Are these signatories abandoning their intellectual leader?

I wish.

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