producer prices

Well I am back and will report some of my reactions to the conference I attended tomorrow. Today, though, let’s catch up on the economy.

Not much seems to be going on. That is, I suspect, the way things will be for a while. Today’s release of October’s consumer spending was a decent, but not great, result. Consumer’s spent 0.5% more – seasonally adjusted – last month, down from September’s vigorous 1.1%, but more than most people had expected. Since consumption makes up about 70% of total GDP, we watch consumer reports like this one for any signs of activity. If the October rate is sustained throughout the fourth quarter we might well see a GDP figure of above the 2.5% benchmark I have been touting all year.

So, the operative question becomes: is such a trend likely?

I have to say the odds are against it. The problem stems from the relationship between incomes and spending. The recent uptick in retail sales has come largely at the expense of savings. Wages are at a standstill after the original climb we saw at the earlier part of the recovery. They cannot, therefore, support continued growth in spending. It could be, of course, that consumers are beginning to feel better about the future and are thus willing to allocate less income to savings; and they may be more comfortable with their debt ratios than they were in 2010. But we are talking about the sustainability of the recent trend – and I just don’t see a firm pattern of income growth sufficient to indicate boisterous spending beyond the holidays.

One reason why consumers were able to spend a little more was that gasoline prices have eased – spending on gas dropped 0.4% in October. Elsewhere the data remains very choppy: people spent much more on electronics and appliances, where growth was 3.7%. People also spent more online – up 1.5% – and at do-it-yourself and garden stores where sales also rose 1.5%. Department stores, however, experienced a -1.2% decline; while both clothing stores and home furnishing stores saw sales fall 0.7%.

So the notion that we are in the midst of a consumer driven acceleration in GDP misses the point: the economy remains a very mixed bag with no clear signal and no obvious change of pace. Or at least no change of pace we can rely upon.

We find a similar message in the Empire State report on manufacturing. This is a report produced as an index where a score of over 0 implies expansion, and, obviously, a score of less than 0 implies contraction. Today’s report, which reflects data collected in early November, eked out a score of 0.6. That is barely on the growth side of the ledger, but is also the first reading of growth for a while. The previous five months had all signaled contraction. October’s score, for instance, was -8.5.

When we dig beneath the surface we see the same mixed message we see in retail sales: the headline is more upbeat than the underlying data suggest. New orders scored -2.1, a drop from October’s -0.2. Obviously a shrinking order book implies a slow down in production at some point in the future. Inventories also scored negatively, at -12.2 in November compared with -9.0 in October. Manufacturers seem to be reining in their inventories. This can, unfortunately, be read in two contradictory ways. Either inventories have fallen because sales have unexpectedly risen leaving shelves bare. Or they have fallen because firms want to reduce the carrying cost of their inventories in expectation of reduced sales ahead. Given the other recent signs in the economy I tend towards the more cautious interpretation, but the next month or two could prove me wrong: maybe there’s a boom going on somewhere that we don’t know about yet.

One last thing in this round up: producer prices dropped 0.3% in October – the largest drop in almost two years. Obviously there is little or no inflationary pressure building in the economy, which must irritate all those interest rate hawks no end. The key factor in the drop was the continuing decline in energy prices. Recall that all those hysterical concerns about imminent hyperinflation were based on the steep rise in commodity prices – especially oil – earlier in the year. Some of us looked askance at that rise based upon the subdued outlook for the global economy and the likelihood that the uptick in prices was, therefore, temporary. So it has transpired. Looking at the last twelve months producer prices have risen a steep 5.9%, but the last few months have seen all that steam dissipate, and we are back into a period of much lower, if any, price inflation.

For those of you who like to get into the arcane details of the numbers, here’s a good one: the October price decline includes a 0.8% drop in car prices, the largest in a year. But October is also the month the new year’s car line-up is introduced and so we can look at year-on-year pricing too. This year’s new models are priced at $681.87 more, on average, than last year’s. This begs a question: how can prices be reported as declining in that same period, when the cash we have to pay is going up? Because the government also factors in the quality of what a consumer receives for the price paid. Evidently the government has decided that all those new bells and whistles we get when we pay the extra $681+ for our new car are worth more. We are thus getting more bang for our buck, and we can interpret this as a drop in prices. Phew. That’s more than we all need, or want to know, about what goes on under the hood of the price indices, but it also helps explain why, periodically, consumers seem to think prices are rising while officialdom thinks they’re falling. The government wants to calculate whether we are better off in real, rather than nominal, terms. Whereas we all tend to think in nominal terms, i.e. the amount of cash we hand over when we buy stuff. Economists get vexed about this: they criticize our apparent inability to discern the real values, and it is increases or decreases in real terms that matter to our standard of living. So they ignore our inability, or, more usually, simply assume we all know real values. They thus think we are all smarter than we are. It makes building their models more easy. It also makes most of their models hopelessly wrong.

But that’s a question for another day.