wholesale inflation

There isn’t much to discuss in this morning’s release of new home starts: they fell very slightly from June’s annualized rate of 587,000 units a year to 581,000 units a year. No big deal. The more interesting question is whether we can say anything about the longer term based upon this data. Probably. It looks as if the housing market is at the bottom of its cycle. Starts are off 74% from their peak. That means there is only one way to go: up. So I expect housing to become a positive growth factor in GDP this quarter and into next.

But I don’t expect it to be very significant.

The point is that the government’s stimulus efforts, in the case of housing that first time buyer tax credit of $8,000, has worked like a charm. The lower end of the market, in both the existing and new home sectors, have seen plenty of activity. This has allowed low end prices to firm up and stop declining quite as fast as before, and it encouraged a small upturn in new home construction as builders rushed to have appropriate inventory available before the tax credit expires. This more than anything seems to be the cause of strength in housing right now.

What happens when that tax credit goes away at the end of this year is more problematic. It may mean that housing wallows around for a while: a victim of consumer fear and tougher credit standards. In which case that positive contribution I mentioned above will ebb away next year which is why I focussed my comments on this quarter and next.

Even the most optimistic scenario for housing is a weak one. The bubble destroyed so much wealth – albeit it mainly paper wealth – and took whole states along with it. The entire feel good story of Florida for the past ten years has been swallowed effectively by the bubble: all that growth turns out to have been an illusion.

Hopefully the next housing cycle will be more solid. Given America’s obsession with real estate, and its continued welfare status – that awful tax credit for mortgage interest drives up home prices and skews investment – I doubt whether my hopes are justified.

As for today’s news on wholesale prices: they dropped sharply in July, by 0.9% at annual rates, based on the decline in energy costs. Even excluding energy they dropped very slightly, by 0.1%.

This supports my view that inflation simply is not an issue right now. Wholesale prices have dropped a record 6.8% over the last twelve months. The huge swing in energy costs is responsible for that: without energy prices rose 2.6% on the year, but even that is a low enough figure for it not raise inflation alarms.

With labor costs also dropping, as they did last month, average business costs are falling, not rising. If we then factor in extraordinarily weak consumer demand businesses have neither the motivation nor the ability to raise prices much, it at all. So inflation remains non-existent as a policy issue.

Taking all today’s data together what do we learn?

Not much new unfortunately. The economy remains very weak, although in parts it is beginning to show some life. The big questions are now about how strong and how sustainable those improvements are. And whether there is sufficient strength for the recovery to become self-sustaining next year. I have my doubts about that still.

With banking about to take a hit from commercial real estate and credit card debt right downs, credit extension will be soft. There are no signs of jobs suddenly becoming abundant. And debt still presses down on household budgets. That is a recipe for a very pallid tone to the recovery.

Today’s news seems to fit that scenario very well.