Summary of My Post-CPI Tweets (August 2019)

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy. Or, sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments or Enduring Intellectual Properties (updated sites coming soon). Plus…buy my book about money and inflation. The title of the book is What’s Wrong with Money? The Biggest Bubble of All; order from Amazon here.

  • Welcome to another CPI day. The tone going into this one is soooo much different than last month. We are coming off of a surprising jump in core CPI of 0.29%, rather than three straight weak numbers, for starters.
  • For another, the Fed is already in easing mode; last month we were just preparing for it. Despite the high inflation print, and median CPI near its highs y/y (2.84%), the Fed eased anyway.
  • (If you needed any more evidence that the Fed cares more about the stock market and “risk management” of forward growth expectations, than about inflation, that was an exhibit for you.)
  • With global growth sliding, protests in Hong Kong, the Argentinian peso collapsing…this CPI number today won’t change the Fed’s trajectory. They’re going to keep easing for a while.
  • I expect inflation to peak later in Q4 or in Q1, but in the meantime it may make the Fed feel a bit uncomfortable. List 4 tariffs being implemented will probably finally result in a tariff effect (not for a few months, as they take effect Sep 1).
  • As for today: last month’s jump was fueled by housing, and by used (not new, not leased) cars and trucks. Most of that was catch-up although housing’s strength is a little surprising.
  • I don’t expect retracements there. And there’s upside risk from medical care, especially hospital services, though it’s hard to time.
  • Recent increases in the CPI for health insurance, which is a residual, may indicate coming acceleration in inflation for drugs and/or hospital services, which are due. Hard to time this though.
  • Consensus on the Street is for roughly 0.19% on core CPI. That would keep y/y steady, right at 2.1%. Good luck.
  • Well whoopsie. Another 0.29% on core CPI. That brings y/y core to 2.21%
  • This makes the lull earlier this year look decidedly different.

  • Let’s see. Lodging Away from Home jumps out, retracing a -0.64% fall last month to +0.94% this month, but that’s only 1% of CPI.
  • Primary Rents and OER both were better behaved this month, +0.28% and +0.25%, but that actually lowers the y/y for both of them.
  • Heh heh…did someone say hospital services? It rose 0.46% m/m, pushing the y/y to 0.77% from 0.50%. No real victory lap for me yet…it’s got a long way to go.

  • Pharma was also positive, +0.29% m/m versus -0.46% m/m last. Overall, Medical Care rose to 2.57% y/y versus 1.96% last month. Medical Care is about 9% of CPI.
  • Used cars and trucks accelerated to 1.47% y/y versus 1.25%. So no retracement to the bounce last month. I hadn’t expected any since the move last month looked like a return to fair.
  • Apparel +0.44% m/m. That takes the y/y to -0.55% versus -1.29% last month. Couple of months ago there was a sharp fall as BLS shifted to a new methodology. Looks like this is catching up. Still mild deflation in apparel, no tariff effects.
  • Overall, Core Goods was +0.40% y/y. Wait, what?? About time! HIGHEST Y/Y CORE GOODS SINCE 2013. The persistent-deflation-in-goods narrative just took a hickey.

  • However, hold the victory lap on that. Model says we may be close to the highs on core goods. (But the model doesn’t know about tariffs.)

  • This is rare…Other Goods and Services, the eighth of eight major subgroups in CPI, rose 0.52% m/m. That category (only 3% of CPI) is a dog’s breakfast so unusual to see a m/m jump that large. Will be worth looking into.
  • Core inflation ex-shelter rose to 1.31% y/y from 1.16% last month.
  • New Vehicles and Leased Cars and Trucks both decelerated further. So if anyone ‘blames’ used cars for the strong print, point out that overall “New and used motor vehicles” decelerated to 0.30% y/y from 0.43%. This kind of talk will make you popular at parties.
  • CPI for health insurance continued to surge, now up 15.88% y/y. Remember, this is a residual, but I think that means it may signal changes that the BLS hasn’t picked up yet. It’s the highest on record.

  • Back to that dog’s breakfast of “Other”. Nothing really stands out. This category has cigarettes, personal care products (cosmetics, etc), personal care services (haircuts, e.g.), funeral expenses, legal services, financial services, dry cleaning…pretty balanced increases.
  • Biggest declines this month are jewelry and watches (-17% annualized) and infants’ and toddlers’ apparel (-12.8% annualized). Bunch of annualized >10% gains tho: Mens’ & boys’ and womens’ & girls’ apparel, public transportation, lodging away from home, tobacco, motor fuel.
  • Early look at median CPI…my estimate is 0.28% m/m, which would put y/y to 2.88% and a new high.
  • OK, time for the four-pieces charts. And then a wrap-up. First, Food & Energy.

  • Second piece: Core goods. This is really where the story is, and where it’s likely to be going forward. A reminder here about how long the inflation process can take! Folks were looking for tariff effects the moment they went into effect. But businesses wait-and-see first.

  • Now businesses have seen, and the tariffs look to be pretty sturdy, and they’re moving prices. And more to come probably.
  • Core services less rent of shelter. Medical Care maybe has stopped going down, but it isn’t going up yet.

  • And the stable Rent of Shelter. A little surprised it’s so buoyant still.

  • Well, the wrap-up is obvious here. Second 0.3% core month in a row, and no obvious outliers. The acceleration seems to be concentrated in core goods, but fairly broad. I still think we will see inflation peak later 2019 or early 2020, but…there are no signs of it yet.
  • So this is what the Fed faces: slowing global growth, political unrest, and rising inflation. In that circumstance, will they keep easing? OF COURSE THEY WILL, THEY DON’T CARE ABOUT INFLATION. Haven’t for a decade at least.
  • And what about markets? 10-year inflation swaps are shown below, compared to Median CPI (last point estimated). There’s a serious disconnect here.

  • So as Porky says, “That’s all, folks!” Thanks for tuning in. I’ll put the summary of these tweets up on my site mikeashton.wordpress.com within the hour.

What is amazing about inflation is both how slowly it changes and also how quickly it changes. Three months ago we were looking at four soft months in a row on core CPI and people were starting to chirp about the coming deflation. Then we get two of the highest core prints in a long time – and broad-based at that – and the story will be 180 degrees different. (Another reason to watch Median CPI rather than Core CPI is that the head fakes aren’t very good in Median – there was never much question that the broad trend was staying higher).

To be sure, the Fed doesn’t really care about inflation, and markets don’t much care either. Unless, that is, it causes the Administration to slow its march toward tariffs. As I write this, the Trump Administration has announced they will delay the tariffs on “some” products – including cell phones, laptops, video game consoles, some toys, and some apparel – until December 15th (just in time for Christmas, but it means that these goods won’t see prices higher during the holiday shopping season since everything on store shelves will have already been imported. Thanks Wal-Mart!). Stocks have taken that as a signal to rip higher because the fact that inflation is rising on 98% of the consumption basket is so one-hour-ago. Happy days are here again!

But make no mistake. The inflation pressures are not all from tariffs. In fact, few of them seem to be specifically traceable to tariffs. This is a continuation of a broad accelerating trend we have seen for several years. See above: inflation changes slowly. The Federal Reserve will ignore this because they believe the slower global growth will restrain inflation so that there is nothing they need to do about it. In some sense they are right, because the market has already lowered interest rates by so much it is likely to push money velocity lower again. I still think inflation will peak later this year or early next year, but if I were on the FOMC…I’d be somewhat nervous about that projection today.

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Be Quiet! Let the Man Stop Speaking!

July 31, 2019 3 comments

I continue to get more and more disappointed in Powell as a Fed chairman. When he came in, as someone who was not an economist by training and therefore not (yet, as it turns out) captured by the economic orthodoxy, I was optimistic that he might be able to break the cycle of tragic decisions by the Federal Reserve. The Fed’s path has (along with errors in other central banks mirroring the Fed’s “leadership”) led to a series of bubbles and busts, with the busts not even being allowed to cleanse the system and so defer future bubbles. It has led to an overleveraged consumer, overleveraged business, and overleveraged public accounts, and this has in turn helped produce an exceptionally fragile financial economy.

The Fed has now embarked on a new easing program, as “insurance” and “risk management” against a future slowdown. Considering that it isn’t the Fed’s job to prevent business cycles, this represents enormous hubris – but that’s what happens when you take a bunch of people and put them in a really fancy building and tell them how smart they are.

For years, the Fed has been telegraphing their moves, so that the sort of Fed watching I used to do as a fixed-income strategist is almost moot. The amount of market volatility around the Fed’s rate cut today – or, really, around Powell’s ham-handed presser afterwards – is remarkable considering that the market got exactly what it expected, except for some mild adjustments to possible paths forward in the distant future. But let’s face it: relying on what the Chairman says today about what monetary policy might be next year (for the record, he said it is unlikely the Fed could hike rates again) is like relying on today’s weather forecast for next Tuesday. There is just so much other stuff that has yet to happen that you really shouldn’t put any weight at all on that future forecast. If you’re canceling next week’s picnic because the meteorologist today said it could rain next week, you haven’t been paying much attention to the efficacy of meteorological forecasts. Count that double for economists.

But for whatever reason, I found myself listening to part of the Q&A period and instead of continuing to scream at the television I thought I’d write down a couple of the things that annoyed me. But just a couple.

  1. Powell said “Global disinflationary pressures persist.” This seems to be more of a slogan than analysis. Let’s take more than three seconds to examine it. Pray tell, what are these “disinflationary pressures?” Here are some popular candidates.
  • Aging populations in developed countries – this certainly isn’t it. Aging populations are of course inflationary, not disinflationary. An aging population implies lower potential output, all else equal, and a leftward shift of the aggregate supply curve is plainly inflationary. To be sure, this isn’t economic orthodoxy, but the economic orthodoxy in this case (as in so many cases) is simply wrong.
  • Trade – Globalization of trade has been the dominant disinflationary force for thirty years. Unfortunately, it seems to have run its course. There certainly doesn’t seem to be any sign that global trade is continuing to broaden and in fact it seems to be recently in reverse. At best, it is going nowhere fast after many years of being in fact a disinflationary force.
  • Lower interest rates – It is plain to monetarists that lower interest rates cause lower inflation, since lower interest rates cause a decline in monetary velocity by increasing the demand for real cash balances (decreasing the prevalence of attractive substitutes). However, it also seems pretty plain that the Fed is not arguing this, both because they aren’t really monetarists any longer but more importantly because it this was their argument then it’s weirdly circular: “we’re lowering interest rates because of global disinflationary pressures, such as the fact that interest rates are going down.”
  • Global debt overhang – this seems to be the only reasonable argument about a possible source of  global disinflationary pressures. A high level of private debt tends to be disinflationary because it increases the value of cash flow compared to profit. You can go broke realizing profits, if you don’t have enough cash flow to service your debt; this causes heavily-indebted companies to be more reluctant to risk market share by raising prices and causes heavily-indebted individuals to be more reluctant to risk continuous employment by asking for pay increases. On the other side, though, we know that heavy public debt loads have historically tended to be inflationary once they reach some difficult-to-define tipping point, because central authorities have increased incentives to let inflation run a bit hot to help grow out of obligations. But again, this is sort of circular as well since one reason that there is so much debt is because real interest rates are so low. And real interest rates are so low because central banks keep easing. So it would seem weird to be making the argument about too much debt causing disinflation and then lowering interest rates.

I don’t think he is thinking about the “AirBnB effect” (not real) or the “Amazon effect” (not real) or any of the various other postulated effects stemming from gee-whiz technology that never seems to hold up to actual scrutiny. In the end, I don’t think he really had anything in particular in mind. For the Fed, the fact that inflation hasn’t gone up means that there are disinflationary forces. Q.e.d.

Powell also noted: “If you look at the economy right now there’s no sector that’s booming and therefore might bust.”

Nope.

Sources: GuruFocus, Bloomberg, DOE, Enduring Investments.

 

Categories: Federal Reserve

Summary of My Post-CPI Tweets (July 2019)

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy. Or, sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments or Enduring Intellectual Properties. Plus…buy my book about money and inflation. The title of the book is What’s Wrong with Money? The Biggest Bubble of All; order from Amazon here.

  • Big, big CPI day today. After four straight 0.1s (rounded down to that, in each case) on core CPI, the importance here is hard to overstate.
  • With the Fed gearing up to ease, partly because of low inflation, these prints all matter more.
  • (…although the Fed minutes suggested the Fed is taking a “risk management” approach, which makes the hurdle for NOT easing a lot higher since they can always say they’re addressing future risks, not current data.)
  • The problem is that better measures of inflation, like Median or Trimmed Mean, are not really showing the same slowdown as core. That is, these are still one-offs, or “transitory” in Fed-speak.
  • But that’s one way that inflation involves – as one-offs that become more frequent until those one-offs are the median. Still, while I expect inflation to peak later this year I don’t think that’s happening yet.
  • There is an underlying mystery in all of this and that is: where is the tariff effect?! The markets have moved on from worrying about it because it hasn’t shown up yet.
  • But the short-term bump from the actual tariffs was never the real threat with de-globalization. The important effects are long-term, not short term. Still, it makes investors more confident that China tariffs don’t really matter much.
  • OK, just a few minutes until the number. After the number and my reactions to it, tune in to @TDANetwork where I will be talking with @OJRenick at about 9:15ET. The consensus is for 0.2% on core CPI, keeping y/y at 2.0%. Good luck out there.
  • Well, that’s more like it. Core CPI +0.29%, pushing y/y from 2.00 to 2.13%.
  • Breakdown in a moment but first thing it’s really important to remember: this does not mean the Fed won’t ease this month. Almost surely, they still will. Remember, this is “risk management” to them. They’ve set it up to ease anyway.
  • Last 12 core CPI.

  • OK, big m/m jump in Primary Rents and Owners’ Equivalent are the obvious culprits. Rents went to 3.87% y/y from 3.73% y/y on a +0.424% m/m jump. OER rose from 3.34% y/y to 3.41% y/y.
  • Used Cars and Trucks also finally caught up a bit…they’d been way below where private surveys had them, but this month +1.59% m/m, vs -1.37% last month. y/y goes from +0.28% to 1.25%.
  • Apparel +1.13% m/m. Y/y it’s still in deflation at -1.3%, but last month that was -3.1%. Tariff effect or just the new method adjustment starting to smooth out? I expect the new method will show more volatility, FWIW.
  • You can see the main trend in apparel hasn’t really changed; this month’s bump just moves it back towards the prior flat-to-slightly-down trend.

  • CPI-Used cars and trucks vs Blackbook. Had been a bit below, now spot on.

  • Core ex-shelter rises to 1.16% from 1.04%. That’s still well below the highs from late last year but underscores that this is not JUST housing (although…housing is a big part of it).
  • This is interesting. Hospital Services (part of Medical Care) continues to plunge. -0.1% m/m and down to +0.50% y/y.

  • also medicinal drugs continues to decline. And Doctor’s services was stable. But Medical Care as a whole drooped to 1.96% from 2.08% y/y. Those are the three big pieces, but…

  • …Medical Care CPI didn’t decline further because Dental Services (0.79% weight, about half of doctors’ services) had a big jump, y/y to 1.94% from 1.15%. Get those teeth taken care of, people.
  • College tuition and fees ebbed to 3.45% from 3.81% y/y.
  • Back to Transportation…while Used Cars jumped (mostly just getting back to trend), New vehicles continued to droop. 0.58% y/y from 0.90% y/y. And leased cars got cheaper.
  • My early estimate of Median CPI is +0.27%, bringing y/y back up slightly to 2.81%. Note the monthly series is much more stable than core, which is one reason to like Median.

  • The largest negative changes this month were in Motor Fuel, Fuel Oil, Miscellaneous Personal Goods, Infants’ and Toddlers’ Apparel, and Public Transportation. All -10% or more on an annualized basis, but mostly small too.
  • Largest increases were Jewelry and Watches, Car and Truck Rental (both of those over 60% annualized), Footwear, Used Cars and Trucks, and Men’s and Boys’ Apparel.
  • I think that’s enough for today as I have to go get on air for @TDANetwork in 15 minutes. Tune in! Bottom line here is: keep focusing on Median, inflation isn’t headed down YET, but…Fed is still going to ease this month.
  • Totally forgot to do the four-pieces charts. Will have to skip this month.
  • OK, the four-pieces charts – I’ll have them in my tweet summary so might as well post them here. As a reminder these are four pieces that add up to CPI, each 1/5 to 1/3 of the total.
  • First up, Food and Energy.

  • Core goods. Now, this is interesting because it shows the reversal of some of the ‘transitory’ effects. Our model has this going to 1%, but recent outturns had been discouraging. Now back on track.

  • Core services, though, continues to be drippy. A lot of the sogginess is medical care. I wonder what happens if the Administration wins and Obamacare is repealed? Short term, probably higher, but in the long-term less government involvement is also less inflationary.

  • Finally, rent of shelter. Running a bit hotter than I expected it to be, and due to start fading a little. But no sign of a sharp deceleration in core while this is stable.

(I had to end this earlier this month because of the TD Ameritrade Network appearance, but went back and added the four-pieces charts later.)

The bottom line here is that nothing has changed in terms of what we should expect from central banks. They’re willing to let inflation run hot anyway because they thing low inflation was the problem. So they will ease this month, and probably will continue to ease as growth wanes. They will feel like they are ahead of the curve, and when inflation ebbs as I expect it to, they will say “see? We were right and we were even pre-emptive!”

Indeed, this is really the biggest risk in the longer-term. The Fed is going to be “right” but for all the wrong reasons. Inflation is not going to be declining because growth is slowing; these are merely coincident at the moment. Lower interest rates causing lower money velocity (since the opportunity cost of holding cash is going to go back towards zero) is the cause of the coming ebb in inflation which, by the way, won’t be as severe as in the last recession. But the risk is that the Fed becomes more confident in their models because they “worked,” and rely on them later.

Here’s an analogy. I just tossed a coin and the Fed went off, and ran complicated models factoring in gravity, wind resistance, the magnetism of the metals in the coin, biometric analyses about the strength of my thumb, and they concluded and called “heads.” It turned out to be heads, and the Fed is very happy about how well their models worked. Now, I know that it was “heads” because I tossed a two-headed coin.

So later, when I toss the coin again, the Fed runs the same model and calls “tails.” But this time, they are much more confident in their call, because of the model’s past success. Of course, since they didn’t actually get the right answer for the right reason the first time, there’s no more chance of being right than there was before…they’re just going to rely on it much more. And that’s the risk here. When the next inflation upturn happens, which I think will happen in the next cycle, the Fed will be very confident that their ‘expectations-augmented Phillips curve’ and Keynesian models will work…and they’ll be very, very late when inflation goes up.

But a really important point is: that’s not today’s trade. I doubt it’s even this year’s trade, although if I’m wrong and the peak isn’t happening yet it may be. The market realities remain:

  1. The Fed is going to ease this month, almost certainly 25bps.
  2. The Fed and other central banks are likely to keep easing preemptively, and then keep easing when the recession begins, and keep policy rates too low once the next expansion starts (although market rates will signal when that’s happening).
  3. Equities are too high for this growth regime; TIPS are way, way too cheap for any reasonably likely inflation regime…at least, relative to nominal bonds. But equities will probably take a while to figure that out.

Summary of My Post-CPI Tweets (June 2019)

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy. Or, sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments or Enduring Intellectual Properties. Plus…buy my book about money and inflation. The title of the book is What’s Wrong with Money? The Biggest Bubble of All; order from Amazon here.

  • OK, CPI day at last. We get to find out if Powell meant “transitory” in the one-month sense (probably not) or in the 3-6 month sense (more likely).
  • After all we have had three weak core CPI figures in a row: 0.110% for Feb, 0.148% in March, 0.138% in April. Three 0.1%s, rounded.
  • Last month the culprit was used cars, -1.3% m/m, and Apparel at -0.8% m/m, the latter due to a methodology change. These are both short-term transitory, probably.
  • Meanwhile, the evidence that core is being infected these last three months by tail events is in the median CPI, which was +0.26%, +0.27%, and +0.20% the last 3 months.
  • Housing, on the other hand, remains strong, and this should continue for a bit; Medical Care remains weak with pharma especially (+0.1% y/y)…and I think that is “longer-term transitory” that should start to retrace higher.
  • I am expecting a return to normalcy, not so much a rebound, in autos and apparel. But that should be enough to hit the consensus figures of 0.21% on core, 2.09% y/y.
  • Longer-term, the fact that interest rates have fallen so far suggests that the small rebound we have seen over the last year and a half in money velocity may have trouble extending.
  • So I think Median probably peaks late this year or early next, though I don’t expect it to fall off a cliff, either, in this recession.
  • Grabbing coffee. Back in 11 minutes.
  • So maybe a liiiiiittle more transitory than we thought! Core +0.11% m/m, +2.00% y/y.
  • Last 12 months. The comp is easier next month, but none of the last 4 months would have exceeded it anyway!

  • Apparel basically flat m/m, which is approximately what I expected…-3.06% y/y though, which includes the methodology change.
  • CPI-Used Cars and Trucks was again down sharply m/m. -1.38%. That’s unlikely. Pushes y/y to +0.28%, Black Book has it about 1% above that.

  • Housing: OER +0.26% m/m, Primary Rents +0.24%. Actually those aren’t far from the trends (y/y in each case declined a couple of hundredths, to 3.34% and 3.73% respectively), but last month had been chippier.
  • Medical Care (and then I’m going to take a few minutes and dig deeper on some of these)…Medicinal Drugs (pharma) went into deflation. -0.11% m/m, -0.82% y/y. Chart in a moment. Doctor’s Services roughly unch, but only 0.30% y/y. Hospital Services bounced a bit, 1.30% y/y.
  • Even with the bounce, Hospital Services is lower than two months ago, 3 months ago, etc. One year ago it was 4.70% y/y. Hospital Services is the largest component of the Medical Care subindex.
  • Here is the y/y chart for drugs. Now, it’s very hard to measure this because there is tremendous dispersion in consumer costs for prescription drugs…massive differences based on which outlet, formulary, insurance, etc you have. Doing a lot of work on this. Sooo…

  • this is the y/y picture for NONprescription drugs, which are much easier to measure. Basically no chg. So either prescriptn drug mkt is getting much more competitive (I doubt it), there is some change in collection method (possible), or a shift showing up as change.

  • there is no lower-level index for drugs so we can’t really dig any deeper on that unfortunately. But it’s significant, not only for the CPI of course but for consumers generally (and the budget deficit) if health care costs really ARE slowing in a permanent way.
  • CPI – College Tuition and Fees, essentially unch at 3.81% vs 3.86% y/y. But well off the lows.

  • Now what does that last picture look like…oh, yeah, the S&P Target Tuition Inflation Index (my baby).

  • Core inflation ex-housing down to 1.04%, the lowest level since February 2018. Still nowhere near the lows, nowhere near deflation, and with lots of transitory stuff in it.

  • Core goods prices still in deflation, -0.2%. But lagged effect of the dollar’s 2017 selloff should just now be starting to wash into the core goods data. And we still haven’t seen the tariff effect yet. So this is still to come and the reason I don’t think we’ve peaked yet.

  • WEIRD: Biggest declines on the month were used cars & trucks (-15.3% annualized), Leased cars & trucks (-13.8%). Biggest gainers: Car and Truck Rental (+26.5%), Public Transportation (+24.8%).
  • Early estimate for Median CPI is +0.21% m/m, making y/y 2.81%. So, again, it’s a tails story.
  • Sorry, didn’t calculate the sheet for y/y. Should be 2.76% y/y for median, down from 2.80%.
  • Here is m/m Median CPI. Notice there’s really no major slowdown here. It’s been pretty steady and rising slightly y/y for a while. Nothing below 0.2% m/m since last August.

  • OK, four pieces and then we’ll sum up. Piece 1 is food and energy.

  • Piece 2 is core goods. As I said, I expect this to turn back higher. This is where you find Used Cars and Apparel…so transitory stuff is big here. This is also where tariffs fall heaviest.

  • Piece 3 is Core Services less Rent of Shelter. Same story here: “What is up with medical care?” It may be that since consumers under the ACA end up paying out of pocket for a much larger share, they’re bargaining harder. That could be why it feels so much worse than this.

  • Finally, rent of shelter – same old same old. No deflation while this remains steady as a rock.

  • So, in sum. I do think that Powell is right in focusing on the “transitory” inflation slowdown. Better measures, such as Median (see below for Median vs core), show no significant slowdown yet.

  • …and it’s hard to see where a slowdown would come from. Medical Care is already very slow. Core goods is already very slow, with negative tails already in the data but not much sign yet of the tariff effect sure to come. Housing is solid.
  • So for now, I expect median inflation to continue to crawl higher. As we get later in the year, though, unless interest rates rebound a lot higher there’s a decent chance that money velocity droops again.
  • Now, money velocity is already REALLY low so it may not. This chart isn’t our best model but it suggests velocity is already too low for the level of int rates (I’m not sure it’s a linear function near zero though). It was responding, but lower int rates may truncate a bounce.

Nothing more really to add – I will say that although Powell is right and these are transitory factors, I have lost faith that the Chairman is a “different sort” of Fed Chair since he doesn’t have an academic background. He was at first, but appears to have been captured by the econocognoscenti. Ergo, I expect the Fed will ignore the fact that inflation is still drifting higher, and start to cut rates as the growth figures make it ever clearer that the economy is heading towards (if not already in) recession. Long-end yields are already 110bps or more off the highs, so I think the bond market already has more than half its recession-rally finished (I don’t think we’ll have new low yields this cycle since I don’t think inflation will collapse and I don’t think the recession will be as bad). But stocks haven’t even begun their earnings-recession selloff, so…

How Not to Do Income-Disparity Statistics

June 10, 2019 4 comments

I am a statistics snob. It unfortunately means that I end up sounding like a cynic most of the time, because I am naturally skeptical about every statistic I hear. One gets used to the fact that most stats you see are poorly measured, poorly presented, poorly collected, or poorly contexted. I actually play a game with my kids (because I want them to be shunned as sad, cynical people as well) that I call “what could be wrong with that statistic.” In this game, they have to come up with reasons that the claimed implication of some statistic is misleading because of some detail that the person showing the chart hasn’t mentioned (not necessarily nefariously; most users of statistics simply don’t understand).

But mostly, bad statistics are harmless. I have it on good authority that 85% of all statistics are made up, including that one, and another 12.223% are presented with false precision, including that one. As a result, the only statistic that anyone believes completely is the one they are citing themselves. So, normally, I just roll my eyes and move on.

Some statistics, though, because they are widely distributed or widely re-distributed and have dramatic implications and are associated with a draconian prescription for action, deserve special scrutiny. I saw one of these recently, and it is reproduced below (original source is Ray Dalio, who really ought to know better, although I got it from John Mauldin’s Thoughts from the Frontline).

Now, Mr. Dalio is not the first person to lament how the rich are getting richer and the poor are getting poorer, or some version of the socialist lament. Thomas Piketty wrote an entire book based on bad statistics and baseless assertions, after all. I don’t have time to tackle an entire book, and anyway such a work automatically attracts its own swarm of critics. But Mr. Dalio is widely respected/feared, and as such a simple chart from him carries the anti-capitalist message a lot further.[1]

I quickly identified at least four problems with this chart. One of them is just persnickety: the axis obviously should be in log scale, since we care about the percentage deviation and not the dollar deviation. But that is relatively minor. Here are three others:

  1. I suspect that over the time frame covered by this chart, the average age of the people in the top group has increased relative to the average age of the people in the bottom group. In any income distribution, the top end tends to be more populated with older people than the bottom end, since younger people tend to start out being lower-paid. Ergo, the bottom rung consists of both young people, and of older people who haven’t advanced, while the top rung is mostly older people who have Since society as a whole is older now than it was in the 1970s, it is likely that the average age of the top earners has risen by more than the average age of the bottom earners. But that means the comparison has changed since the people at the top now have more time to earn, relative to the bottom rung, than they did before. Dalio lessens this effect a little bit by choosing 35-to-64-year-olds, so new graduates are not in the mix, but the point is valid.
  2. If your point is that the super-wealthy are even more super-wealthier than they were before, that the CEO makes a bigger multiple of the line worker’s salary than before, then the 40th percentile versus 60th percentile would be a bad way to measure it. So I assume that is not Dalio’s point but rather than there is generally greater dispersion to real earnings than there was before. If that is the argument, then you don’t really want the 40th versus the 60th percentile either. You want the bottom 40% versus the top 40 percent except for the top 1%. That’s because the bottom of the distribution is bounded by zero (actually by something above zero since this chart only shows “earners”) and the top of the chart has no bound. As a result, the upper end can be significantly impacted by the length of the upper tail. So if the top 1%, which used to be centi-millionaires, are now centi-billionaires, that will make the entire top 40% line move higher…which isn’t fair if the argument is that the top group (but not the tippy-top group, which we all agree are in a category by themselves) is improving its lot more than the bottom group. As with point 1., this will tend to exaggerate the spread. I don’t know how much, but I know the direction.
  3. This one is the most insidious because it will occur to almost nobody except for an inflation geek. The chart shows “real household income,” which is nominal income (in current dollars) deflated by a price index (presumably CPI). Here is the issue: is it fair to use the same price index to deflate the incomes of the top 40% as we use to deflate the income of the bottom 40%? I would argue that it isn’t, because they have different consumption baskets (and more and more different, as you go higher and higher up the income ladder). If the folks at the top are making more money, but their cost of living is also going up faster, then using the average cost of living increase to deflate both baskets will exaggerate how much better the high-earners are doing than the low-earners. This is potentially a very large effect over this long a time frame. Consider just two categories: food, and shelter. The weights in the CPI tell us that on average, Americans spend about 13% of their income on food and 33% on shelter (these percentages of course shift over time; these are current weights). I suspect that very low earners spend a higher proportion of their budget on food than 13%…probably also more than 33% on shelter, but I suspect that their expenditures are more heavily-weighted towards food than 1:3. But food prices in real terms (deflated by the CPI) are basically unchanged over the last 50 years, while real shelter prices are up about 37%. So, if I am right about the relative expenditure weights of low-earners compared to high-earners, the ‘high-earner’ food/shelter consumption basket has risen by more than the ‘low-earner’ food/shelter consumption basket. Moreover, I think that there are a lot of categories that low-earners essentially consume zero of, or very small amounts of, which have risen in price substantially. Tuition springs to mind. Below I show a chart of CPI-Food, CPI-Shelter, and CPI-College Tuition and Fees, deflated by the general CPI in each case.

The point being that if you look only at incomes, then you are getting an impression from Dalio’s chart – even if my objection #1 and #2 are unimportant – that the lifestyles of the top 40% are improving by lots more than the lifestyles of the bottom 40%. But there is an implicit assumption that these two groups consume the same things, or that the prices of their relative lifestyles are changing similarly. I think that would be a hard argument. What should happen to this chart, then, is that each of these lines should be deflated by a price index appropriate to that group. We would find that the lines, again, would be closer together.

None of these objections means that there isn’t a growing disparity between the haves and the have-nots in our country. My point is simply that the disparity, and moreover the change in the disparity, is almost certainly less than it is generally purported to be with the weakly-assembled statistics we are presented with.


[1] Mr. Mauldin gamely tried to object, but the best he could do was say that capitalists aren’t good at figuring out how to share the wealth. Of course, this isn’t a function of capitalists. The people who decide how to distribute the wealth in capitalism are the consumers, who vote with their dollars. Bill Gates is not uber-rich because he decided to keep hundreds of billions of dollars away from the huddling masses; he is uber-rich because consumers decided to pay hundreds of billions of dollars for what he provided.

Categories: Economics, Politics, Rant, Theory

Tariffs and Subsidies…on Money

Many, many years ago (27, actually) I wrote a paper on how a tariff on oil actually has some beneficial effects which needed to be balanced against the beneficial effect that a lower oil price has on economic growth. But since the early 1990s until 2015 or so I can count on the fingers of one hand how many times the issue of tariffs came up in thoughts about the economy and markets. To the extent that anyone thought about them at all, it was to think about how lowering them has an unalloyed long-term positive effect. Which, for the most part, it does.

But the economics profession can sometimes be somewhat shamanistic on the topic of tariffs. Tariffs=bad; time for the next chapter in the book. There is much more complexity to the topic than that, as there is with almost any economic topic. Reducing economics to comic-book simplicity only works when there is one overwhelmingly correct idea, like “when demand for a good goes up, so does the equilibrium price.” The end: next chapter.

Tariffs have, though, both short-term and long-term effects. In the long-term, we all agree, the effects of raising tariffs are deleterious. For any given increase in money and velocity, we end up with lower growth and higher inflation, all else equal. It is important to realize that these are largely one-time effects although smeared out over a long period. That is, after equilibrium is reached if tariffs are not changed any longer, tariffs have no large incremental effect. It is the change in tariffs that matters, and the story of the success of the global economy in terms of having decent growth with low inflation for the last thirty years is largely a story of continuously opening trade. As I’ve written previously, this train was just about running out of track anyway so that we were likely to go back to a worse combo of growth and inflation, but reversing that trend would lead to significantly worse combinations of growth and inflation in the medium-to-long term.

In the short-term, however, tariffs can have a positive effect (if they are expected to remain) on the tariff-imposing country, assuming no retaliation (or even with retaliation, if the tariff-imposing country is a significant net importer). They raise employment, and they raise the wage of the employed. They even may raise the real wage of the employed if there is economic slack. The chart below shows the y/y change in manufacturing jobs, and ex-manufacturing jobs, for the last 40 years. Obviously, the manufacturing sector has been shrinking – a story of increased productivity, but also of trade liberalization as manufacturing was offshored. The Obama-era work programs (e.g. “Cash for Clunkers”) temporarily reversed some of that differential decline, but since 2016 – when we got a new President – manufacturing payrolls growth has caught up to non-manufacturing. That’s not a surprise – it’s the short-term effect of tariffs.

The point is that tariffs are a political winner in the short-term, which is one reason I think that people are overestimating the likelihood that “Tariff Man” is going to rapidly concede on trade and lower tariffs. If the Administration gets a clear “win” in trade negotiations, then I am sure the President is amenable to reversing tariffs. But otherwise, it doesn’t hurt him in the heavy manufacturing states. And those states turn out to be key.

(This is a relative observation; it doesn’t mean that total payrolls will rise. The economic cycle still has its own momentum, and while tariffs can help parts of the economy in the short term it doesn’t change the fact that this cycle was very long in the tooth with lots of imbalances that are overdue for correction. It is no real surprise that employment is softening, even though it is a lagging indicator. The signs of softening activity have been accumulating for a while.)

But in the long run, we all agree – de-liberalizing trade is a bad deal. It leads among other things to bloat and inefficiency in protected sectors (just as any decrease in competition tends to do). It leads to more domestic capacity than is necessary, and duplicated capacity in country A and country B. It promotes inefficiency and unbalanced growth.

So why, then, are investors and economists so convinced that putting tariffs or subsidies on money has good (or even neutral) long-term effects? When the Fed forces interest rates higher or lower, by arbitrarily setting short-term rates or by buying or selling long-term bonds – that’s a tariff or a subsidy. It is protecting interest-rate sensitive sectors from having interest rates set by competition for capital. And, as we have seen, it leads in the long run to inefficient building of capacity. The Fed evinces concern about the amount of leverage in the system. Whose fault is that? If you give away free ice cream, why are you surprised when people get fat?

The only way that tariffs, and interest rate manipulations, have a chance of being neutral to positive is if they are imposed as a temporary rebalancing (or negotiating) measure and then quickly removed. In the case of Federal Reserve policy, that means that after cutting rates to address a temporary market panic or bank run, the central bank quickly moves back to neutral. To be clear, “neutral” means floating, market-determined rates where the supply and demand for capital determines the market-clearing rate. If investors believed that the central bank would pursue such a course, then they could evaluate and plan based on long-term free market rates rather than basing their actions on the expectation that rates would remain controlled and protective.

It is no different than with tariffs. So for central bankers criticizing the trade policy of the Administration, I say: let those among you who are without sin cast the first stone.

What “Transitory Factors” Might Tell Us About Inflation

May 23, 2019 2 comments

There is a lot of buzz around inflation these days. Some people are explaining why we shouldn‘t worry and some people why we should, but regardless – it’s a topic of conversation for the first time in ages. And despite this (or rather, because of it, because I find myself very busy these days), I haven’t written in a long time despite the fact that I have a few things worth writing about. I keep trying, though.

Today I am cheating a bit and taking a column from the quarterly inflation outlook that my company (Enduring Investments) just sent to customers. But I think it is fair to include it here, because the musing was provoked by a recent exchange I had on Twitter while doing my monthly CPI analysis/tweetstorm (follow me @inflation_guy).

As readers know, I tend to focus on Median CPI, rather than Core CPI, as my forecast target variable. The reason is that price changes are rarely distributed randomly. If they were, then the choice of core or median CPI would be irrelevant because they would normally be the same, or roughly the same. But when a distribution has long tails, the ends of the distribution exert a lot of pressure on the average and so median can differ substantially from the mean simply because one tail is much longer than the other even if most of the distribution is similar.

Consider a playground see-saw and imagine that on one side of the see-saw are seated several small children. Think of the “average” of the see-saw system as the point where the see-saw balances. Well, there are lots of ways to balance the system with weight on the other side of the see-saw: a very large weight close to the fulcrum will do it. But the further away from the fulcrum one places the weight, the smaller the weight necessary to balance the scale. As Archimedes said, “give me a lever long enough, and a place to stand, and I can move the world.” The point is that an influence far from the middle of the distribution can have a very significant effect on the average because it is far away from the distribution:  the effect on the mean is (weight * distance from the mean).

Example: the mean of 98% of a distribution is 12. The remaining 2% of the distribution is 28. The weighted average is [(12 * 0.98) + (118 * .02)] / (0.98 + 0.02) = 14.12.  That little 2% caused the mean to go from 12, without the tail, to 14.12 with the tail…a movement of 17.7%! Notice that .02 * 118 = 2.12, which is the amount the mean moved. And if that tail is 228 rather than 118, the mean goes to 16.32. So you see, the length of the tail matters. In both cases, the median was 12, which I would argue is a better indicator of the “central tendency” of the distribution.

(If the distribution is approximately normal, then the tails roughly balance and so the mean and median are about the same. But many economic indicators are not normally distributed, especially ones like income or home prices which are bound by zero on one side. Thus, for many economic series the median, rather than mean, is a better measure. Even though CPI is not bound by zero, it is not normal because prices are not set in a continuous process but instead to have jump-discontinuities.)

The chart below, which I often show in my CPI tweetstorm, shows the see-saw of CPI, where I’ve broken up the index into its lowest-level components and placed those weights on a number line representing the most-recent year-over-year changes. The height of the bar indicates the amount of the basket that sits in that bucket. As you can see, nearly half of the CPI is inflating faster than 3% (which is why Median CPI is 2.8%), and the mode of the distribution is between 3.5% and 4.0%. But because of the far left tail, the mean – which is what core CPI is – is just barely over 2%. Because we have much longer left-hand tails than right-hand tails, the average is biased lower relative to median.

But is this “normal?” Some people have occasionally accused me of picking Median CPI because it tends to be higher, and so the number makes it look like there is more inflation. If the spread were constant, then it would be a bit academic which we chose as the forecast variable, and in fact Core would have a better claim since after all, as consumers purchasing that basket we are in fact paying the average price and not the median.

In fact, though, I think that the tendency of core in recent years to trade below median really is its own interesting story about how prices evolve. If we have 3% inflation, it does not mean that all prices are going up at 3% per year, 0.75% per quarter, 0.25% per month. The price of any given good doesn’t move smoothly but rather episodically, sporadically, spastically. When we are in a disinflationary period, or anyway a low-inflation period, what is happening is that those episodes involve periods of slower prices and “transitory factors” that tend to be on the downside.[1] In that sense, it may be that the Fed, and me/Enduring, both err when they try to look through ‘transitory factors’ because transitory factors may be part of the process. The argument for that perspective is similar to the argument I myself make about why “ex-items” measures make sense when you are looking at an individual company’s earnings but not when you look at the aggregate earnings of the economy. Because bad stuff, or “items,” are always happening to someone somewhere. You can throw them out of any one analysis but if you own the index, you’ll get some of those “items.” You just don’t know from where. Perhaps inflation is the same way.

However, I should point out that median inflation is not always below core. The chart below shows median and core CPI going back to 1983, which is when the Cleveland Fed’s series for Median CPI begins. Notice that from 1983 until 1993, Median CPI was generally lower than core CPI. In 1994, this changed and it has been the opposite ever since.

The year 1994 is significant because that is also the year that most models for inflation that are calibrated on pre-1994 data break down (or, conversely, it is the year prior to which a model calibrated on post-1994 data breaks down). I have written previously about this phenomenon and the fact that the Fed believes this is when inflation expectations abruptly became “anchored,” whatever that means – but *I* believe that this discontinuity is when globalization kicked into high gear with an explosion in the number of bilateral and multilateral trade agreements. It strikes me as plausible that these items are related. When markets are suddenly opened to global competition, affected markets will suddenly show slower price appreciation due to the pressure from that competition (and the replacement of high-cost domestic goods with lower-cost imports). But which market is currently being affected will not stay constant, but change over time. In other words, I think the fact that core has been persistently below median for a long time is a symptom of the globalization “dividend.”

If I am right, and if if I am also right about the arrow of globalization changing direction, then it follows that core and median might flip positions at some point over the next couple of years. And then the “transitory effects” will be mostly on the high side.


[1] It could also be indicative of a bias from the measurers that their improved methods are always looking for lower inflation – not in the “the BLS is making up this *@&$^” sense but in the sense that for lots of reasons the CPI appears to be overstated because of technical details about the functional form, the way measurement errors happen, etc. And so researchers may spend more time looking for ways that inflation is overstated. I don’t think that research bias is actually much of a problem. But I figured I ought to mention that that is one possible interpretation.

Categories: Causes of Inflation, CPI
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