The Smoke Is There, But No Fire Yet
The economic data released on Friday was another mixed bag, continuing to show a recovery from the recession’s depths but not yet thrilling us with the breadth and strength of said recovery. As I noted on Thursday, though, my focus is on CPI.
The print was right on the market’s expectations for a rise in core CPI of +0.1%, but of course that was slightly above my expectations. I am very sensitive at the moment to deviations of inflation above my expectations, since the dynamics of the number create an unsettling stand-off between the rising and falling components of CPI to produce the illusion of stable inflation.
I have shown Core-CPI-ex-Housing before and you will hear me chirp on that again. But I want to show the issue with a little more detail. It is normally the case that some subcomponents of inflation are rising faster than others; what is abnormal is that in this case the subcomponent that is holding core down is just so darn large.
Looking at the eight CPI major groups (Housing, Medical Care, Transportation, Apparel, Food & Beverages, Education & Communication, Recreation, and Other), we can say that 58% of that group is rising slower than core inflation on year-on-year basis; on average, this group is rising at +0.5% held down by Housing (which is nearly half of core inflation) at +0.1% year-on-year, ex-energy. Incidentally, I’m approximating these numbers – to actually subtract energy from many of these subcomponents you have to dig down into the strata further than I had the time for.
The other 42% is going up faster than the average, of course, by an average of 3.4%. So far, this seems to confirm the general sogginess of the inflation data: core is heading lower, and most of the index is heading lower. The numbers are summarized in the table below
|Approx Core Y/Y change||Approx Weight in Core|
|Food & bev||0.8%||1.5%|
Here’s the thing, which is the same thing I’ve said before but you can see it here more viscerally perhaps: if you remove housing from core inflation, then about 73% of what’s left is rising 2.4% or faster. There is a really good reason to think that housing should be treated as something a bit unusual in this cycle, and without housing we have what appears to be an inflation problem.
We know about the Medical Care and Education inflation increases and we hear about them every day it seems (funny story, by the way: Education would seem to have nothing to do with Communication, unless you happen to major in communications while at college. But if you separate those two series you get the cost of communication going always lower, while the cost of education goes always higher, for decades. So combining them has the effect of hiding two major trends. I have no idea why these two are combined in one Major Group). But I wonder if we should be concerned about the Transportation part.
Transportation includes car prices (both new and used), and as we know the auto manufacturers have been in dire straits for a while. Why are these prices actually rising, in the midst of a huge recession? Cash-for-clunkers might be expected to help hold up auto prices by artificially stimulating demand, and by junking the perfectly good “clunkers” it might also have kept used car prices higher than they otherwise would be. But…really? Car companies actually have pricing power? See the chart below (Source: BLS), which shows the seasonally-adjusted price series for “New and Used Motor Vehicles”. Car prices have been rising since early 2009, long before C-f-C became a reality:
Airline fares, too – also part of Transportation inflation – are recovering but in this case it looks like just a resumption of the previous work airlines had done to restore pricing power after the recession in the early part of the decade. Capacity is down, so load factors are up, and that gives airlines some pricing power. They briefly relinquished this when the global financial crisis hit, but prices are rising again as they had previously been.
The airline fares increase doesn’t bother me, as a worrywart on inflation, because it’s been well-earned. Airlines ought to have pricing power, because they have rationalized their cost-revenue models and aren’t flying big empty jets all the time. For a change, airlines have decided to make some money on less volume rather than no money on more volume. But autos are more worrisome.
Inflation is what happens when prices generally start to rise as too much money chases too few goods, thus cheapening the value of that money in terms of goods. When the stock of money is increasing, prices don’t need a reason to go up. Firms don’t need to cultivate business models that live on the right part of the demand curve – as a vendor in inflationary times, you raise the price and people pay the higher price. This is not supposed to be happening in a recession.
As I said, Cash-for-Clunkers may well be part of the story there. But it isn’t only autos, and only Transportation, where we see inflation percolating. And that’s the concern.
There is an interesting correlation among the groups that are inflating the most, however. Medical Care, Education, and now Transportation…can you spot it? What fundamental force is different in those sectors of the economy compared to, say, Apparel and Recreation?