Wednesday, April 15, 2009

Bob Murphy, the CPI and the Future

Bob Murphy comments on today's CPI numbers (and yesterday's PPI number) that show deflation:

CPI Officially Fell At 1.2% Annualized Rate in March (!)

Well hmm. If today's CPI numbers had shown a positive (seasonally adjusted) growth rate, I was all set to trumpet from the mountaintops: "WAKE UP PEOPLE!!

Bernanke et al. keep warning us of 'deflationary' pressures when there were three straight months of price hikes higher than the Fed's alleged 'comfort zone' throughout the whole first quarter of 2009!!"But alas, my case is now rendered dubious by the announcement that the (seasonally adjusted) CPI fell 0.1% from February to March.OK look kids, yesterday I tried to do the honest thing by admitting that the falling PPI number was disconcerting, for those of you who share my estimate of my own economic acumen. So I hope you will not now roll your eyes when I question these BLS numbers.First off, if you look at the actual BLS release (top row), you'll see that the unadjusted CPI rose by 0.2%--an annualized rate of 2.4%--from February to March. OK? So the BLS's "seasonal adjustment" took a 0.2% increase and transformed it into a 0.1% decrease. Notice that that's a change of 150% downward from the raw number...Last point, and I realize this is anecdotal: Have you folks been grocery shopping lately? I am quite sure that the prices of just about everything are a lot higher now than they were a year ago.

Bob is correct here on all points. Part of what is going on is a distortion because of BLS seasonal adjustments. As I have pointed out, sales of a lot of very immediate consumer goods such as movie, sports and concert tickets have been strong, and their prices appear to be decidedly up from last year. Thus, it is easy to see the BLS is not completely picking up what is going on at the consumer level. The numbers are distorted. (As a matter of fact, there are a lot of distortions at the BLS, beginning with the fact that CPI isn't a labor statistic, which means the Bureau of Labor Statistics should really be called the Bureau of Statistics and we could then officially refer to the data they put out as the BS numbers.)

Getting back to business, if you look at the three month CPI data, i.e., January to March data, you see that almost all the categories are in positive territory. But still the overall annualized CPI for the three month period is only 2.2%. This has to be a frustrating number for Bob to see because, as he then points out, Bernanke is really pumping in the money:

Let me very briefly explain why all the people talking about "credit unwinding" etc.--and making comparisons to the Great Depression--are missing a big point. From 1929-1933, the quantity of money (let's say M1) declined by about one-third. During 2008, M1 increased by 17%. OK, everyone got that? Not only did Bernanke prevent the quantity of money held by the public from falling, he boosted it at one of the highest annual rates in history. I'm not talking about bank reserves or the Fed's balance sheet--which Bernanke of course has exploded--I'm talking about cash in circulation and checking account balances.
Bob, again, is exactly correct here. So has the BLS gone out and completely distorted the CPI numbers all out of whack? I think not. Their seasonal adjustments are mildly out of whack and their are problems I have with what they sometimes call a consumer good, but the big suffocater of the inflation is real and is what FA Hayek called a secondary deflation.

Here's Steve Hanke writing in 2002 about the then mild downturn that really nails the current situation (My emphasis):

If this hangover phase-working off excess capacity and transforming the capital structure to shorten the length of production processes-is not bad enough, the economy is vulnerable during this phase to what Austrians termed a "secondary deflation." If a general feeling of insecurity and pessimism grips individuals and enterprises during a Hayekian hangover, risk aversion and a struggle for liquidity (cash reserves) will ensue. To build liquidity, banks will call in loans and/or not be as willing to extend credit. Not surprisingly, banks are already scrambling for liquidity. During the past 17 months, banks have been cutting back on corporate lending, shunning especially industries like energy, textiles, steel and telecommunications that over-invested during the boom. Moreover, banks are charging higher rates and bigger up-front fees on most other loans, even to top-rated companies. Households, too, are liquidating assets to increase their cash positions and pay down debts. Indeed, they pulled $13.8 billion out of U.S. equity mutual funds in June. This scramble for liquidity will put a further damper on investment as well as consumption.

Several aspects of a secondary deflation are worthy of further comment. If the forces of a secondary deflation are strong enough, a central bank's liquidity injections can be rendered ineffective by what amounts to private sector sterilization. When people expect falling prices and a real deflation, their demand for cash will increase, soaking up liquidity injections. This has been the recent experience in Japan, where prices continue to fall in the face of year-over-year base money and yen note (cash) growth rates of 30 and 15 percent, respectively. While milder forms of a so-called secondary deflation don't result in real deflations, they do undermine economic growth and extend the life of Hayekian hangovers.

Even though the primary cause of a downturn is an over-investment boom, understood in the Austrian sense, Hayek acknowledged that a secondary deflation could ensue and that it could be best understood in Keynesian terms.
I think that has been what has been going on. The extreme desire for cash and near cash (demand deposits) versus even holding balances at mutual funds was a sign of the fear that was prevalent. This absorbed a lot of the Fed's money printing. Of course, Bernanke's continued money printing will eventually overcome this demand for cash and cause a flight away from cash. The current strength in the stock market, in my view is the first signal of this. Once the "recovery" is obvious the inflation won't be far behind. But it will be "recovery" first, inflation second and then panic climbs in inflation.


  1. I will comment the same way as I did on Bob's post. Is it just me, or does the numbers look A LOT more stable if you remove the "Energy" component of the CPI? The series CPILEGNS (All Items Less Energy, Not seasonally adjusted) and CPIENGNS (Energy, Not seasonally adjusted) tells an interesting story.

    Or am I missing something? Regardless if I look at YoY or MoM numbers the annual "inflation" seems to lie steadily over 2%, if we remove the energy component.

    But I am not an economist :)

  2. Former Goldman MD and current NYSE head Duncan Niederauer is talking the market down, saying the rally was driven by short-term traders trying to take advantage of high volatility and not by large institutional or other long term investors. If that's not a long term contrary indicator, I don't know what is.

  3. Re: my above post on Niederauer. He may be talking Goldman's quant fund book, which is either short or trying to get long on a pullback. The below link discusses a Barclay's report that states that quant funds have not participated in the rally. ZH reminisces about July 2007 when Goldman Alpha was caught short and lost 30% that month. If current resistance cannot hold, we could see an incredible short squeeze.