April’s Consumer and Producer Price indexes, showing prices up 4.2% and 6.2% respectively year on year, were well ahead of expectations and have produced widespread discussion.
Everyone from Ray Dalio and Stan Druckenmiller to my next-door neighbor has chimed in. The Federal Reserve, Democratic politicians and media apologists all proclaim this move to be “transitory.” The usual suspects trotted out the to-be-expected excuses: it’s all because of the “base effect,” starting from a low point last April when the economy first went into lockdown. It’s all because of pent-up demand as the economy reopens. While these factors have some validity—any comparison can be distorted by a low starting point—they are only part of the story. Fundamentally, the Federal Reserve’s unprecedented binge of credit creation on the back of the new administration’s unprecedented spending plans—following the hardly hawkish last four years—is the necessary and sufficient cause of the jump in inflation numbers.
It is important to note that various price indexes are symptoms of inflation; they do not represent inflation itself. Inflation is the creation of excess credit above the current needs of the economy. That excess can show up in increased asset prices or in consumer prices, depending on many factors, including, most importantly, the velocity of money. But usually, these excesses do show up in asset prices (including equities) and, after a lag, in producer prices followed by consumer prices. Events such as the economic lockdowns and restrictions we saw over the past year have the effect of reducing the velocity of money and postponing the rise in consumer prices.
Increased prices across the board
The headline CPI jumped 0.8% month on month. Sometimes, a change in the CPI is driven by one or two items, but virtually, everything was up in the last 12 months and this year to date: computers, furniture, toys, TVs, travel costs and used car prices. In fact, used cars saw a record price increase. The almost 10% one-month jump is the highest since records started in 1953. Airfares and hotel rooms were among the largest increases—to be expected as the economy reopens and demand for travel recovers—but so too was gasoline; the average price is over $3 a gallon, the highest since October 2014. This, remember, was before the hack of the Colonial Pipeline. All the apologist media and politicians are lumping the hack and higher gas prices together, but they were already high well before that event. (The big increase in basics like food and gas is another example of how policies of the Federal Reserve and so-called progressive politicians hurt working people and widen the wealth gap.)
Who lives without food or shelter?
There are peculiarities in the index that tend to distort the number downwards. The Fed’s favorite measure is the core Personal Consumption Expenditures (PCE) index which not only excludes food and energy but also is “dynamic,” meaning that the index components are frequently changed, also tending to distort the number downwards. In truth, we must acknowledge that the structure of any index—be it the price level, equities or anything else—presents difficulties. Indexes must change; otherwise, horseshoes and buggy whips would still be major components of the consumer index. But one also cannot avoid the strong sense that all the changes the government introduces are not only frequent but also have the effect, and perhaps the intention, of reducing the rate of price increases.
Another peculiarity of the official index is that “shelter” was up less than 2%, and shelter comprises rises a whopping 40% of the core CPI. Of course, rents have not increased much in the last year, given that the illegal CDC moratorium on evictions remains in place. But something less than 2% does not begin to match the increase in house prices over the last year, and typically housing prices tend to lead rents.
Not a one-month phenomenon
The base effect is real, though it did not exactly work very well for the latest employment numbers! If you look at absolute numbers on the index for the past 18 months, two things are clear: The index has been moving up for months now, and it is today higher than it was in the months before April last year, before the lockdown, by almost 4% (well above the Fed’s 2% target). The April-to-April increase was high but not a particular outlier. Therefore, the base effect clearly does not explain everything.
The second reason given to justify calling price increases transitory has more validity, and at the minimum, we will not know with certainty for some months yet. This is that with the economy opening up, there is much pent-up demand, with demand coming back more quickly than supply; there is too much demand for too few goods, driving up prices. This is certainly true in the economy as a whole, though in some sectors, there is no shortage of supply as well (for example, hotel rooms). The question is whether this will be transitory or more permanent.
There are reasons to think it will be long lasting. The Fed asserts that recent commodity price increases are due to supply bottlenecks as the economy reopens, apparently ignoring that commodity prices have been going up for over a year. Commodity prices have been increasing much more rapidly than consumer prices—either side of 50% over the past 12 months—and as they work their way through the supply chain, eventually, consumer prices will go up more. Food companies, which are seeing double-digit input price increases, will absorb some of this but only for so long before passing on higher prices. Companies test price increases, which may not fully reflect all their increases, and if consumers accept them, then there is room for additional increases. On corporate earnings calls, there have been the most frequent references to inflation since the Bank of America started tracking it in 2004. Market-based inflation expectations keep moving higher.
How long is “transitory”?
Of course, much depends on what one means by “transitory.” If you excuse April’s numbers because April last year was a particularly low number, then presumably transitory means one or two months. If you excuse April’s numbers because the economy is now rapidly reopening and demand is recovering sooner than supply, then perhaps you mean three or four months. But Federal Reserve Governor Christopher Waller said “it could be” that inflation will exceed the Fed’s 2% target “through 2022,” adding that the Fed “will not overreact to temporary overshoots of inflation.” I would think that higher inflation “through 2022” is stretching the definition of transitory. In the context of the history of the Republic, perhaps the inflation of the 1970s could be termed transitory. Another Fed official, James Bullard, said that inflation over 2% “would be welcomed.”
When consumers are not expecting higher prices to continue, there is no urgency to buy. But when consumers see their dollars buy less each trip to the store, they start to spend more to beat future increases, and thus inflation can build on itself. A friend told me he spent the day at Costco stocking up on several months of supplies of nonperishables.
Another factor that might confirm that more increases are ahead is that the indexes do not yet reflect the increase in wages, which are now beginning in earnest as unemployment pay and COVID-19 relief payments disincentivize many from returning to work. Higher wages tend not to be transitory.
With commodity prices higher than the Producer Price Index, which, in turn, is higher than the Consumer Price Index, we can expect higher consumer prices as higher commodity and producer prices flow through to consumer prices.
Money presses are working overtime
Underlying these factors, to have consumer inflation, one needs “money creation,” and there is no doubt that the administration, Congress and the Fed are doing their best to meet this criterion. Federal Reserve bank credit has been up over 19% in the last six months, but over 21% in the last three months alone. This means that the pace of credit creation is increasing. Further, the administration is trying to pass spending bills totaling $10 to $12 trillion dollars for “COVID relief,” infrastructure, to fight inequality and racism and more. Though some politicians are saying this will be met with increased taxes, it is completely unrealistic to think all that spending will come without additional borrowing and without resorting to the magic money tree. If taxes were increased to pay for all the additional spending, that would not be inflationary, but rather, on that scale, massively deflationary. But that is not going to happen. Increasing the deficit and creating new “money” is extremely inflationary.
The Fed keeps repeating that price increases are transitory, but repeating it does not make it so. They have a vested interest in making this argument, given how dismissive they have been of inflation and actually working for more. Human nature being what it is, they will be exceedingly reluctant and slow to admit that there is an inflation problem, and slow to react. Even if they were to acknowledge the problem, they would be limited in what they can do about it. Typically, central banks have fought inflation by raising interest rates. But the Federal Reserve cannot meaningfully increase rates without hurting employment and the dollar further and risking derailing the economic recovery. There are too many zombie companies that have borrowed cheap money to keep going—not to mention the federal government that is reaping the benefits of low rates in servicing its massively increased debt.
Market reaction seems perverse
How did the markets react? When the April CPI number was released, the markets responded in a peculiar way: The dollar rose, and gold fell. Though this seems perverse on the face of it, markets were likely thinking that the high inflation number increased the odds that the Federal Reserve would raise rates. But given that the Fed publicly says that it wants higher inflation and repeatedly asserts that inflation is transitory, it clearly does not think that it needs to increase rates. Most market participants appear to believe the Fed, but a sufficient number of them do not and are buying gold as the primary hedge against higher inflation. Some of the smartest analysts around, including Druckenmiller and Peter Boockvar, say that Fed policy is more out of touch with reality than it has ever been. As the months progress and inflation continues to be strong, but the Fed does nothing, more will give up on the Fed and buy gold.
Inflation is positive for gold, but even more dramatically positive is the increasing inflation that the Fed does not fight. And that is where we are now.
Editor’s Note: It’s clear the Fed’s money printing is about to go into overdrive. The Fed has already pumped enormous distortions into the economy and inflated an “everything bubble.” The next round of money printing is likely to bring the situation to a breaking point.
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