Fed’s Asymmetric Policy: Stagflation Lite Coming Up? Here Already?

Today the BLS reported the CPI for All Items rose 0.4% in October.

by Mish

“On a seasonally adjusted basis, the Consumer Price Index for All Urban Consumers increased 0.4 percent in October after rising 0.3 percent in September. The index for all items less food and energy rose 0.1 in October, the same increase as in September.”

Many have hopped on the Stagflation or Stagflation Lite bandwagon recently. Is stagflation coming up? Has it arrived already?

Food Prices

Some people might dispute the above food item line. I don’t. If anything, I find food prices substantially lower, and I do nearly all of our shopping.

The vast proportion of our food budget is fresh meats and vegetables. Beef prices are way down. I buy pork and chicken when they are on sale and store them in a freezer. I seldom buy boxed or can goods of any kind. Your results may vary.

The BLS Detailed CPI list shows the category of meat, fish, poultry and eggs is down 0.6% from September and 6.4% from a year ago. Those are believable numbers. If you only buy items on sale and freeze them, you could have done much better.

Unless there is a sudden surge in gasoline or food prices, the headline number is likely to be negative next month.

Shelter

Shelter did jump 0.4% and is up 3.5% on the year. This seems on the low side especially for some cities. Moreover, the numbers do not include housing prices.

The Fed totally blew it during the housing bubble years by ignoring a jump in home prices. Have they done that again?

Case Shiller Home Price Index

The Fed massively understated the CPI in the bubble years and has done so again.

Comparative Growth in HPI vs. OER

From 1994 until 1999 there was little difference in the rate of change of rent vs. housing prices. That changed in 2000 with the dot.com crash and accelerated when Greenspan started cutting rates.

The bubble is clearly visible but neither the Greenspan nor the Bernanke Fed spotted it. The Fed was more concerned with rents as a measure of inflation rather than speculative housing prices.

Fed Funds Rate vs. CPI and HPI-CPI

The above chart shows the effect when housing prices replace OER in the CPI. In mid-2004, the CPI was 3.27%, the HPI-CPI was 5.93% and the Fed Funds Rate was a mere 1%. By my preferred measure of price inflation, real interest rates were -4.93%. Speculation in the housing bubble was rampant.
In mid-2008 when everyone was concerned about “inflation” because oil prices had soared over $140, I suggested record low interest rates across the entire yield curve. At that time the CPI was close to 6% but the HPI-CPI was close to 0% (and plunging fast).

In the above chart HPI stands for Home Price Index, with data from Lender Processing Services (LPS) as opposed to Case-Shiller.

See the article for still more charts including the CPI and HPI-CPI Variance From Fed Funds Rate.

Medical Expenses

I also take serious exception to the BLS reporting of medical expenses. I commented on the medical component of the CPI on November 7, in Diving Into the Medical CPI: Are Your Medical Expenses Up Only 5% from Year Ago?

Medical CPI Weights

  • Medical care constitutes 6.513 percentage points of the overall CPI basket.
  • Physicians, dentists, eye care providers, and other medical professionals contribute 2.796.
  • Dental services alone contribute 0.715 percentage points to the CPI.
  • The BLS assigns a weight of just 0.487 to health care insurance.

In simple terms, the BLS tells us that dental services alone are nearly 50% more important than health care premiums.

The BLS also assumes that regardless of what you pay, if the insurance company pays more to the hospital, you must have received more benefits!

I expect major revisions to this nonsense sometime down the road.

Please see the above link for more details, including its healthcare insurance explanation.

Short Term – Where to From Here?

It’s relatively easy to estimate what the reported CPI will look like next month. I suspect it will be very low, and probably negative.

The BLS will of course strip out food and energy and report something higher on that line.

The BLS will remain behind the curve on medical expenses.

Stagflation?

What the BLS reports and how the economy reacts are two different things. A sustained home price decline would be a hugely deflationary force, as would an asset bust in general.

Without a doubt, the Fed has blown another huge asset bubble. Meanwhile, stagflation is in the eyes of the beholder.

If one factors in home prices and a more realistic assessment of medical expenses, some might think we are in it now. But don’t jump the gun. Stagflation is a combination of inflation and recession (something Keynesian economists thought impossible).

Keynesian economic theory should have died in the 70s and 80s along with inflation, but unfortunately it survives with even more proponents.

I wrongly called for recession this year it appears. We have flirted with it several times actually, but misguided Fed efforts to prevent routine CPI deflation “worked”.

The problem is the Fed blew major asset bubbles in the wake. When they burst, the results will not remotely look like inflation.

Long Term – Where to From Here?

San Francisco Fed president John Williams has been yapping about the need for interest rate hikes, 4% inflation targets, and Fed-set GDP growth targets.

Williams is bullish on jobs. He also says the US economy is at “full strength” but inflation needs to be higher now so we can cut rates later.

The Fed, central banks in general, have not beaten the economic cycle.

This expansion is extremely long in the tooth on a foundation of cheap money, asset inflation, subprime auto lending, and massive expansion of eateries, drinkeries, and retail stores. Those conditions cannot last even though they have lasted longer than I expected.

Moreover, we have a rising US dollar, at least one more rate hike coming, and a looming trade war that rates to be very destructive.

Economic Setup Could Hardly Be Worse

As I have said before, the economic setup could hardly be worse.

When a sustained downturn triggers is anyone’s guess. Meanwhile, enjoy your central bank sponsored inflation, while you can, if you can.

Please note that central bank attempts to defeat routine consumer price deflation are extremely counterproductive. The BIS agrees with on that score. For discussion, please see Historical Perspective on CPI Deflations: How Damaging are They?

Finally, those who wish to understand the origin of this trade mess should take a look at Hugo Salinas Price and Michael Pettis on the Trade Imbalance Dilemma; Gold’s Honest Discipline Revisited.

In short, a deflationary asset bubble bust is coming up, and it will be made far worse by global trade wars.

Mike “Mish” Shedlock

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