Thursday, May 15, 2008

These aren't the prices you're looking for...

Inflation has become a dominant theme in investment markets recently. There is considerable debate over what measure of inflation is the best one. My fellow blogger Barry Ritholtz has derisively referred to "Core" figures as "inflation minus inflation" in the past.

But if you thinking as an investor, and are reading this site looking for trading ideas, the answer to the inflation debate is obvious. Inflation is what the Fed thinks it is. Period.

What do I mean? First of all, think about why you care about inflation, again thinking solely in terms of trading strategies. You care because inflation influences monetary policy and interest rates. You care because higher inflation will cause the Fed to hike rates, causing a myriad of ripple effects throughout the economy.

Thinking in those terms, its clear that the measure of inflation you should care most about is the same measure the Fed cares most about. Currently that is Core PCE. Some other measures are gaining popularity within the Fed, including the Median CPI, calculated by the Cleveland Fed and the Trimmed Mean PCE, calculated by the Dallas Fed. Both the Cleveland Fed President Sandra Pianalto and Dallas Fed President Richard Fisher are currently voting members of the FOMC. So if they care, you should care.

But what about rapidly rising food and energy costs? As far as the Fed is concerned, those cost increases results in an increase in the cost of living, but not inflation in the monetary sense. Remember that the Fed is in charge of the money supply. The theory goes that if every consumer suddenly had more money to spend (because the money supply increased) and the supply of goods were held constant, the price of all goods would have to increase.

Thinking about inflation in those terms, Core-style measures make sense. Trimmed Mean and Median make even more sense. Because you are trying to measure a generalized movement in prices, not movements that are the result of specific supply and demand factors for a given good. A perfect example is the effect of ethanol requirements on food prices. Clearly ethanol is crowding out other food production, creating upward pressure on food prices. And yet this effect has nothing to do with the money supply and therefore isn't the Fed's problem.

Express all the outrage you want over the rising cost of living. As long as the Fed doesn't think its their problem, it isn't going to influence their decisions. If it doesn't influence their decisions, should it influence your trading? No.

The Fed will continue to be more concerned with the current recession and less concerned with inflation. Fed economists realize that its difficult to get rising inflation without rising wages. Its simple supply and demand. If consumers don't have more money to spend, they can't bid up the price of goods. Its simple math. Hence as long as wage growth remains tepid we can conclude that food and energy price increases have to do with supply and demand in those markets and not generalized inflation.

What about the dollar? I believe a depreciation of the dollar can be a symptom of inflation. Obviously a dollar that buys fewer goods is the very definition of inflation. But the trading value of the dollar is influenced by various things, most notably interest rate differentials. Interest rates are low in the U.S. and high in Europe. Dollar gets weaker. Through in the account deficits and you have plenty of reasons for dollar weakness. Besides, whatever happens with the dollar, we still need consumer spending to increase in nominal terms to make the basic math of inflation work.

What about M1? M2? or M3? Economists have soured on these measures in recent years as changes in banking as well as foreign holdings of cash have rendered simple measures of the money supply invalid. But I'll indulge those who hang on to the classics. Let's assume the Fed prints $10,000 in new cash for every man, woman, and child in the U.S. and just gives it away. But all that cash just gets stuffed under citizen's mattresses and never sees the light of day. Do we have any inflation? Granted, this is a silly example, but it drives home the point: if consumers don't spend, we don't have any inflation. And consumers won't increase their spending unless they are seeing an increase in wages.

And we know the trend in wages: down. While job losses to date have been relatively minor, negative job growth is negative job growth. Besides that, the historical trend has been for job losses to continue even after the recession is over. I haven't even mentioned home prices yet, which are destroying wealth and will continue to hamper spending. Consumers are going to remain pinched for the next 1-2 years, perhaps longer. Its just not too likely generalized inflation will accelerate given this backdrop.

Am I dismissing food and energy price increases as meaningless? No, just saying that rising prices in those markets don't have anything to do with money, and therefore won't influence the Fed's decisions. Want to do something about energy costs? Buy a hybrid car. Want to do something about food prices? Write your congressman. The Fed ain't going to help.


Superbear said...

Hmmm. Inflation is not what Fed thinks it is.

Inflation is what people think it is and it is their expectations that Fed tries to 'manage'.

Fed can overlook (or believe in BLS numbers), but if the population changes behavior based on their perception then Fed's actions become completely useless.

For example, the CPI data yesterday was 'good', but the TIPS market didn't seem to believe it. Who are the losers? BLS and the Fed.

As they say - you can't fool all the people all the time.

- Shankar

Anonymous said...

Interesting article.

Your contention is that the FED should not (and does not) look at supply side inflation (for example fuel costs) and yet the fed has historically done so - in the late 70s, early 80s the fed raised interest rates to reign in inflation caused by high oil prices even though the average American consumer wasn't very well off.

Two third of the US economy is based on consumer spending and at the end of the day consumers are concerned about how much they spend on food and how much they spend to fill their gas tanks. Is it then prudent to totally disregard food/energy ?

Yes, by keeping interest rates low we provide more liquidity to the consumer but at the same time by ignoring food/fuel prices (and hence making the interest rates super-low) aren't we hurting them (since the extra cash they have now is absorbed by higher food/fuel prices). Shouldn't the policy be changed to be more inclusive of all these effects.


Anonymous said...

You have a serious flaw in your "logic"

The Fed cares about the public's inflation expectations. If people start to expect inflation, and behave like inflation is a problem-- it becomes a problem.

It is rather ignorant to assume the Fed lives in some vacuum and can blissfully ignore what is happening outside of Wall Street.

If nothing else, Congress created the Fed -- and can destroy it too. Congress has to approve the Fed Chair periodically. Its just laughable that you suggest the Fed can exist on its own

I usually like your blog... but this was a really bad and poorly thought out post

Anonymous said...

AI: But if you thinking as an investor, and are reading this site looking for trading ideas, the answer to the inflation debate is obvious. Inflation is what the Fed thinks it is.

I think you meant to say if you are a trader, then inflation is what the Fed says it is.

Investors want to earn a positive real return on their money, meaning they want their money to buy slightly more "stuff" at the end of the year than it did at the beginning. Matching and beating the cost of living is clearly the goal. The Fed isn't even relevant.

Even if you are a trader (playing with other people's money), you cannot view the world only from the perspective of Wall Street. It was Wall Street's myopia that prevented it from seeing the incredibly obvious problems in housing (and the resulting effect on mortgage backed debt).

Whether it likes it or not, the Fed is going to be effected by the issues facing Main Street.

Its all very well that TRADERS (not investors) only care about the BPV of a bond. But in the real world, the whole point of a bond is to transfer wealth across time. Investors DO care about preserving purchasing power.

Why should I lend my $1000 to Uncle Sam today when I know very well that it will buy less when the bond matures? This is the thinking of an investor.

What the Fed is going to do with short term interest rates is the thinking of a speculator.

No investor is buying US Treasuries today. Its all speculators and foreign central banks. Even Bill Gross is saying Treasury bonds are a big bubble.

It is only because of a group of non-economic players (foreign central banks) that the Fed has been able to avoid reality thus far. Without them, interest rates would be markedly higher.

Anonymous said...

A couple decades ago, some arrogant people at the Bank of England decided the British pound was worth what whatever the BoE said it was.

George Soros is one billion pounds richer as a result.

Both investors and traders need to be aware when the central bankers are wrong.

Anonymous said...

gramps is right again. There is no investor buying treasuries as the inflation metrics are a joke. The Fed has lost all credibility and trading what the Fed thinks is a sucker's game that eventually will get you killed. There is a monster bond bubble and the FCB's are the ones propping it up, but I may differ with gramps as to what the reason for this is.

Gramps seems to think that this is either a "kindness of strangers" play or maybe a prisoner's dilemma, instead of what it REALLY is, which is a Godfather Protection Racket. The FCB's prop up our agencies and treasuries and in return we keep oil ultra-high (with strategic reserve stuffing) so they don't have to print TOO much, although they still must print a lot. Obviously this recycling regime is absurd and is unstable. When it cracks, you will get to see how real bond prices actually are.

Anonymous said...

Your argument is faulty. The money supply DIRECTLY increased vis-a-vis larger credit extended, due to lower intrest rates 5 years back. This is DIRECTLY related to monetary theory: more credit = more dollars chasing the "constant" supply. And worst of all, most of it was on non-productive assets: personal homes.

Also, you seem to separate the definition between "cost of living" and "inflation". This is just the same thing from viewing it at two different perspectives. "Cost of Living" applies to consumers, "Inflation" applies to business: same coin, just with 2 sides. They both need to expect price stability to sustain their current living conditions.

The Fed is NOT in control. Their act of lowering rates was to restore a solvency crisis in the credit markets. Preventing a fire is control; seeing the fire in front of you when its too late is being OUT OF CONTROL.

There's been a structural rise in commodities and energy. Are you saying that this supply phenomena is a cogent part of the definition of inflation? Once again, 2 sides of the same coin: supply/demand. Even the perception of a lower supply, capitalists will automatically raise prices.

Regarding the Fed's social responsiblity, I agree with you: there is none. Their perpection is that their action will work its way through the system. But this is a matter of credit insolvency not looser money. The standards have been raised which have crowded out the ones who reckless borrowed. There's less business and people, the suckers, that will borrow because of the insolvency issue, not because rates are lower

Anonymous said...

Hostile crowd that you face here. If we got down to the last 10 barrels of oil in the world without any immediate substitution, the price would skyrocket possibly to millions or billions of dollars per barrel simply due to lack of supply. Monetary policy and interest rates would have absolutely zero impact on the price of oil and the reality would be that in that case the price of oil would become irrelevant to inflation; one could probably "count" the price of oil in some statistic, but it would have nothing to do with the ordinary "cost of living". The question is whether "peak oil" or some similar phenomenon is starting to impact price in a way that goes well beyond inflation the way that the prior comments seem to assume. As for food, the supply disruptions related to the ethanol fiasco may explain a large portion of that distortion as well. The difficult part of this for Americans seems to be that we tricked ourselves into thinking that the market would always supply what we wanted at the same time that we decided to severely constrain suppliers (no new refineries, no new nuclear power plants, etc.) If I am correct about such supply constraints, then energy needs will simply continue to gain market share of the consumer wallet one way or another, and right now it is through higher relative prices for energy. If energy needs to gain market share of consumer spending, then if energy prices don't rise, the price of all other items will need to fall; that spells D-E-F-L-A-T-I-O-N for everything else. Perhaps home price deflation only represents the first symptom of the deflation of everything else.


Brian Gilstrap said...

Reality can be denied only until the evidence is overwhelmingly against you or until you are dead due to consequences of action taken based upon your mistaken beliefs. I expect (and hope) the Fed's mistaken beliefs will lose before the Fed ceases to exist.

JoshK said...

AI, great article. I always enjoy your blog.

This is a fascinating topic for sure. Here's my question:

If money supply is constant, then an increase in one price should be offset by a decrease elsewhere, right? eg: corn prices go up so there's money available for buying electronics. So you would have a different distribution of purchases, but the amount of money available is the same.

So, if that's true, than isn't the # to look at the headline # then? And not cpi-ex whatever?

Anonymous said...

Very interesting post. Thank you. I am now seeing what the Fed is seeing. However, this does not explain whey CPI shows gasoline prices decreased in April. CPI = COLA, and Fed is not seeing that. Weird.

Anonymous said...


not sure why you are stuck on oil prices. Prices of LOTS of things are going up:

- Food
- Education (property taxes or college tuition)
- Healthcare
- Transportation

And even though home prices are down, houses are LESS affordable due to credit tightening-- so its hard to argue there is true "deflation" (your dollar doesn't go further)

At any rate, even if you want to argue about peak oil, AI's central argument (that inflation is what the Fed says it is) is faulty.

The Fed is a political creature; it always was to an extent, but Bernanke has made it even more so.

The Fed's dual mandate is to control inflation (not oil prices) while maximizing growth.

If people expect prices to increase-- that means an inflationary mindset has taken hold-- doesnt matter what M3 is or whether peak oil is true or not... in other words, if inflation mindset takes hold: the Fed has FAILED.

If people believe that there wages aren't keeping up with their expenses, they will be economically depressed and won't want to invest for the future. Again, the Fed fails.

It is absolutely nonsensical to argue the Fed can ignore inflation as perceived by the average citizen. If nothing else, Joe Citizen will have Congress replace Bernanke if he has the same attitude as AI.

The Fed's definition of inflation is secondary at best, even if you are a trader. The Fed can sometimes "fine tune" the economy, but in the end it does not control it, never did, and never will.

And exactly why is a Wall Street capitalist idealizing economic central planners anyway?

Anonymous said...

I don't think the foreign central banks are buying Treasuries as "kindness to strangers" nor prisoners dilemma. They are doing it in effort to maintain a fixed (or near fixed) foreign exchange rate. In the case of Asian banks, this is to encourage trade with the US. In the case of OPEC (mostly Saudi Arabia), it is to keep US interests allied with the House of Saud (they want to stay in power). In short, they are buying Treasuries out of perceived self interest.

I have to say I am very puzzled by AI's assertion that the Fed defines inflation, even for speculators / traders. I don't want to put words into his mouth, but I assume he was somehow paraphrasing the old theorem "Don't fight the Fed".

That theorem might be true in general, but it is not a universal truth. George Soros showed us there are tremendous profits to be made when a central bank thinks its currency is worth more than it actually is (a central bank can ALWAYS make a valuable currency be worth less than you think).

I would also argue with some of AI's supporting logic. While he goes to some lengths to discredit M2 and MZM and so forth -- he is missing the big picture:

We live in global markets.

M2 and MZM are less relevant now, because money / credit can be created anywhere in the world and then transported anywhere else in the world at the click of a mouse.

Maybe the Fed didnt create money (this is somewhat debatable, but lets go with it). That does not mean the Bank of Japan or ECB or Bank of England didn't create money.

Secondly, the reason MZM is less relevant today is because the fractional reserve system has come apart. When you deposit money into Citibank, they are (supposed to) put x% of that into reserve at the Fed.

First, Citi uses a lot of games to classify some monies as "savings" (no reserve) instead of being a demand deposit (which requires reserves). Hence the money multiplier for standard banks has gone way up, even without the Fed changing a single rule.

Second, non-bank banks like GE Capital, GMAC/Ditech, etc. These are not part of the Federal Reserve system, and do not have any reserve. Their money multiplier is (theoretically) infinite.

And lastly, the money aggregates implicitly assume a velocity of money that is (at least in the short term) somewhat fixed -- or maybe its more accurate to say the velocity of money is assumed to change slowly. Great concept a few decades ago, but in modern times the same cash can change hands thousands of times per night via ATMs, debit cards, and electronic transfers.

The problem with M2 and MZM is that the medium of exchange has changed. It is no longer just cash and slowly processed checks -- now it includes electrons beamed around the world almost instantly.

And "money" isn't just the stuff your bank created-- it could easily come from a foreign bank.

All of which is a fancy way of saying the Fed isn't anywhere near as important as it used to be. It is no longer THE central bank, it is merely A central bank.

And the dollar is increasingly being viewed as A reserve currency (albeit the most important for the moment), it is no longer THE reserve currency.

If the economy that backs the dollar slips (say because its population's purchasing power slips), the dollar loses its status in the global market place.

As a trader and as an investor, it is important to remember that is where the true economic value lies -- not in speeches and rhetoric from the Fed.

Daniel Newby said...

Gramps wrote: "Hence the money multiplier for standard banks has gone way up, even without the Fed changing a single rule."

Let's think about how the Fed is trying to deleverage that multiplier: swapping Treasuries for slow-accrual lower-velocity instruments. That seems to me to be highly inflationary. It is not much work, nor very risky, to swap a pile of Treasuries for a boat load of any tangible good.

And the recipients of those Treasuries are born-again fundamentals investors, now that they have pried their money loose from Bear & friends. They are looking for things that can be immediately sold to a market that will not—can not—lock up overnight. So we would expect them to lemming on over to things like potash, ammonia, nitrates, light sweet crude, protein, starch, etc.

Anonymous said...

"rising prices in those markets don't have anything to do with money, and therefore won't influence the Fed's decisions"
If those rising prices reduce Consumer Discretionary spending, the Fed might mistake the result for a sharper recession, and adopt an unnecessarily stimulative policy. So I claim the rising prices would, indirectly, influence the Fed's decisions.
Beyond this minor oversight, I think your post shows sound economics thinking.

Accrued Interest said...

Alright I can't react to everything here but I will react to a few...

I don't think anyone argued directly my main point. Perhaps I didn't write clearly enough. If consumers don't have more money, how can they bid up consumer prices in aggregate?

In other words, the budget constraint hasn't been revoked. No someone pointed out that if the budget constraint is held constant, and one price rises, then others must fall. Right. I've heard that house prices aren't doing so well. And in reality, aggregate wages are still going up, so we would expect some inflation anyway. So it might be that food and energy prices are exaggerating what would be a more mild inflation.

Gramps: I completely agree that changes in the banking system mean that the Fed has lost a lot of the control over money that they once had. But again, that doesn't revoke the basic math of the budgetary contraint.

Back to your thought about the money multiplier. Let's take your initial presumption that changes in finance have increased the money multiplier and that should be inflationary. I happen to agree with this view.

But you can't seriously believe that current lending practices are accelerating the velocity of money! Surely velocity has fallen from 2006 to today. That should be disinflationary.

Shankar: You've made the best counter-argument to my post. That is the Fed actually does care about inflation expectations. Consumers tend to equate inflation with prices they see every day, e.g., food and gas.

But I'd like you to suggest what you think the Fed should do about it. If it isn't a money problem, then tightening the money supply would create real deflation in an attempt to battle perceived inflation. Doesn't seem like smart policy.

And don't try to argue that its the dollar. Currencies are a zero-sum game. If it were all about the dollar, then oil would be up in US terms and down in euros. But it isn't.

Please keep up the comments. I love the back and forth.

Anonymous said...

I think that your initial point is a good one--if you are trading inflation releases, rather than debating whether CPI is a good benchmark, watch what the Fed is watching.

But later on in your analysis, I think that you miss a key point. The US economy is not a closed loop. US wages/employment can go down and demand for products can still go up if that demand is coming from outside the US. Alcoa estimates that 11% of the world's aluminum consumption was coming from North America in 1997. Fast-forward a decade and China is consuming 32%. They accounted for 59% of the growth in aluminum consumption over that period. And they are projected to account for 58% of the growth over the following decade. How much of that aluminum is just a raw material that will be used in a car/skillet/bicycle that will eventually be purchased by an American. Certainly some of it. But domestic consumption by the emerging world has the potential to increase demand for a host of products even if it softens domestically.

Decoupling has been radically overhyped, but I think it's clear that more Chinese are buying cars, computers, etc. than a decade ago, and that that increase in the emerging world's consumption will impact demand. All of the marginal growth is coming from the emerging world (you see the same thing in Europe, where nearly all of the export growth from Europe is coming from exports to Russia).

Accrued Interest said...

If you are saying the world isn't quite as simple as I make it out to be... fair point. I think the basic point stands, given that net exports are such a small percentage of total GDP.

Maybe the crowd would feel a little better about my argument if I put it this way: do we think that consumers will be spending more or less, in aggregate and in nominal terms, over the next 12 months. If your answer is less becuase they are crunched, then how do we get inflation?

Anonymous said...

"If your answer is less because they are crunched, then how do we get inflation?"

AI, you are misunderstanding what is going to happen here. The currency has been debased and the Fed's balance sheet has been trashed. Therefore prices will rise, businesses will shrink, folks will consume less, and the standard of living will decrease for most.

You correctly note that wages are stagnant so this isn't Wiemar where folks were getting paid up to three times a day and a hyperinflation ensued. This will be more like Brazil where the average American will be reduced to living in a favela, riding a bicycle, wearing a t-shirt and flip-flops and eating a lot less.

You want proof? Look at the Airlines. Up until recently air travel was widely available for the common person, but not any longer. There is a tremendous need for consolidation in the industry and seat reduction. Why? The airlines can't make a profit with the high oil prices without substantial airfare hikes, but there are too many airlines and too many seats. Eventually the airlines will re-create their business models in order to be profitable and this means no more air travel for JSP. This process has already begun. Air travel will be reserved for the upper class only and they will be the only ones that can afford it. Kind of like it was before the 1960's.

Many types of transportation and housing will be considered luxuries. Giant SUV's, monster trucks, McMansions, and frequent restaurant outings will be relegated to the scrap heap. Folks will need to live in apartments or other more efficient dwellings, drive very small cars, take the bus, or rides bicycles, and eat low cost food like beans and potatoes.

This isn't really about peak-oil as Kunstler constantly drones on about. This is about the trashing of the dollar and reckless monetary policy and the decay of a once great empire that has been hollowed out by years of outsourcing and off-shoring. Sure, peak-oil may have something to do with it, but the monetary policy is a much more immediate problem.

Anonymous said...

I get the consumer argument and, okay, there's probably reduced demand pull from that source at least except for items such as food and transportation that everyone must buy and, with the exception of the real estate that allowed folks to leverage their ability to afford said items, appears to be where most of the increased prices are.

But that's not the only kind of consumption going on; consumers aren't just folks and the goods they buy, there are a host of other players, mainly institutions such as investment banks, who are consuming credit at very high velocity to stay alive or at least buffer the unknown values of assets they hold. Add to that a continuing high level of overall government spending (including an ungodly amount that still appears to be off-budget) and, well ...if we agree that both Keynesians and monetarists are at least partially correct then both real demand and an increase in money supply play a part in increasing prices.

So I think we've got the whole ball of wax: demand-pull inflation (spending in excess of our productive abilities), cost-push inflation (supply shock from increased price inputs), and inflation that is built-in to our expectations including the growing perception that wage-earners are falling behind and must find a way to catch up.

But it hasn't detonated (yet) because there are some fairly serious deflationary forces including third-world wage-arbitrage out there which is why the best metaphor I've been able to come up with is the Pushmi-pullyu: the antelope in the Doctor Dolittle stories that has two heads at opposite ends of its body and struggles to move because each head is rather contrary and wants to go in the opposite direction.

I don't think that's going to last much longer though and increasingly serious stagflation still seems the most likely outcome to me. FWIW

Anonymous said...

Inflation expectations I agree is the biggest point not mentioned. Housing deflation + commodity inflation is going to give the perception of a major inflation problem.

The damage is done. No wage inflation will enhance the negative inflation expectation of rising commodity inflation, which just so happens to be occuring at the exact same time that housing wealth is being killed.

Again, it will enhance inflation expectation. This scenario is a living thing, and we should all agree that this period of time is quite unprecedented. Its clear that govt stats are not explaining or correlating to the rise in inflation expectations.

Anonymous said...

AI: do we think that consumers will be spending more or less, in aggregate and in nominal terms, over the next 12 months. If your answer is less becuase they are crunched, then how do we get inflation?

Consumers will be spending about the same- in total. However, the things we must buy (food, gasoline, etc) are costing so much more that the "must" spending will crowd out all the "want" spending.

Inflation can be spending more money to get the same stuff...

...or it can be spending the same amount of money to get less stuff.

Its loss of spending power either way.

Anonymous said...


You say, if the Fed isn't worried about inflation, why should we be? The statement presupposes that the Fed sets interest rates and not the market.

A 5-yr note purchases in 2003 had a negative real return. A retiree buying that bond lost purchasing power. What did the Fed do to Fed Funds in the interim? Who cares.

Now, would you have a retiree buy a 5yr note at 3.11% today? For me, the answer doesn't depend on what I think the Fed will do, it depends on what I think will happen to the purchasing power of that bond. This is an example of inflation expectations of course. So with the Fed's past rate hikes resulting in a 4% inflation rate, I'd avoid that bond like the plague. You, presumably, would buy it. I think if it weren't for China, the yield on that bond would reflect my point of view, and not yours.

Anonymous said...

Hypotheticals aside, you make an interesting point. Your observeration regarding the phenomena of "peak oil" is correct; I don't know why you seem to discount its merit.

Oil, energy, gas -- call it what you will -- but the the general impact of growing "emerging" economies, in both consumption and production has started. Higher, more sophisticated, standards of living have emerged. Resources are being demanded to support this standard. This is a domino effect. The "assummption" of which you so casually disregard is one based in historical context.
Where was China? Where was India? South America, etc? 50 years ago. Now they're major consumers for PRODUCTIVE resources, the same energy needs that America consumes for NON-PRODUCTIVE purposes are the same ones other contries use for PRODUCTIVE purposes. Do you see the double-headed monster here? US borrowing to sustain "CONSUMPTION??" We're living in the most assinine country in the world with a credo like this. Do the math throughout history, this country , America, is ultimately F***ED!

In brief, a while ago, energy needs were constant. Then more components were added to the variable. 1) A simple 1-2-3 punch: 1-Punch: US borrows, goes into debt, attaching a component of "non-productivity" to it (its value is lessend because of an intrinisic lien against each dollar out there), 2-Punch, The intrinisic devaluation because of heavy borrowing and lower interest rates causes a rise in Oil prices, even without any supply argumenent. All dollar-based imports go up in price because more dollars is now demanded for each unit of forgein good because the dollar is now worth less. 3-Punch, now, with Higher energy costs, AMERICAN costs have to be passed through the system. How will this be done? You can make the argument that D_E_V_A_L_U_A_T_I_O_N on all other goods will occur, but how is that possible when all the crap we buy is ultimately based on energy costs, and food costs, to make the crap. Sure, have your devaluation, but how will business handle higher production costs? Does your Mcdonald's burger look a little thinner? Is your food packaged a little smaller? I think people may like quality. But business must now account for higher energy costs. THen you can argue the companies will layoff workers as growth will go down. Sure, go ahead and make that argument. However, if America is no longer the main consumer/producer in an international economic, do you think prices will go down here if the commodity in question is demanded throughout the WORLD? US prices will never go down now because of the new international structural demands in place. China trades with Europe, and Europe trades with the whole world. The US "FIAT" currency is irrelevant. This is becoming common knowledge. The underlying forces are informational-future-drive. Even central banks are shifting out of US Dollars gradually. REad (Brad Sester's Blog, what a remarkable thinker!)

A high debt, a loss of confidence, central bank activity pushes dollars down making the food/oil combination (now that you make energy from food) the center-put, the epicenter, of rising prices, including America. Food production relies on energy, and now energy relies on food (corn, soybean) production. There's no choice but the Fed to Raise rates in US, I think that's what everybody is waiting for. Their first step to restore the fin. system is over with. Now this paradox: because higher interest rates will reduce the holdings of retirement savings of the baby-boomers, as bonds and stocks they're in act accordingly. THis is going to be VERY INTERESTING, how the FED plans to rationalize it.

Anonymous said...

Josh Kalist,
Not to be funny, but I read your post. Do you mean this in your "offset" theory?

Gas Price $2/Gallon MacDonald Burger: $1 / Total Cost = $3

Gas Price $4/Gallon MacDonald Burger: $-1 / Total Cost $3

Getting a free hamburger and an extra dollar is exactly what this economy has been up to, and its offset perfectly. Good job, Josh!

Anonymous said...

"And don't try to argue that its the dollar. Currencies are a zero-sum game. If it were all about the dollar, then oil would be up in US terms and down in euros. But it isn't."

AI, I don't know how you can argue its NOT the dollar. In fact, I don't understand what your saying in this small blurb here. Oil IS up in US Terms and down in Euros. Oil is traded in US dollars. And 1 Euro buys more and more dollars, then mathmatically speaking, Oil is less money to Europeans.

Please enlighten us to your statement.

Anonymous said...

from RW

But it hasn't detonated (yet) because there are some fairly serious deflationary forces including third-world wage-arbitrage out there

RW, are you referring to real wages in third-world countries compared to this country? What is "third-world arbitrage"? Do you mean the guaranteed profit making the product outside the US and then selling it here?

which is why the best metaphor I've been able to come up with is the Pushmi-pullyu: the antelope in the Doctor Dolittle stories that has two heads at opposite ends of its body and struggles to move because each head is rather contrary and wants to go in the opposite direction.

No, one head is the Federal Reserve and the other head is Walls Street F***KS! Great metaphor!

mOOm said...

The effect of inflation on Fed interest rate decisions isn't the only way inflation affects investors. For a start they don't directly control long-term treasury yields and those reflect the inflation expectations of investors. And then inflation expectations of investors and actual inflation rates affect the real economy stocks in so many ways...

JoshK said...


Do you mean this in your "offset" theory?

Gas Price $2/Gallon MacDonald Burger: $1 / Total Cost = $3

Gas Price $4/Gallon MacDonald Burger: $-1 / Total Cost $3

What I'm talking about is simple monetarism, which I think is the best regarded approach to money supply and inflation.

Remember that there is more than one consumer. If gas goes to $1m/barrel, there will be very few barrels of $1m oil being sold. And then consumers will have a lot less left to spend on anything else. Of course you couldn't hit a negative number, this is just a optimization equation that will squeeze out the currency allocated to lower demanded items.

Or think about it this way. If everyone bought nearly the same amount of oil at a much higher prices while other prices stayed the same either the quantity distribution is changing or there is broad-based monetary inflation. ie, more money chasing after the same amount of goods.

Anonymous said...


I was just being ironic. I was illustrating the implications of your "offset", or what you now call "monetary theory", and how they're flawed. You won't "hit a negative number". So that is why, ultimately, you'll get inflation.

Also If the cost of the number of inelastic goods the consumer buys (gas, food) is greating than the cost of elastic goods, then you get inflation. Both production and consumer inputs depend on the inelastic goods.

Or if your a pure monetarist, then companies will simply rachet quality down, which is just producing less of the good, and then lower prices. Monetarists call this delflation. But its just lower quality which offsets the lower prices.