PPI and CPI - Don't Get Excited Just Yet

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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Yesterday the PPI (producer price index) indicated that wholesale prices dropped 2.8% in October, the biggest one-month decline in the 60 years that this data series has been in existence. Today the CPI (consumer price index) report had consumer prices falling 1.0% last month, the biggest monthly drop in its 61 year history. One item alone, energy prices, made a disproportionate contribution to falling prices. Oil has dropped over 60% from its high in July and gasoline prices in the U.S. are down around 50% from their top the same month, having dropped an unprecedented 60 days in a row (with sharp decreases just before the election). This entire drop is still not fully reflected in PPI and CPI and is likely not yet over either, so expect further drops in both in the next couple of months.

Core inflation (inflation minus food and energy) painted a very different picture from the headline numbers however. PPI core rose 0.4% on the month. CPI core fell only 0.1%. There is also no year over year deflation either. Prices for finished producer goods have risen 5.2% in the last year and consumer prices are up 3.7%. At least these are the official numbers. The New York Investing meetup has demonstrated several times in its meetings how consumer price inflation is significantly understated by the U.S. government. Falling prices based on drops in commodity prices also have their limitations. While there is no maximum to commodity prices, there is a minimum which is determined by the cost of production. As this is approached, less efficient wells and mines are closed down. New projects are postponed. Supply falls so that profitable prices are maintained.

How does this compare to the deflation that took place in the early 1930s during the Great Depression? Estimates are that U.S. consumer prices fell approximately 3% in 1930, 9% in 1931 and 11% in 1932 (the bottom year). Production output was also falling by similar amounts during this period. Similar drops in prices and production took place in a number of countries. The one common denominator among these countries was a fixed-exchange rate gold standard and not the inherently inflationary fiat currency standards that now prevails throughout the world. Big increases in money supply, which are inflationary, are not sustainable under a gold standard, but can now take place in seconds by hitting the enter key on a computer keyboard. While the U.S. monetary authorities actually supported deflation by constricting the money supply at the beginning of the Depression, today they are doing everything possible to expand the money supply and create inflation.

Nevertheless, there are a large number of people who maintain that deflation is taking hold in the U.S and will only get worse over time. The crux of their argument is usually that bank credit is in collapse and the amount of bank credit available determines inflation or deflation (not rising or falling consumer prices, which is everyone else's definition) . They also frequently claim that inflation is led by rising wages and can't take hold otherwise. This was indeed true in the U.S during the 1970s, but apparently unbeknownst to these people, history began before that decade. Large inflations have existed since at least the Roman Empire and have taken many forms. As for Wiemar Germany, the one case of hyperinflation so far in an advanced industrial economy, there doesn't seem to have been any major increase in bank credit, which would be required in the deflationists world view. The government simply spent money it didn't have and had to keep printing more and more currency to keep up. For something like this to happen in the here and now, the U.S would have to be running larger and larger budget deficits and the national debt would have to be skyrocketing. Or in other words, exactly what is taking place.

NEXT: Market Must Hold In Here

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.