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Inflation
Posted by: Jon Henke on Thursday, October 20, 2005

Along with energy prices, concern about inflation has been spiking on news that the Consumer Price Index increased by 1.2% in September; meanwhile, the Producer Price Index rose 1.9%.

Those are very significant numbers. Keep that up for awhile and we'll be calling Paul Volker again to see if he has any plans for January 31st, 2006. But, while inflation may still rear its ugly head, I'm not so sure that September's Index spikes are necessarily proof of that.

Inflation is usually defined as a general, sustained increase in the price level—and each bit of that is important.

But in the most recent Consumer Price Index to which so much attention is being paid, the core inflation rate is only .1%. It's primarily energy prices that are increasing ("12.0 percent in September")—ultimately accounting for 90% of the increase in September CPI.

So, at least for now, the price increases are not generalized as we would see with genuine inflation. They represent a sector/resource specific change in the supply and demand factors, rather than a decline in the purchasing power of money.

And one more thing: those price level increases have to be "sustained". But, as we get out of the summer driving season, energy prices are dropping quickly. In my area, for instance, gas prices have declined from ~$3/gallon to ~$2.50/gallon.

Industry specific price spikes are not inflation. Temporary price spikes are not inflation. Price spikes that cannot be passed on to consumers are not inflation.

Barry Ritholtz has some contrary data and perspective worth considering, and he may well be correct that we'll ultimately see more problematic inflation. But I'm not sure that September's numbers are sufficient proof.
 
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Comments
Correct, and well said.

The big price spike is energy related. To the end of averting such problems, then, the central focus here, should be getting the energy prices back under control. And yes, that means loosening the noose from the energy sector... domestic drilling, diversifying the refining capacity..location wise... eliminating the crazy quilt of regulation of gasoline formulation, and so on.

The question comes, then, if the WH is smart enough to pursue such a course.
 
Written By: Bithead
URL: http://bitheads.blogspot.com
Volker, no. Steve Forbes, yes.
 
Written By: Dan
URL: http://
Dan; I tend to agree, though I think the implication Jon was making was that the Democrats would be back in power, and thereby Volker....
 
Written By: Bithead
URL: http://bitheads.blogspot.com
No. Volker was the Fed chief appointed to get ahold of inflation in the late 70s. He was successful at that.
 
Written By: Jon Henke
URL: http://www.QandO.net
Ah, that’s right.(forehead slap)
Withdrawn.
Thanks.
 
Written By: Bithead
URL: http://bitheads.blogspot.com
Energy prices will eventually work their way through out the whole economy. What does NOT depend on energy for an input?

While I will grant that inflation is most easily and most often caused by over-printing of money, an increasing REAL cost of obtaining energy is another and one that we’re beginning to see here.

In the ’70s we saw the exercise of monopoly pricing with OPEC. In that case, inflation was proper response since the US has a monopoly on printing dollars and doing so was the countervailing weapon of choice - give us high priced oil, we’ll just give you devalued dollars. Plus, Petrodollars resulted in some change in ownership of assets going to the producers.

Today, the problem is more difficult. The price increase is not monopoly power but a reflection of supply/demand imbalance. There is no short-term source of idle oil production! Today, the marginal barrel of oil (and cubic meter of natural gas) is going to be more expensive in inputs to extract and deliver. Deep water drilling or tar sands are much more energy-intensive than Ghawar.

In effect, we are entering an decreasing EROEI regime (energy return on energy invested). The overall net output of the global economy will decline as more capital and labor are required to maintain energy inputs.

Some of this is our own fault - Clinton’s Rocky Mountain drilling moratorium, Bushs’ ban of Florida offshore drilling, ANWR. Fixing these will help for a while but eventually, oil sands, coal-to-liquids, hydrogen, nuclear power, will all cost more and yield a lower return. It needn’t be the end of civilization; we just need to better understand what is going on.
 
Written By: Whitehall
URL: http://
"Inflation is usually defined as a general, sustained increase in the price level—and each bit of that is important."

No, it’s not!

Inflation is properly defined as an increase in the money supply.

Read the Austrian economists. Mises, Hazlitt, Rothbard, etc.

Price increases bubble up in chaotic fashion, first affecting some goods then others. These price increases follow (in time) the money supply increases. The price increases are NOT one for one, usually starting at less than the money inflation rate and later exceeding it.

Data in billions from St Louis Fed M3 series

http://www.economagic.com/em-cgi/data.exe/fedstl/m3sl+1


% change % change
from last from last
data period AR year

2004 09 9358.822 6.687% 5.047%

2004 10 9369.946 1.436% 5.231%

2004 11 9401.368 4.099% 5.812%

2004 12 9450.486 6.453% 6.361%

2005 01 9502.881 6.860% 6.267%

2005 02 9538.993 4.657% 5.911%

2005 03 9568.845 3.821% 5.362%

2005 04 9620.643 6.693% 5.209%

2005 05 9662.698 5.374% 4.652%

2005 06 9748.105 11.138% 5.148%

2005 07 9776.674 3.574% 5.430%

2005 08 9878.661 13.262% 6.125%

2005 09 9976.907 12.609% 6.604%

Year over year that is a 6.5% rise, about double the CPI, as expected.

 
Written By: Dennis Corrigan
URL: http://
Energy prices will eventually work their way through out the whole economy. What does NOT depend on energy for an input?
That does not necessarily mean inflation. As Barry Ritholtz points out, businesses may not be able to pass along the additional costs, causing profits to decline. As he doesn’t point out, that could ultimately result in a decline in aggregate demand.

In such an eventuality, higher input costs would simply lead to less spending, rather than to a "general, sustained" higher price level. Without actual monetary inflation driving a higher general price level, spending will be shifted elsewhere, rather than increased everywhere.
 
Written By: Jon Henke
URL: http://www.QandO.net
"Inflation is usually defined as a general, sustained increase in the price level—and each bit of that is important."

No, it’s not!

Inflation is properly defined as an increase in the money supply.
I said it was "generally defined"; you respond that it’s "properly defined". Those are two different things.

What’s more, an increase in the money supply is not necessarily inflation, so long as purchase power remains constant. Inflation is probably best defined as a decrease in the purchasing power of money.
 
Written By: Jon Henke
URL: http://www.QandO.net
I have to disagree with Whitehalls conclusion that overall output on a global level has to decline. I think it’s more likely efficiency/technology/productivity gains will allow output to continue to grow. There’s an interesting article on the front page of the WSJ that stated the U.S. today uses only about half as much energy as it did in the early 1970s to produce every dollar of gross domestic product. Maybe I’m just an eternal optimist, but I don’t think that trend is going to reverse.
 
Written By: Tom
URL: http://
I can understand some of the discussion on my exposition above. Certainly, a global economy can have lots of stuff go wrong and in many ways.

As to Tom’s note about energy efficiency, he correctly notes the US energy productivity gains - different from "efficiency." However, much of that increase in $GDP/BTU for the US economy came from outsourcing and offshoring. For example, American aluminum production collapsed in the late ’70s and early 80’s. Why? it is highly electricity consumptive. Likewise, much of the electrochemical industry has fled. How much steel do we import these days? Where have the factory jobs gone? Instead we export services for energy-intensive products. On a global scale, the balance remains. Granted, real efficiency increases are possible but changes are just better approaches to an asymptote and aren’t likely to make much difference overall.

As to Jon’s expectation that higher energy net costs will lead to a decline in aggregrate demand, I posit that the way that will happen is inflation out-running wages. Wages, in the real world, are sticky and not subject to decline although incomes could through unemployment and reduced overtime. Profits will shift to energy so that energy production can attract capital but overall return to capital will be lower than when energy was easier to obtain.

Granted, increasing costs for energy need not necessarily lead to inflation but real-world behaviors and politics will find that the easiest way to spread the pain and reallocate the resources necessary for maintaining energy output to the general economy. Voters generally find it less distaseful to retain their jobs and buy less while liquid asset holders suffer than retaining the value of the dollar and being unemployed.

Without the reallocation of capital and labor to energy, the alternative is declining real output across the board - a depression. Name YOUR poison!
 
Written By: Whitehall
URL: http://
"There’s an interesting article on the front page of the WSJ that stated the U.S. today uses only about half as much energy as it did in the early 1970s to produce every dollar of gross domestic product."

Is that corrected for inflation?

Thank you, TDP, ml, msl, & pfpp
 
Written By: Tom Perkins
URL: http://
Inflation is an alteration in the supply of and/or demand for money such that its perceived purchasing power declines. Whether there will be a general increase in prices depends on other factors.
 
Written By: Charles D. Quarles
URL: http://spaces.msn.com/members/cdquarles/
I have to disagree with Whitehalls conclusion that overall output on a global level has to decline. I think it’s more likely efficiency/technology/productivity gains will allow output to continue to grow.
Well, if resources prices increase in a non-inflationary manner, aggregate output would pretty much have to decline. It may not be a net decline, but supply curves don’t go up when demand declines.

Productivity, etc increases may well overwhelm cost increases, but the underlying effect from the cost increases should remain the same.
Without the reallocation of capital and labor to energy, the alternative is declining real output across the board - a depression. Name YOUR poison!
It’s very true that, if resource costs continue to increase, we’ll probably be faced with either recession or inflation. But for inflation to happen, either the Fed would have to cut rates, or foreign dollar holders would have to dump their holdings. Resource price increases alone won’t cause inflation. Only the reaction to that can cause inflation.
 
Written By: Jon Henke
URL: http://www.QandO.net
Only the reaction to that can cause inflation.


Ok, I can agree with that definition. My position then resolves to a prediction that the reaction will be inflation rather than depression. More precisely, I’d predict "stagflation" where we have no or slow growth (less excess energy for the economy plus increased diversion to energy production) plus inflation.

And if energy productivity gains can happen AFTER energy costs increase, why don’t they happen NOW? The answer is that the system is close to optimized with respect to capital, labor, energy, and management attention. That’s what bugs me about the politically correct energy policies that force energy "savings" on the country via efficiency standards and cross-subsidization. Let the market decide.

Good thread!
 
Written By: Whitehall
URL: http://
Whitehall:
Energy prices will eventually work their way through out the whole economy. What does NOT depend on energy for an input?
Jon Henke:
That does not necessarily mean inflation.
Well, once the rise in energy prices works its "way through out the whole economy," then yeah, it will then mean inflation. Up until then, it’s only active in some sectors and not in others. But in that situation, it’s "everywhere."
As Barry Ritholtz points out, businesses may not be able to pass along the additional costs, causing profits to decline. As he doesn’t point out, that could ultimately result in a decline in aggregate demand.
Well yeah, we could have a recession instead of inflation.
Or we could have a recession along with inflation. There’s precedent.
And yeah, it does depend on whether some businesses (are or are not) able to pass along the energy-driven costs, to other businesses, and then to consumers. Well, some will and some won’t, is my prediction. Advantages will be gained and lost.
In such an eventuality, higher input costs would simply lead to less spending, rather than to a "general, sustained" higher price level. Without actual monetary inflation driving a higher general price level, spending will be shifted elsewhere, rather than increased everywhere.
If higher input costs really DO end up leading to less spending, then spending will not be shifted elsewhere, but will indeed be decreased everywhere. Not just the bad and silly spending, and not just the centralized and governmental spending, but all spending. That’s how recessions are.
 
Written By: Stoop Davy Dave
URL: http://
[reads thru rest of damn thread]
Oh!
hmp.
Um, never mind.
[/reads thru rest of damn thread]
 
Written By: Stoop Davy Dave
URL: http://

 
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