U.S. Hyperinflation - Route Causes

‘Flations and the Fate of the Little Guy

Deflation, Inflation, Stagflation maybe Biflation or Agflation (or both!)… all the ‘flations (as Bill Bonner puts it) are up for grabs though the real tussle appears to be over those who believe the general price level is in decline versus those expecting prices to abruptly start (or continue) to rise.

Whether the result is a dollar buying more things or dramatically less, these two groups are united by the fact they both see a pretty dire future and worse yet… they may simply be independently dwelling on two different aspects that will together materialize in sequence from this sorry economic period, one leading to the next.

How is the little guy supposed to navigate these troubled times? Should he move his nest egg to stocks, gold, assets like real estate or stay in cash? Should he borrow or save? Should he spend? What if he doesn’t even have a nest egg?

Despite this being the “Summer of Recovery” the typical American household is likely more than a bit unnerved, cautious and looking for a little guidance.

Unfortunately for them though, all the “experts” they had grown to rely on in the past (even if just just tangentially through the thick filter of the traditional media) like the Federal Reserve Chairman, various popular economists, business leaders and an ever shrinking list of credible political figures, haven’t a clue where the economy is going next all imposters having totally missed the severity of this period in the first place.

Yes… things are turning out to be quite the crap-shoot… Could this be an indication that the final day of reckoning is upon us?

Watching the government writhe in an epic display of populous-bile spewing partisan retching while academic and professional forecasters bury their heads in past trends presumably searching for clues from the 1930s and individual “investors” desperately seek out the next yield fix no matter the complexity of the “investment” or level of speculation has me thinking we are getting close.

At the very least these issues are receiving more popular attention as witnessed by yesterday’s On Point episode titled “Deflation Fears: U.S. as Japan?” featuring a lineup of David Wessel, Frederic Mishkin, David Resler and Dave Scott.

Notice that though the show is in itself fairly interesting, it was most revealing in exposing how poor the visibility is even for the supposed “experts”.

In times like these possibly its best to throw aside the rubes, quacks and charlatans of modernity and turn to the ancients for advice… What would Ben Franklin Say? Or the truly ancient Aesop?

Have the “great part of the miseries of mankind [been] brought upon them by false estimates they have made of the value of things”?

Have Americans lived as the Grasshopper and not the Ants? Do we deserve the Grasshopper’s fate?

Long Cycles and a Century of Expansion, Contraction and Rates

Looking at the nonfinancial commercial paper rate juxtapose recessions and depressions from the late 1800s to today provides a fascinating view of long economic cycles as well as potentially holds some important perspective and clues to the economic climate going forward and the conundrum the Federal Reserve and all of us are now in.

First, for a quarterly series stretching back more than 100 years (relatively ancient times as far as macro-data is concerned) , this series is surprisingly well synched with recessions and depressions.

The general pattern typically sees rates climbing through expansions and crashing during recessions and depressions.

From a long cycle point of view, we can see that in the decades preceding the Great Depression successive recessions brought the rate down to successively lower lows finally reaching an ultimate low of .56% in the belly of the Great Depression.

All told, the rate stayed below 1% for 12 years during the depression period of the 30s and 40s before beginning a long up trend after World War II.

The rate then proceeded to trend up for better than 30 years reaching a striking 16.27% crescendo in the early 80s that pitted the Fed against inflation in an epic battle.

Looking at the period of the last 30 years you can see that, similarly to the period preceding the Great Depression, rates have trended down with each successive recession reaching what must surely be nearly the ultimate low.

The pattern has a notably deflationary look to it.

The Fed has, more or less, reached the zero bound, the lowest rates on record and a level not seen since the 30s and 40s.

Are we stuck here as we were during the Great Depression? Are we better than a decade away from any form of re-inflation? Will the next inflationary period be an epic generational trend building to a crescendo dwarfing all prior?

Manufacturing Inflation?

Ahead of tomorrow’s Q2 2009 Productivity and Costs report I thought I would highlight and interesting trend emerging in the manufacturing components that might signal early inflationary pressures.

It appears that along with the immense, yet typically timed, cyclical decline in manufacturing output that commenced (more or less) in Q1 2008 came an uncharacteristically large decline in manufacturing productivity.

In fact, Q4 2008 (-1.98%) and Q1 2009 (-3.18%) registered the first annual declines in manufacturing “output per hour” in over 20 years that the Bureau of Labor Statistics (BLS) has tracked manufacturing productivity.

To make matters worse, real hourly compensation appears to be increasing at the fastest annual rate on record jumping 8.65%.

The combination of plummeting productivity and surging labor costs is working to push the “unit labor costs” into the stratosphere… a possible harbinger of higher consumer prices.

Of course, we have to remember that the American manufacturing sector has looked pretty sickly since 2000 so while these early inflationary signals may serve as an interesting academic exercise, they likely don’t tell the full story.

A more concerning inflationary development that I’ll post on after tomorrow’s Q2 release is that a similar trend of higher real hourly labor costs outstripping gains in hourly productivity appears to be playing out in the more general business sector component…. Though it will be helpful to also reflect on the employment cost index in order to really get a thorough sense of any early inflationary action…. More to come!

The following chart (click for larger dynamic version) shows manufacturing output since 1987 along with the annual percentage change. Notice that after a fairly robust run-up during the 1990s, manufacturing activity weakened notably in the 2000s and since Q3 2008 has been seriously on the ropes.

Also interesting is that fact that during the recessionary periods of the early 1990s and 2000s there were consistent gains in productivity even as the contraction side of the business cycle worked to significantly ebb total hours worked... today though it appears a different trend is playing out.

Next, take a look at manufacturing “output per hour” versus “real compensation per hour” … notice that output has declined on a year-over-year (… green bars) basis now for two quarters … the first annual declines on record.

Also note that “real compensation” (… black bars) is surging at the fastest annual pace on record.

Given that annual gains in real compensation have rarely outstripped gains in hourly output over the last 20+ years what we are seeing today, a combination of surging compensation and declining productivity, is truly unusual.

Finally, looking at the seasonally adjusted manufacturing “unit labor cost” you can see the result today’s unusual dynamics… is unusual increases in general price inflation on the way?

Philadelphia Feeling: Federal Reserve Bank of Philadelphia Business Outlook Survey March 2008

Today, the Federal Reserve Bank of Philadelphia released the results of their Business Outlook Survey for March showing some moderation in the recent weakness seen in the regions manufacturing sector.

The survey of the Philadelphia regions manufacturing sector has been a pretty solid leading indicator of the overall strength or weakness and recession experienced by general economy.

As you can see by the following chart (click for larger version), during the past three post-recession expansion periods, the “current” diffusion index generally vacillated between 0 and 35 while the “future” index left the period of contraction at an elevated level and eventually joining the “current” index.

Finally, as the economy pushes closer to contraction, both indices decline dramatically with a breach of -20 by the “current” index generally indicating that recession is upon us.


As you can see from last month’s results, -20 has been breached by the “current” index which now stands at -17.40 while the “future” index stands at -0.5.

Clearly, there is trouble afoot but components of the latest results also display a potential dangerous parallel to the stagflationary eras of the 70s and early 80s.

The following chart shows the latest results of the “current new orders” “current prices paid” and “future employment” components (click for larger versions).

Notice that while current orders and future employment declined, current prices paid have increased indicating a potential return to a stagflationary environment that hasn’t been seen since the early 80s.

It’s important to note that these three indicators have moved, more or less, together since the expansion of 1983 and have especially moved together during the recessionary periods of 1990 and 2001.

Now though, it appears that we may be seeing a divergence with an increase in prices paid and simultaneous decrease in growth.

The following chart (click for larger) shows these measures during the last stagflationary era seen between 1976 – 1980. Notice the clear divergence of rising prices and falling growth.

Conspicuous Correlation: November 2007

In light of yesterday’s results for Producer Prices, and Retail Sales and Today’s results for Consumer Prices, I’m reworking my analysis of the possible correlation between falling home values and declining consumption of the most “discretionary” retail items.

On a “nominal” basis, there appeared to be “rough correlation” between strong home value appreciation and strong retail spending preceding the housing bust and an even stronger correlation when home values started to decline.

The following charts show the initial analysis plotting the year-over-year change to an aggregate series consisting of the primary discretionary retail sales categories that I termed the “discretionary” retail sales series and the year-over-year change to the S&P/Case-Shiller Composite home price index since 1993 and since 2000.


As you can see there was, at the very least, a coincidental change to home values and consumer spending during the boom and then the bust, but as home values have continued to decline, retail spending has remained low but has not continued to consistently contract.

One problem with this initial analysis is that both retail sales and the S&P/Case-Shiller Composite index are reported in “nominal” (i.e. non-inflation adjusted) terms and thus result in a somewhat skewed view especially for the retail sales data.

In fact, the year-over-year change to “nominal” discretionary retail sales has been positive for the last seven months while the year-over-year change to “real” discretionary retail sales has been negative for twelve straight months (see the following chart).

The key point here is that although inflation (as reported by the CPI) has been relatively stable in recent years it is always a factor and in light of the latest surprise increases to the PPI and CPI results as well as many anecdotal reports of producers now passing through increasing energy prices to the consumer, it’s important to adjust retail sales (and home values) in order to fully understand its direction.


As you can see from the above charts (click for larger version), adjusted for inflation (CPI for retail sales, CPI less shelter for S&P/Case-Shiller Composite) the “rough correlation” between the year-over-year change to the “discretionary” retail sales series and the year-over-year S&P/Case-Shiller Composite series seems now even more significant.

Given the anecdotal accounts of homeowners drawing equity out of their homes with refi’s and HELOCs and using the proceeds to buy consumer goods, it could be interesting to attempt to “shift” the retail spending in time as the decline to home values would surely precede a pullback in consumer spending but for now I’ll leave it aligned and work on the shifting in a later post.

To make the analysis even a bit more formal (at the prompting of reader Deejayoh) I also plotted the year-over-year changes an overlaid a 12 month moving Pearson’s correlation in order to see the “exact” correlation between the two data series (click for larger chart).

As you can see, although there was a significant correlation of the declines of these series starting in August 2006, this relationship has been falling away as real home values consistently contract and real retail sales remain negative but not falling as consistently.

This is probably a reasonable conclusion as expecting perfectly correlated changes in home values and consumer spending seems unlikely BUT it is probably important to note that home values and the level of consumer spending on discretionary items are in fact both consistently contracting.

Defining Inflation: CPI October 2007

In an effort to gain a little better perspective on the historic, current and more importantly future direction of inflation, I’m adding coverage of the monthly CPI data to the lineup of regularly occurring posts.

I’ll continue to develop the analysis adding other housing and economic related data in future posts but for now, let’s just get a sense of how well inflation is measured and read.

I think it’s safe to say that the notion of inflation being moderate and contained is a widely held belief.

But is it entirely accurate?

Although there is a clear difference between today’s circumstances and that of the troubling inflationary eras of the 70s and early 80s, consumer households still appear to be facing some pretty significant rising price pressures.

We are all aware of the fact that gasoline is priced considerably higher now than just three years ago but what about other essential consumer goods and services?

The following chart (click for larger version) shows indices for Food and Beverage, Apparel, Gasoline, Medical, Education, Owners’ Equivalent Rent, Household Fuel, CPI Core and for sanity’s sake, the Case-Shiller Composite index since 1997 all normalized to a base of 100.

First, notice that the black “dotted” line is the CPI Core index, which is simply the CPI minus food and fuel.

If you were to dwell mostly on CPI core, as the Fed does when evaluating future expectations, inflation does look moderate.

But, notice that, excluding the Case-Shiller index for a moment, Gasoline, Household Fuel, Education and Medical prices have increased (and are continuing to increase) fairly significantly.

This seems to fit well for our general knowledge of both the obvious increase in oil costs and the widely reported increasing prices for medical goods and services and of college room, board and tuition.

Next, notice that Owners’ Equivalent Rent, the price index that the government uses to represent housing in the CPI, looks unusually stable and seems to understate increases to housing prices when compared to the more realistic and accurate S&P/Case-Shiller home price index.

Lastly, notice that Food and Beverage prices recently appear to be tipping up a bit, likely as a result of the prolonged increase in fuel prices leaving only Apparel to be considered a truly moderate (and even falling) essential consumer cost.