A Tale Of Two Inflations: Why US CPI Is Flawed And Why Bernanke Will Maintain ZIRP As Revolutions Rage
For all those wondering why the Federal Reserve will likely never hike rates on the basis of undisputed surging food and energy prices, here is the reason: in the US, the food component as a percentage of overall CPI is 7.8%. In China it is 31.4%. In India 47.1%! The US CPI, therefore, is a completely irrelevant metric when it comes to measuring the one factor that has been responsible for two revolutions already year to date. In other words, if food prices were to double, US CPI would go up by 7.8%, while in China it would grow by nearly 50%. As Nicholas Colas observes when he looks at this data: "This dichotomy points to the potential for increasingly disparate monetary policies when comparing the Federal Reserve future actions to other central banks." This is a huge point that needs far greater prominence in the media, as it confirms that the very models that run central planning for the world's increasingly more involved and desperate central banks are so divergent that it is likely that the US will continue exporting inflation to the developed world long after most of its drowning in bloodshed and rioting. Genocide Ben indeed.
The chart below is all one needs to realize just how great the food price impact variation is for various central planning committees:
Note the US and India at the opposite ends of the spectrum!
For those who wish to learn more, here is Nic Colas of BNY explaining why this really is "a kinda big deal":
It is called “Tonghuo pengzhang” in China and “mudrasphiti” in India; in the U.S, the word is “inflation.” And, just as the word is different in each country, so are the weights given to various components in the baskets used to calculate price inflation all around the world. In this note I will focus on how the recent price spikes in food and energy commodities filter through to the Consumer Price Index (CPI) used by a variety of countries to measure their rate of inflation.
The reason to focus on food and fuel is easy to explain – the prices of both have risen dramatically in the past 12 months. Two points here:
- According to the Food and Agriculture Organization of the United Nations (FAO) Food Price Index, the price for basic food commodities around the world is up 28.3% over the past year. See here for more details: http://www.fao.org/worldfoodsituation/FoodPricesIndex/en/. The price of a barrel of oil has risen by 19% over the same period (see attached chart). Compare these changes to how financial assets such as the S&P 500 have performed – up 24% in the past 12 months – and you will see that the commodities complex has largely kept pace with traditional risk assets such as equities. That is a function of low interest rates in the U.S. and Europe as well as infusions of incremental liquidity from the quantitative easing.
- More disturbing than the rapid increase in price for these basic and necessary commodities is the fact that these prices are now much more correlated than at any point in the last 2 decades. While the overall correlation for the FAO Food Price Index and spot prices for oil is only 14% for the period from 1990 to the present, this relationship is 61% for the past 6 years. From 1990 to 1995, it was actually -22%.
Yet while the rising tide of global inflation may be lifting both energy and food prices in lock step, the effect of these changes does not fall equally on all countries. The accompanying charts show the proportion allotted to food and fuel prices in the Consumer Price Index calculations for 25 countries, across a wide swath of the developed and emerging economies of the globe. Three points merit attention:
- Food and energy are an unusually small portion of the basket of goods and services used to calculate the CPI inflation rate for the United States. They are a combined 16.4% of the CPI basket versus an average of 26.4% for the +20 other countries we sampled for this note. Rising food and energy prices therefore effectively have a 60% greater impact on the rest of the world’s inflation metrics than they do on these measurements in the United States.
- Yes, we know that economic purists focus on “inflation expectations” rather than simplistic and rearward looking price surveys. At the same time, monetary policymakers around the world do lean quite heavily on CPI measurements to evaluate their next moves. And inflation expectations can rise quickly once the general interest news media latches onto the story that CPI price inflation is marching higher.
- This disparity is most pronounced in comparing the American economy to those of emerging markets. Take, for example, weighting for the food component in various countries’ CPI measurements. The U.S. has the lowest percent allocation for food of any country in our sample, at just 7.8% of the total CPI basket. The average for the other 24 countries is 17.3%, and this includes developed economies such as Japan (19%), Sweden (14%) and Germany (10%). But at the far end of the distribution are two important emerging markets – India (47%) and China (31%). It certainly makes sense that still-developing economies with low income/capita would have higher proportions of consumer spending going towards food. But this means that the food inflation we noted at the top of this piece falls disproportionately on these economies and their citizens relative to the United States.
- The spread for the energy component of CPI is less pronounced, but still visible. The cost for gasoline, heating oil and natural gas takes up 8.6% of the average U.S. consumer’s expenditures according to the weightings of the American version of CPI. That is lower than the rest-of-world’s 9.1%. India, which is not yet as motorized as many emerging economies, is only at 5.5%.
These differences are important, to my mind, because of what they tell us about prospective central bank policies around the world. The U.S. will be quite literally the last country to feel dramatic inflationary pressures from rising food prices. This leaves the Federal Reserve open to keeping its current policies in place, everything else equal, than any other central bank. At the other end of the spectrum, the high percentage of food costs represented in Chinese CPI means that central bankers there must be more aggressive in their fight against rising inflationary expectations.