By Michael Every of Rabobank
CPI Basket Case
On Sunday on ‘60 Minutes’, Fed Chair Powell said “We can wait to see actual inflation before we raise interest rates.” Well, today is the US inflation report. The market consensus is headline prices will rise 0.5% m/m, which would be around 6% y/y annualised, and on a straight y/y basis CPI will go from 1.7% to 2.5%. Of course, excluding food and energy CPI is seen rising just 0.2% m/m, or around 2.4% annualised, and up from 1.3% to 1.5% y/y. Yet the Fed won’t see any actual inflation in those numbers. When it comes to inflation, what one does and doesn’t see is all political.
For example, we are currently seeing a housing boom in many economies, most so in Australia, on the back of ultra-low interest rates. What do central banks and regulatory bodies say when house price inflation is, say, 5%, or even 10% - let alone 30% as in Oz? Answer: nothing. Once upon a time they had to do something - but then we removed accurate measures of house prices from CPI, so now they don’t. It isn’t happening, or isn’t their remit. True, they can waffle about financial stability, and in the case of the odd outlier like New Zealand (and on/off in China), the government can force action from the central bank. Yet until that revolution is imposed globally --in the same ‘yes,-that-is-going-to-happen’ way the US wants minimum corporate tax rates to be-- house-price inflation just is what it is. As such, is it any wonder that such a vast slice of the US, Chinese, European, Aussie, etc., economies are focused on endless property speculation?
How about stock prices? Can anyone remember back to Alan “Bubble Boy” Greenspan and his empty warning of “irrational exuberance”? Indeed, can anyone remember the last time a major central bank deliberately raised interest rates in order to slow down an ascent in stocks, because this was inflationary? Conversely, does anyone seriously think that stocks could ever fall significantly before our monetary authorities slashed interest rates (where they still can), or boosted QE further, or did “whatever it takes” to get them to go back up again? So clearly not much fear of inflation there – just deflation.
Of course, there is wage inflation. Nowadays there are more frequent and widespread calls to ‘Build Back Better’ and ‘level up’, and recognition that this involves higher pay. (Just not for NHS workers in the UK, who were initially offered 1%). Even the US Treasury Secretary is using quasi-Marxist terminology of “labor vs. capital”. However, since the neoliberal reforms of the late 1970s/early 1980s, wage inflation has not been tolerated by central banks – outside of finance and after-dinner speaking fees of USD250,000 a pop. Any sign of general salaries going up to, say, 5% or even 10% is terrifying, was met with an immediate response of higher interest rates.
Yes, central-bank rhetoric has now changed: but it’s easy to say one is willing to let wage rises happen when one is also aware that the economic structure will not allow it! You can’t sit on rates or yields or talk about “labour vs. capital” and expect wages to just go up. You need to *strengthen* the bargaining power of labour vs. capital. How do you do that without empowering unions/weakening the power of firms? How do you do that while allowing off-shoring and free trade, because the logical response will be to shift production elsewhere. And how do you stop capital replacing labour, i.e., automation? Our global system is designed to ensure we don’t get general wage inflation. Slashing rates, QE or even YCC are performative in a political vacuum: but, handily, they produce higher house and stock prices.
Meanwhile, expensive Aussie house prices and cheap rhetoric are not the only things growing 30% y/y. As the US CPI report will probably only partially show, so are food and energy costs. I wrote recently about geometric vs. arithmetic means and hedonic adjustments made to the CPI basket that keep it lower than it feels for most people. One other what-you-see-and-what-you-don’t impact in the same basket I didn’t mention is periodicity.
How often do you buy a TV, for example? The price of those has come down when one adjusts for quality, and even in absolute terms. Yet my own experience is that if I am buying more than one every five years, I am pretty angry about it. The same goes for key pieces of furniture and lots of other items where our neoliberal system *has* seen prices come down (and Western supply chains and jobs shift to Asia in tandem). By contrast, how often do you buy food? How often do you fill up your car with petrol/gas, or buy something delivered by somebody who did? Inflation fails to capture this time distribution effect. Everything around you that you need to buy today is going up in price rapidly – but don’t worry: something big you might not need to buy until 2028 is going down in a hedonic-adjusted price. Sit back and feel the savings.
All this neoliberal deliberate (“neo-liberate”) stupidity was perhaps tolerable before 2008-09 because most of the population was in a debt- and housing-fuelled stupor. Even with far more somnolent monetary policy being lavished on us today, that is no longer the case. Especially for those who can’t afford to fill up their cars; or buy the same foods they used to be able to; for those who can no longer find somewhere affordable to live in a country like the US or Australia, which are hardly short of land - talk about “labor vs. capital” to labor looking at the price of a home anywhere near a capital; or for those trying to do DIY/construction to avoid moving home and seeing eye-watering price-spikes. (Check out social media for more timely and accurate measures of what people are *actually* paying for key inputs than the BLS will provide today.)
When one then throws in the combination of drought in the US and voracious commodity demand in China --and Wall Street finding time in its busy schedule of suppressing wages and pushing up house prices to also speculate on soft commodity futures-- then the structural scene is potentially set for much higher food prices yet. (On which note, here was our warning of the tail risk of a Biblical commodity-price surge from a few weeks ago.) When we add disrupted global supply chains for all kinds of goods on top, things get even more ‘interesting’.
Let’s watch as central banks try to explain this all away rather than having to raise rates and see deflation in house and stock prices - which somehow they *can* measure accurately on the downside in real time. Unless we slip into a true inflation-wage spiral, which is unlikely given weak labour power, once we are on the other side of this real-income crushing CPI peak in 2022, let’s then also watch central banks explain why we still aren’t seeing any wage inflation, just in house prices and stocks.