Essential Inflation Essentials

Stirring the inflation broth.  Riffling through its drawers.  And conclude the official inflation reporting regime is now irrevocably broken, and at best irrelevant.

And I do not mean as in Argentina, where the numbers are simply false.  There, they are reputedly reporting inflation of 10% and the real number is closer to 20%.  Or as the Telegraph reported, its inflation may be 2-3 times greater than that reported.  And it is not alone in my view. 

Official inflation is a critical number, more so than almost any other in economics.  It is used to determine “real” returns or growth in economies, stocks, bonds, property and households.  Investors, pensioners, savers and spenders all need to know the official inflation rate.  Evan when it is disinflation or even deflation. 

It has been about 15 years now that my view has been growing stronger that there is a problem with official inflation reports.  I wrote here about the difference between headline inflation and underlying inflation (sometimes called “core inflation”).  Put simply, underlying inflation seems to be becoming mainstream; as investors strip out the volatile items in official inflation to better assess the economy.  In their view.

Well that may be okay with the elites, but for the mums and pops, those “volatile items” are the day to day bread of life, literally.  The volatile items, usually include fuel, food, increasingly energy, you know, basic living requirements.  

Some could argue education is one as well.  Well all over the developed world there are millions of young graduates who can’t get a job as a cleaner.  

And it is my view (see previous blog) that many western economies have been suffering through stagflation.  Defined as, high inflation, low economic growth, and high unemployment.  It may not be rampant yet, but on a relative basis it appears to be everywhere.

And when I mention inflation, I mean inflation of the essentials:  food, shelter, water, warmth, health services, and of course air.  Availability of air, or oxygen, is certainly deflating in aggregate, as we pump ever more amounts of carbon into the atmosphere.  So that’s proven.  It is the critical cost of living issues that seem to be out of inflationary control. 

Please click on any of the graphs for a larger view. 

“The FAO Food Price Index (FFPI) averaged 214 points in January 2012, nearly 2 percent (4 points) up from December. The rebound represented the first upturn in the FFPI since July 2011 but the index remained 7 percent below its corresponding value last year.”  So says the FAO.  But any glance at the graph shows there has been a structural shift in the price of food of epic proportions.  And it remains around all time highs.  Indeed the index has risen 61% since the beginning of 2007 (where it was at a high, the ceiling of a previous two decade volatility range).  That is an average of 12% per annum over the past 5 years.  

 Hamburger anyone?  This is the price of feeder cattle in the USA. And I have published this graph before.  There has been a structural change in the price of beef.  By my estimate, 10% per annum over the last five years.

And the point here is that very very few people anywhere in the world have been achieving a 10-12% increase in revenue / earnings over the last five years.  Let’s call them the 99%ers.  Indeed, in the USA the growth of income is now below the rate of growth in spending (which itself is also way down relative to pre GFC).

Unless you invested in food commodities of course, as I wrote previously.

It is not just food:  price of crude oil continues to bubble.  In both the UK and USA, the price of fuel / petrol / gas (all very confusing) are at near all time highs.  That will also be a drag on the economy – one side of the stagflation equation.  Indeed HSBC have suggested that the “fragile economic recovery in the developed world could quickly be derailed”.  

As Ambrose Evans-Pritchard reports  in the Telegraph “The West has the disquieting experience of watching crude soar even as we languish in stagnation. This never used to happen…..  Rising utility costs have already raised the numbers of UK households in poverty from a fifth to a quarter.”

And the cost of shelter is rising as well.  Whether the cost of the home or rent.  Rents are high in many places around the world, and mortgage spreads are expanding if you can get finance at all.  Historically, in the decades before the GFC it was a rule of thumb that credit in developed economies grew at double the rate of GDP.  Today, in the credit crunch being experienced everywhere, and as banks attempt to improve profits, the spread between borrowing and lending has widened.  In the UK, and Australia, they are at highs not seen since deregulation decades ago.  And even if there is some credit growth, it “feels” like a crunch relative to those times.

I wrote in February that with the enormous quant easing occurring in Europe, UK, and the USA, and despite my comments above there will be significant increase in inflation as the money eventually rolls out of the banks into the general economy.  It is inflation delayed not averted.  And the global debt continues to balloon – as this graph shows.  And as global GDP continues to fall, the ratio is ballooning also.  

Since that blog others have also written of the dire warnings about forthcoming inflation; especially in the UK, they are commenting on hyperinflation.  And how dangerous the quant easing is to the economy.  And there was a call for it to end.  You see we haven’t been here before.  What happens if the inflationary genie really takes off?  Pulling all the excess money out of the system in response would create an economic shock.  Maybe worse than we have already seen. 

This excellent article in particular speaks of the significant increase in “essential items” in the UK and makes a farce of the reported inflation figure.  Water, fuel, etc have been in double digit growth for a number of years.  Ian Cowie’s article is called “Inflation ‘falls’ while the cost of living continues to rise: which planet are these economists on?”  Exactly my point. 

There is another way to measure stagflation:  with the unemployment rate plus CPI.  It is called the misery index.  However first you have to include the correct unemployment rate, and also the “true” inflation rate.  We can’t produce the graph because we cannot find that data.

Inflation should be changed to measure the real cost of the essentials of life.   Until then don't believe a word they say.