#11 – Inflation

The U.S. Government, via the U.S. Bureau of Labor Statistics (BLS) released monthly inflation data this morning that showed inflation slightly above expectations. How is it measured and what does it mean?

Inflation occurs when the value of money declines relative to the goods and services that money can purchase. High inflation, like that in Venezuela, occurs when the supply of money is greater than the demand for money. Prices go up because inflation is happening, but not all inflation is bad. When the outlook is for prices to modestly appreciate in the near term, for example, this can encourage consumer demand, investing, and optimism; hence, many argue that low (but above zero) inflation is actually beneficial.

The Consumer Price Index (CPI) refers to a measure of change in prices paid by consumers for a fixed basket of goods and services. The CPI is based on prices of food, clothing, shelter, fuel, drugs, transportation fees, healthcare, and “day to day living”. For whatever reason, the index is based on prices of those items selected for the period 1982 through 1984. Therefore, a CPI reading of 100 means inflation is equal to the level it was at in 1984, and today’s current reading of 260 (see below) means that inflation has risen 160% since 1984.

CPI Index 1970 – 2021

CPI Index – 1970 – current

Outlined by the red box below you can see that today’s report shows the Year-Over-Year (YOY) change in the CPI (Dec.) +1.4% (in green font) vs. a forecast of 1.3%, and a previous reading of 1.2%. This means that December 2020’s inflation reading was 1.4% higher than that in December 2019.

Jan. 13, 2021 Investing.com Economic Calendar

And taking a look underneath the hood at the actual components, we can see that there were significant moves higher across the index between Nov 2020 – Dec 2020, reflecting higher inflation month-over-month.

What’s wrong with the CPI?

To calculate the monthly CPI, a group of statisticians estimate what percentage of a “typical” household budget is spent on certain items. The higher the percentage decided by these economists, the more “influential” that item’s price change is in the index. Fiscal and/or monteary policy, such as the Federal Reserve flooding the economy with new dollars, can have tremendous impacts on the price of goods or services too. There are many other criticisms of the CPI; the index as an incomplete the truth at best.

Inflation Outlook

Today’s report also included an inflation outlook: the U.S. central bank does not see inflation rising above 2% until at least 2023. The Fed has an inflation target of 2%, and the Fed wants inflation sustained above that level before raising interest rates. In other words, record low interest rates are here to stay. The impact that this has is that people are disincentivized to save money (because we earn no interest on it) and are thus forced to either spend money (this is the Fed’s goal: to “stimulate spending in the economy”) or to allocate savings to riskier places for returns.

A history of Interest Rates – Federal Reserve

Stimulus checks and higher unemployment benefits pushed household incomes higher even as economic output shrank – a rare combination. Rising stock and housing markets helped add more than $5 trillion to the net worth of U.S. Households in 2020. This chart shows total U.S. household income, broken down by wages/salaries (black) and benefits (blue). The more blue and the less black, the more of a welfare state we are.

The Georgia run-off that certified Democratic control of Congress opens the way to +$750 Billion of extra pandemic aid, Goldman Sachs estimates. That allocation of that spending is shown here:

Source: Goldman Sachs Investment Research

More government spending and accomodative monetary policy (low interest rates) are forecast under a Biden administration, both of which could be supportive for risk assets barring price shocks. I’m interested to see how the incoming president handles Trump taxes – whether or not he will roll them back for corporations – and Section 230 as it relates to liability of technology giants such as Facebook and Google.

Meanwhile, the St. Louis Fed’s data shows M1 Money Stock, including dollars in circulation, having gone parabolic in the last 2 years. This chart should be very alarming to anyone monitoring inflation.

fred.stlouisfed.org Source: Board of Governors of the Federal Reserve

More Interesting than they may seem:

A Historical Analysis of Monetary Policy – stanford

Interest rates and the conduct of monetary policy

Interest Rates, 1914 – 1965

Update 3/1/21:

The Commodity Price index ($GSCI) has experienced its’ second strongest start of any year since 1973 (only behind 2003)

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  • Google trends data for search term “inflation” on the rise.
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Published by J. King

Growth through transparency

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