Inflation in the US has been trending down now for 30 years(Chart).
As seen on the chart, the downtrend has not been a narrow, smooth
one as inflation -- driven periodically by surges and declines in
commodities prices -- is volatile. However, the chart shows clearly
that this data series (yr/yr % chge) is becoming deflation prone at
cyclical low points. This is not a welcome development for an
economy that has grown much more strongly levered by debt over
the same period, as collateral values become more suspect in such
an environment, which, in turn, is an impediment to further growth
of private sector credit.
The consumer price index (CPI) has recovered from a cyclical low
point registered at the end of 2008, but remains slighly below its all-
time high reading set in Jul. 2008. So, technically speaking, the US
is still in a deflationary period, which will not end until the CPI starts
rising above its old high.
The recovery of the CPI since YE 2008 pre-dated the end of the
recession, but was a normal enough cyclical move which was
correctly captured by the inflation pressure gauges I use. However,
the gauges have flattened out over the course of 2010. This reflects
the leveling off of commodities prices coupled with a further
unwinding of inflation pressures excluding the volatile but critical
food and fuel measures. After all, there is still a large amount of slack
in the US economy.
There has been a moderate pick up in commodites prices this month
but it is easy to understand the Fed's concern about the spectre of a
return to a declining CPI (deflation) if the economy does not begin to
re-accelerate in growth.
My longer term inflation pressure gauge -- built off the momentum of
the leading economic indicators and the trend of capacity utlization --
is still signaling further recovery of the CPI over the remainder of this
year and into 2011, but it has lost substantial momentum since the
spring of this year.
My long term inflation potential measure still has inflation set to
rise eventually to near 3.5% a year, but that too has eased reflecting a
dip in the long term (10 yr.) growth of the broader money supply.
The economy has entered its second year of recovery and it is not
unusual to witness a loss of growth and inflation momentum. Since my
principal economic leading indicators are still consistent with
continued economic recovery, I have not abandoned the idea that
inflation pressure will re-emerge in this cycle. However, I have this
view on a short leash as I strongly prefer to see improved financial
liquidity conditions and a lessening of strong private sector caution
Continued strong consumer, bank and business caution would put the
US on the razor's edge of economic decline and renewed deflation
pressure. Thus, you have to take developments month by month and
see if folks do finally "loosen up" a little.
So it is that the Fed is holding further quantitative easing in abeyance.
It would greatly prefer to see the economy loosen up and see credit
flowing to meet rising demand without further intervention on its part.
As discussed in the prior post, I would like to see the Fed begin to
ease up moderately now and certainly hold off on a massive bout of
additional easing as the latter could be quite obviously problematic.
- Peter Richardson
- Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!