Posted by: Bruce Allen | June 13, 2008

Why Is Everyone In Denial About Inflation?

Thomson Financial NewsU.S. May CPI up 0.6 pct; core CPI up 0.2 pct

06.13.08, 9:51 AM ET WASHINGTON (Thomson Financial) – Consumer inflation pushed higher in May as gasoline prices rose at the fastest pace in half a year, the Labor Department said on Friday.

Overall prices rose 0.6 pct, while core inflation, which strips out volatile food and energy prices, rose 0.2 pct.

Why are so many economists so busy telling us there is no great risk of inflation? That without wage leverage, labor cannot secure the increases necessary to support the wicked inflation of the mid- and late-1970s. Someone find me a one-handed economist.

Let me assure you that inflation is here now, that it is going to get worse, and it is going to be with us for some time. It is inevitable, baked in to the economy, so to speak, and is due to the convergence of a number of trends:

  • The sudden spike in oil prices which, though perhaps somewhat overbought at $150, are unlikely to return under $100 during the next several years, if ever;
  • The weakness of the US dollar, a function of a steadily worsening balance-of-trade, massive Federal deficits, and, now, inflationary expectations. The dollar is down an average of 30% since 2003 against the Euro, the pound, the swiss franc and the Canadian dollar.
  • Increasing frequency of external events–floods, fires, storms–that tend to ratchet oil prices upward;
  • The presence of petroleum in every good and service in our economy. Our is an energy intensive society, one prone to painful adjustments to a new world energy order;
  • Historically high prices for grains and metals, which will continue to find their way into food and manufacturing costs in the next few months;
  • Increased demand for energy and food from China, India and the Pacific Rim outstripping any conservation efforts in the West (US and Europe);
  • The percentage of after tax disposable US family income going to gasoline has increased in the past 2 years from roughly 3% to roughly 9%. Families will be carrying larger balances on their gas credit cards. They will reduce discretionary spending, and will be charging basic monthly expenditures.
  • Lags in the economy have masked many of the effects of $140 oil. So far. This is about to end, as companies move to re-build sagging margins by raising prices or laying off people. Unemployment in May went from 5% to 5.5%, an effective 10% increase in one month. Expect more of the same for the remainder of the year.
  • Small business failures are growing, a direct result of the effects of high gasoline prices. Costs hidden in these failures will show up in data in several months.

No one seems to question the fact that we are in a recession, and have been for probably 4-6 months. Add to this the incontrovertible evidence that we have inflation now and will have it going forward, and you’ve got the perfect stagflation storm. The policy alternatives are limited, due to the fact that almost anything the government wishes to do to help the symptoms of the problems will make the causes of the problems that much worse.

The Keynesian response to recession would be to un-cap Federal spending, re-inflating the corporate lungs but, not coincidentally, making the inflation problem that much worse. Meanwhile, the Fed is sworn to raising interest rates in the face of inflation, constricting growth. The Fed has already signaled that rates have bottomed out and will be heading up in 2008.

Stagflation, as an economic condition, is demonstrative of an economy in disequilibrium. Such an economy will not respond effectively to conventional economic stimuli. In order to push the American economy back toward equilibrium, the President and Congress need address the root causes:

  • excessive imports, especially oil and manufactured goods;
  • ongoing military engagements that we cannot afford;
  • crisis conditions in the housing and automotive sectors;
  • excessive Federal budget deficits; and
  • insolvency of the Social Security and Medicare trust funds.

Welcome to the inflationary recession, last seen in the bad old days of the 70’s. If you were born after 1970 you won’t remember much about it. If you’re old like me, you remember it all too well.

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