One bright day in the middle of night two dead boys rose to fight. Back to back they faced each other, drew their swords and shot one another. A deaf policeman heard the noise, and saved the lives of the two dead boys. If you don’t believe this lie is true, ask the blind man, he saw it too. ~Author Unknown
Are you confused about inflation yet? Everywhere you turn some analysts are worrying about rising commodity prices while others, including Fed Chairman Bernanke, point to the tame core inflation rate. Back in August of 2010, it looked like a double dip recession was in the cards and we were worrying about deflation. Then the Fed threw the stock market a QE2 bone and Pavlovian traders ate it up, boosting asset prices across the board. What now?
In the Q & A session following his February 3rd speech at the National Press Club, Chairman Bernanke addressed inflationary concerns based on rising bond yields and skyrocketing commodity prices. He basically conceded that inflation is rising in emerging markets, but maintained that it’s contained in the United States. According to Mr. Bernanke, it’s up to the nations experiencing food inflation to deal with it, and rising U.S. bond yields reflect optimism about improving economic conditions.
Social Unrest Occurs When People Can’t Afford the “Luxury” of Eating
Others beg to differ. The subtitle above is taken from a chart provided by Keith McCullough of Hedgeye Risk Management. It headlines what he calls his 6-month table of real-world inflation, and was included in a recent article by Mr. McCullough in which he described How Inflation Is Turning Breakfast into a Luxury Item. Apparently, inflation is showing up at the grocery store in America even if it’s not apparent in the core inflation rate reported by the government.
While I pointed out in a recent article on rising commodity prices that there are many climate-related causes for the rise in global food prices, Mr. McCullough places the food inflation blame squarely on the shoulders of Ben Bernanke’s Fed. He points out that the U.S. dollar has been falling and the CRB commodity index has been rising since the dawn of quantitative easing.
Now that we are starting to see rising agricultural commodity prices move from the futures markets to local grocery stores, consumers and consumer-related companies are feeling the pinch. Although many companies have reported excellent Q4 results, “cost pressures” and “rising input prices” are phrases that are creeping into many earnings reports, particularly those with commodity price exposure like consumer bellwether Procter and Gamble.
See No Inflation, Hear No Inflation
That’s another borrowed subtitle. This time, it’s from an article on Paul Krugman’s contribution to the inflation debate. Mr. Krugman doesn’t think we’ll see inflation like we did during the commodity price shocks of the 1970s because unions are much less powerful now and COLA (Cost of Living Allowance) has gone the way of the dodo. No wage inflation, no runaway inflation.
So it sounds like workers can look forward to stagnant income and rising prices. Whether you want to call that inflation or not, it doesn’t sound like fun for the average consumer. Unless unemployment drops, this scenario doesn’t seem like a good one for companies depending on a bounce-back in consumer spending.
Further, Peter Boockvar points out that We Don’t Need U.S. Wage Inflation to Have a Problem. He points out that stagnant wages and rising prices are “the ultimate middle class squeeze” and that we are importing wage inflation from China. Wages have been rising sharply in China lately, and that’s bound to impact the prices of the many “made in China” products that we buy.
Boockvar also points to rising rents as an inflationary dark horse to keep an eye on. Unlike food and energy costs, rent is a component of core inflation and it may force some economists to wake up and smell the inflation. It will also exacerbate the pressure on lower and middle income consumers, many of whom have recently been forced to become renters after suffering misadventures in home ownership.
Rich Bernstein had an interesting debate with the aforementioned Keith McCullough last week on CNBC in which he pointed out that:
- The U.S. is in “the sweet spot” where the economy is improving, but inflation is not out of control.
- Quantitative easing won’t cause inflation unless the velocity of money picks up. People have to actually do something with all of that liquidity to produce inflation.
- This economic cycle is more normal than many think, and bond yields are rising because because normal cyclical growth is kicking in.
- If commodity prices continue to rise, we won’t get sustained inflation. We’ll get another recession.
If you watched the exchange between McCullough and Bernstein, it sounded like they had polar views on the inflation debate. In many ways, I’m sure that’s true. But I couldn’t help but wonder whether one difference in their perspectives was a matter of timing. Bernstein seemed to think higher inflation was possible in the future, but that it would be snuffed out by a recession before it gets out of hand. McCullough, however, thinks inflation is already here and that it could indeed get out of hand if the Fed continues on its present course.
Timing Is Everything
Investing is all about timing. While neither panic nor denial serve us well, markets usually contain ample reason for both. Many were very concerned about emerging problems in the mortgage securitization market as early as 2005, while others saw nothing but blue skies and smooth sailing ahead. Of course, the bears were wrong for a few more years – until they were proven right.
Today’s market environment has some of the same feel to it. While it seems unwise to ignore the rolling social unrest due to rising food prices, markets have largely shaken off these concerns so far, and the U.S. economy has shown signs of improvement. Mr. Mubarak’s departure seems to have stabilized Egypt for now, but protests are already erupting in Algeria and Bolivia, and many pundits are putting out some pretty long “Who’s Next?” lists.
Regardless of what the core inflation index says, rising food and energy prices are not good for consumer spending, especially among the already-stretched lower and middle classes. How much longer all of this lasts likely depends on whether we see Bernstein’s normal cyclical inflation or McCullough’s consumer-crushing inflation. If commodity price inflation is indeed unsustainable, then prices will eventually come down – but from what level?