Offshore Troubles, Domestic Fears

Another monthly report on import prices, and another monthly record high. If that sounds familiar, you're right. In fact, we can almost set our watch by the reliability of the trend these days.

No wonder, then, that we've become a broken record on the subject. Our only defense is that our recurring message is a reflection of the consistent rise in import prices, which we've written about regularly in the recent past, including here and here and here.

As we've discussed over the years, there are many hazards of letting prices rise with nary a monetary peep. The hazards continue to increase now that import prices are advancing at more than 20% a year, as of last month. As far as we can tell, that's the fastest pace on record, based on the data available on the Bureau of Labor Statistics' website, as the BLS chart below shows.

12-month rolling change in U.S. import prices:

Source: Bureau of Labor Statistics

 

The rationale for doing nothing is that a recession/deflation risk coexists with the inflation danger, as the Bank for International Settlements noted in its recently published annual report:

 This combination of rising inflation pressures and financial disturbances slowing demand growth is open to a spectrum of interpretations. On the one hand, if slower growth were thought just sufficient to hold global inflation in check, albeit with a lag, this could be viewed positively. On the other hand, the eventual global slowdown could prove to be much greater and longer-lasting than would be required to keep inflation under control. Over time, this could potentially even lead to deflation, which would evidently be less welcome. Unfortunately, when one considers the possible interactions between a weakening real economy, high household debt levels and a severely stressed financial system, such an outcome, even if unlikely, cannot be ruled out entirely.

With conflicting signals swirling about, these are not easy times for central banks. Dealing with one or the other is within policy powers of the Fed (assuming the discipline to carry out the relevant monetary prescription). Tackling both simultaneously, however, is more of gray area, with limited precedent of success for encouraging optimism with the current battle.

That leaves us to question whether it's time to hedge one's bets a bit by at least tightening slightly. For the moment, the Fed is having none of that and instead seems intent on betting exclusively on the recession/deflation risk, in effect hoping that the inflation hazard will fade away in due course.

It's a nice theory, and it may ultimately prove accurate. But heaven help the man in the street if the Fed's wrong. So far, one can argue that the bet has been a net loser for Joe Sixpack, courtesy of the bull market in oil. Crude is priced in dollars, and to the extent that dollar-based inflation is a problem, oil prices will rise in sympathy. True, supply/demand factors are also pushing up oil prices, but a portion of that rise is surely linked to the weak dollar. And with the Fed's current monetary stance, combined with Europe's monetary tightening, the dollar may weaken further.

It's anyone's guess if Bernanke & Co. will win this game of chicken. So far, there's not yet much sign of success in the numbers, least of all in import prices. Even if you take out petroleum, which is the primary source of the imported inflation, import prices are still climbing by more than 7% a year. That's better than 20%, but it's still not encouraging, all the more so when you consider that higher oil imports are this country's destiny for some time to come.

By comparison, the 10-year Treasury yield is a mere 3.81%, as of last night's close, and Fed funds remain at 2%.

For the moment, we're left to wonder (and hope) that next week's update on consumer prices will bring better news on the inflation front. Meantime, it promises to be a long weekend.

Comments

[Consider_this:]

Longer term, I think Bernanke is right. Time will prove him right. If we are indeed dealing with an upcoming greater depression, the worst thing we can do now is to tighten money supply.

That's what the regulators did in 1930 and in hindsight Bernanke's thesis explained that that was a mistake.

It takes balls to lower interest rate to negative real rates, but I think he needs to do more. Inflation be damned. Act now or it'll be too late when the deflation vicious cycle sets up.

I don't think he has done enough and the oil prices and political pressure to not act is handcuffing him. He wants to do more but public pressure is stopping him.

The public will regret if deflation really happens. Inflation is MUCH better than deflation.

2008 Jul 11 10:09 AM

[rufusmcbufus:]

hc, I don't buy your theory at all. Hyperinflation is infinitely worse than deflation. Hyperinflation gives you wiemar germany. You absolutely do not want to go down the road where it costs thousands of dollars for a loaf of bread. If that happens I guarantee it'll be blood in the streets...possibly ours.

2008 Jul 11 12:59 PM

[moonbat1775:]

A brief history of the Federal Reserve

The Fed has lowered rates;
the banks will now inflate.
We'll have a boom but it is doomed.
Oh , wait!
The Fed has lowered rates ...

2008 Jul 11 01:11 PM

[MarvinMBA:]

Going back to fundamentals, this country was built on the basis of low priced oil. It resulted in an abundance of food and a higher living standard and a strong defense. The cost of energy in all its forms was in the noise and insignificant. Right now we are faced with the reverse because of various negative factors of our own making. The Government has been concentrating on external factors not paying attention to providing the energy the country needs in case of disruptions like the economic failures we now have to cope with. At one time we were able to BS oursleves out of it. It seems to me it too late to provide the fundamentals this country needs like cheap energy from home grown sources. Our sitiuation will continue on a downward spiral and it will be impossible to manipulate our way out of this...the world out there has finally understood our game plan and the Feds attemps to manipulate the failed institutions into life will result in failure and accelerate our fall to DEPRESSION.

2008 Jul 11 01:31 PM

[Jason Rines...:]

Agree with Rufus. Best Fed can do is what is assumed they will do, raise .25 to .50. Backing up the hawkish rhetoric with recent EU moves would restore a bit of investor confidence and take a slight bit of froth out of commodities.

I have said this since March and submitted this to the President directly: The only way to avoid a full blown depression in 3 or so years is to subsidize energy. NOT nationalize it, subsidize it.

Forget the damn mortgage and housing mess. Most people losing there ass were the irresponsible, from i-Banks to speculative consumers and the small percent of NINJA loans. Let them burn and I know that sounds harsh. Truth is, the guy on the street does not know how he will pay his heating bill this winter and state and local budgets are now in war mode to choose between healthcare for the old and poor and heating oil in the cold states. There will be CASUALTIES this year from the dumb-ass socialist party (nice 9% approval rating Congress, where's the lower gas prices Nancy Pelosi?)

Instead, put $300 B from Treasury into drilling and alternatives like nuclear and biodeisel. Have a Buffet and/or Gates combo manage the fund and trickle it down into the responsible commercial banks, private equity firms (with the Fed or Treasury have no decision making in the appointment of).

Further fund the SBA with $50 B to kick-start small business and entrepenerual innovation. This would create a couple of million jobs, kill the oil bubble and increase exports, manufacturing etc. It adds a mid and long-term permanent lift to our economy and way of life.

Bailing out the irresponsible on mortgages means handing the tax bill to the responsible, bill would come due around 2011 (which is where I forecasted Depression in June of 2007).

Washington must move and move now but the dimwits in the Democratic party want us to be the next Cuba so they can benevolently keep coming to the people's rescue. Makes them look like hero's instead of goats by attempting to solve the socialist policies with socialist policies. It's all about power, control and irresponsibility passed off to someone else until there is simply a nation of gods and clods. Ever wonder why Carter, Ted Kennedy, Pelosi love hanging out with socialists and communists?

What these morons don't realize is we are not Cuba, the common man has the PC and Internet (which Dems are also trying to choke off free speech, gun rights etc) will figure this out and 60 million people are ARMED. They also don't realize our military who has been treated like trash by these people will not come at there beckon call like Fidel Castro or Hugo Chavez. Even these evil socialists realized you have to throw a bone and speak nicely to your military. Let the forest burn instead of slow Chinese water torture. Waiting for the next assanine on the Hill is too little too late but again, our Dem House feels just fine that the responsible little guy burns. Gods and clods are exactly what you want in a communist utopia.

2008 Jul 11 02:01 PM

[Larry House:]

User 118015, I am afraid you are exactly right. Each month over 600 BILLION dollars leave the U.S. to pay for oil. About 60 BILLION more is our average monthly trade deficit. Our economy is not growing. Our wealth is flowing away, and we owe TRILLIONS to other countries that hold our Treasuries. We are getting closer to the day that all of our economic shortcomings have to be faced. It won't be pretty.

2008 Jul 11 02:12 PM

[longoil:]

Larryh,

I think you are off by a factor of 10
I get only 72 billion a month leaving the USA to pay for oil imports.

==>22 mbl/day (USA daily consumption) x 30 days x $145/bl x 75% imported

2008 Jul 11 03:19 PM

[Ames Tiedeman:]

I guess we hit 150 on monday.

2008 Jul 11 04:26 PM

[Jason Rines...:]

Think Larry H was typo to 600 B a year. Only $72 B a month? That's it?!? We will keep taxing the public until this dries up, the nation in depression and then our export inflation scheme will no longer be tolerated and some form of default (probably the collapse of the financial system) will occur. That will certainly make meaningful friends across the globe attempting to de-peg from the dollar but can't. Nor are we allowing them to reinvest in massive projects that can provide a sizeable return, noooooo sovereign wealth funds are a threat, my Democratic Senator said so. Let's not sell the globe what they need. Let's do nothing but lie to the public and blame the entire globe for acting like spoiled kids when our cookie jar is empty. Beyond sickening.

2008 Jul 11 04:57 PM

[phdinsuntan...:]

There are those who believe high oil prices are the result of market forces--limited supply meets endless demand, which makes barrels of crude more expensive. In an October 2004 National Review article, “The Oil Bubble: Set to Burst?” it was argued that oil prices, at that time $62 a barrel, would soon collapse. In ten months, oil was $73 a barrel.1 All through oil’s five-year price surge, rising to $105 per barrel as of March 2008, there have been many voices asserting that the precipitous rise is all the result of speculation--unsupport... by the rudiments of supply and demand.2 Speculation will have an effect on oil prices if it leads to hoarding or an increase in private inventories of crude. Some espouse that inventories have remained at “normal” levels, which implies that the rise in oil prices is not the result of runaway speculation, but the consequence of decreasing supply and the rapid growth of developing economies like China and India.3 We would like to point out that the notion of high futures prices reducing physical supplies through “hoarding” has nothing to do with a “normal” level of inventories, but whether there exists a positive relationship between futures prices and oil stocks/inventories. For specifications including longer-term contracts that are inherently more speculative, the real price of oil appears to be determined predominantly by the futures price. Moreover, there is empirical evidence of hoarding in the crude oil market: both oil stocks/inventories and futures prices are found to be positively cointegrated/correlate... with each other.

2008 Jul 11 05:12 PM

[Dirtt:]

Go back to sugar in 1968. Overlap the chart with oil today. $100 barrels? More like $80 - $50 after China is done throwing the Olympic party.

Pop goes the weasel.

2008 Jul 12 03:43 AM

[theobannion:]

Still referring to "Joe Six-pack"? He has long since been reduced to "Joe Twelve-ounce Bottle."

2008 Jul 12 11:27 AM

[Will Rahal:]

It is a scary looking chart. Inflation is staring to be considered a more serious threat to the markets. Also, next week's reports will show that this is far more that a "slowdown" and more like a recession.
There is plenty of room for inflation to deteriorate the earnings picture further, causing more stock market losses.
See

wrahal.blogspot.com/20...

2008 Jul 12 04:26 PM

[Pauly B:]

I agree with Dirt, as the worlds economies slow down oil inventories will rise and oil will fall. For those long oil, the bubble will burst and burst hard. India, China, and other countries are reevaluating how they subsidize their oil.

If your buying futures at some point you will have to deliver the product on your contract, what happens when no one wants your product?

2008 Jul 13 09:53 AM