Andrew
Andrew McCarthy is an expert in all things inflation. He has a Bachelors in Economics and has been working in the finance industry for over two decades.
by Andrew | May 5, 2015 | Definitions
Financial commentary and analysis is usually heavily peppered with “since Lehman” or “Post-Lehman” comparison statistics and conjecture. 2008 were some of the darkest days ever for financial markets; the losses worldwide were truly staggering and we are still wrestling with the consequences of this epic event to this day.
The world has changed a great deal since Lehman closed its doors – the financial world in particular has changed. The policy response from governments and monetary authorities around the world were amongst the most aggressive monetary policy moves of the modern era. As a result, we are now living in the midst of a giant financial experiment with all the theories, uncertainty, fear, greed and hope associated with finance jostling for equilibrium.
The Federal Reserve and other central banks throughout the world have been engaged in loose monetary policy, quantitative easing, ZIRP, and NIRP without issue despite the dire warnings of opponents who see the surge in the money supply as the precursor to rampant inflation and a hyperinflationary currency collapse. These fears for the most part have not transpired. Inflation has remained subdued through this period, and a lot of head scratching has ensued.
We are in uncharted territory, but there can be no argument about some of the major economic themes that have transpired “Post-Lehman” – the most astounding of which has been a complete collapse in the velocity of money throughout the economy. This metric above all others, helps explain why the expansionary monetary policy regimes throughout the world have managed to avoid triggering bouts of high inflation. The low velocity of money statistics also reveal just how fractured the economic recovery has been in the United States – where the exuberant valuation levels of financial markets are not borne out by developments in the real economy.
What is the velocity of money?
The velocity of money refers to how fast money circulates within the economy from one person to the next. Velocity of money is an important tool for gauging the rate at which money within the economy is used for purchasing goods and services. Analysts will often take the velocity of money as part of their consideration when determining how well the overall economy is performing. A high velocity of money indicates an active economy, and by consequence, is likely performing well. A low velocity of money will usually cause alarm bells to start ringing for economists. Low velocity of money is usually the precursor of slower growth and the onset of deflationary conditions.
Another element we need to take into consideration is the overall money supply of the economy. The money supply has many different measures, but economists usually narrow these down into two distinct measures known as M1 and M2.
The M1 definition refers to the most liquid assets in the economy, namely cash and checking deposits. M2 broadens the definition of the money supply by also including “near cash” assets such as savings deposits, time deposits, and other money market mutual funds which can be converted into cash relatively quickly.
How much has money supply increased since the start of QE?
As a consequence of the Federal Reserve’s QE program, the money supply of the United States as measured by M1 has increased by over 100% since September 2008. Increasing the money supply on this scale has never occurred before – the exponential nature of the M1 chart illustrates this well.
Despite the dramatic increase in the overall money supply – we are still concerned about deflationary pressures within the economy. So what has been happening with all of this extra money? Banks for the large part, have been hoarding this cash as excess reserves within the system. The transmission mechanism through credit growth has been sluggish at best – and therefore the velocity of money has been crashing.
The Velocity of Money has been in freefall since 2008
The velocity of money has crashed “Post-Lehman” – the chart below shows by just how much! The implications of this are obvious. Money has been tied up in the financial sector – banks have been unwilling to lend to the “real sector” and the recovery has been going at a snail’s pace as a consequence. Financial markets by contrast, have been soaring with various markets around the word frequently taking out all time highs.
What happens next?
Looking forward from our current position is difficult. On one hand, the deflationary pressures weighing down the economy are still at large but the massive increase in the money supply has the potential to stoke serious inflationary pressures going forward. Central bank around the world have all squeezed the toothpaste tube and the contents are out. The next chapter in the “Post-Lehman” story will undoubtedly be dominated by how to get the money supply genie back into the bottle. Time will tell.
by Andrew | Apr 20, 2015 | Definitions
Official March inflation data from the BLS was a mixed bag with headline CPI continuing to remain under pressure, but a significant rise in Core CPI ex Food and Energy was enough to trigger knee jerk uncertainty about the outlook for the Fed’s immediate interest rate policy. A weak session across all markets following the release of the data suggests market participants are viewing the recent uptick in prices as a signal for rates to rise quicker than expected.
The Deflationary Camp
On one side, the deflationary environment shows no sign of easing up, with headline CPI coming in weaker than expected – consumer prices rose a modest 0.2% from February versus a consensus call for a 0.3% increase. CPI YoY fell to -0.1%, the third successive monthly decrease. Double digit falls in energy prices YoY continue to keep a lid on consumer prices for the time being with Energy (-18% YoY) and Gasoline in particular (-29% YoY). Food prices fell -0.2% for the first time in six month providing further relief to the consumer.
In a worrying sign for business activity and sentiment going forward, the index for airline fares declined for the fourth time in the last 5 months and there seems to be growing evidence of discounting taking place in the business travel segment across the board.
Core CPI Remains Stubbornly High
On the flip side, Core CPI excluding Food and Energy continues to print at elevated levels, rising to 1.8% YoY versus consensus expectations of 1.7% YoY. Increased Housing (+0.3% MoM, 3% YoY) and Health Care costs (0.4% MoM, 1.9% YoY) were the main contributors. The recent stability in Crude and Energy prices could see Core CPI remain on the high side for the next few months and the market is likely to start paying more attention to energy prices going forward to try and gauge potential sentiment within the Fed.
Wages
Real average hourly earnings for all employees increased 0.1 percent from February to March with 0.3-percent increase in average hourly earnings just shading the 0.2% increase in CPI. The NFP numbers for the past few months are likely to give the Fed further room to pause – NFP has been on the slide every month since December 2014, and with the potential for increased layoffs coming from the oil, gas, and shale sectors the unemployment numbers might show increasing stress in the coming months.
Market Reaction
Equity markets were a sea of red all day Friday, as a perfect storm of higher than expected Core CPI, increased volatility in China and wider Asian markets, and ongoing drama with Greece triggered a bout of selling from investors trying to reduce exposure going into the weekend.
Selected Market Performances
S&P500 -1.13%
DJIA -1.54%
WTI Crude -1.71%
EURUSD +0.43%
Outlook Going Forward
Rising Core CPI will be a concern for markets, but with increased volatility within China and Emerging Asia equity markets, and heightened geopolitical tensions it appears too early to assume any imminent rate hike from the Fed – if anything these pressures are likely to keep the Fed on hold for the time being in order to get more clarity on world events. Consumer prices continue to remain subdued and policy makers are likely to want to see a pick up on this side before jumping into action.
The dollar will continue to act as proxy for rates in the meantime, and we expect the currency to remain well bid against its major competitors for as long as the current standoff from the Fed continues to playout. The Gold market has been steady all month with the yellow metal hovering around the $1200 mark in fairly tight trading bands. With the ZIRP, and increasingly NIRP world in which we live, the Gold market might still have a role to play this year.
by Andrew | Mar 6, 2015 | BLS, CPI, Inflation
Inflation is one of the most important economic indicators available to consumers and investors as it gives a strong signal how the economy is currently performing, and perhaps more importantly, a strong hint at which way monetary policy is likely to swing in the coming months. The Federal Reserve analyzes inflation trends in detail, and any sign that inflation is getting either too high, or too low will often be met with a swift policy response; usually an increase or decrease in interest rates. Changes in interest rates affect every aspect of the economy including mortgages, student loans, business loans, savings accounts, and government debt.
In light of this, it is crucial that you gain a strong handle on the numerous ways that inflation is measured in order to give yourself an insight into the potential direction of monetary policy at the Federal Reserve, and how such policies are likely to impact you as an individual. Althought we use the CPI for the sake of our calculator, we understand that there are various other ways to calculate inflation and each way has its pros and cons…
Official Government Inflation Measures: CPI and PPI
The Bureau of Labor Statistics has the unenviable task of producing inflation statistics within the United States. They do this by collating a vast series of data from the economy in order to produce two key inflation indicators – namely the Consumer Price Index and the Producer Price Index.
The Consumer Price Index (CPI), is a measure of price changes in a vast array of consumer goods and services. The CPI measures price change in the most popular products and services purchased by American consumers (basket of goods and services). The CPI is often used a reference point for wage adjustment purposes. The CPI is crucial to monitor as it highlights how much the purchasing power of the dollar increases or decreases. This has wide reaching implications throughout the economy.
Producer Price Indexes (PPI) – are a collection of indexes that measure the average change of selling prices by domestic producers of goods and services. PPI is often followed closely by market analysts as an early indicator of changing trends within the economy. Falling producer prices mean businesses are finding it is difficult to sell their products and are often offering heavy discounts. This can lead to potentially deflationary spirals which plunge the while economy into recession.
Official Government statistics are viewed with skepticism by some parts of the investment community – it is believed that the BLS and the Government have an incentive to “massage” the official inflation figures to suit their own economic message or agenda. Often these analysts and market commentators will use alternative indicators in an attempt to cut through any government bias.
Alternative Measures of Inflation
Gold has been an historically important indicator of inflation for thousands of years and is seen by many as the only real form of enduring money. The purchasing power of gold has endured throughout history without exception. In the past two centuries alone, the purchasing power of gold has held up through countless revolutions and two world wars, fiat currencies by contrast, have come and gone several times over! It is unsurprising therefore, that many investors and market commentators will look at the gold price to gain insight into the overall health of an economy. An elevated gold price highlights stress and distrust within the overall financial system, and a distrust with the monetary policy makers in general. Gold prices tend to rise if inflation is expected to increase. Gold overall is a valuable indicator for providing an inflation indicator free of government bias.
Growing distrust of official statistics has also given rise to independent organizations which keep track of their own data to generate inflation forecasts. One such organization is shadowstats.com which aims to cut through bias in government statistics and forecasting to provide a more balanced view of inflation within the economy.
Cover all Bases
As always, the devil is always in the detail. There is no single measure of inflation which you should accurately rely on to make decisions for your business, or investments. Increasing bias in Government statistics make it necessary to look beyond the official figures to gain a more comprehensive picture of what is really happening with regards to inflation. As we have discussed, by mastering all the different ways to monitor inflation, you will be able to make increasingly informed decisions and opinions.
Which measure of inflation do you like to use? Let us know by commenting below.
