We sometimes think that the honchos at the BLS and other government statistical mills had a previous career selling swampland in Florida. After all, they often want you to believe absolutely preposterous things such as their latest report claiming the battle against inflation has been won—with the Fed’s favorite PCE deflator coming in at a below target 1.65% annualized rate in Q4.
So with the inflation genie allegedly back in the 2.00% bottle, the pot-banging on Wall Street has gotten downright shrill. According to the toddlers in the gambling pits, the Fed should make haste to crank-up its printing presses again, and right soon.
Then again, the wondrous disappearance of inflation reported in the PCE deflator does need some ‘splainin’. That’s because the 1.65% headline gain consisted of some fairly discordant sub-components:
Q4 2023 Annualized PCE Deflator Component Changes:
Durable goods: -3.52%.
Nondurable goods: -1.03%.
Overall PCE deflator: +1.65%.
Sure. An inflation index based on a basket of items is supposed to have components going every-which-way. And, in fact, the actual job of free market prices is to enable demand to shift around in response to relative price changes among available goods and services.
But here’s the thing. The Fed’s only real anti-inflation tool amounts to toggling the money market interest rate (i.e. Fed funds) on the theory that this will cause aggregate demand to ebb or flow. In turn, the latter will presumably levitate the rate of inflation up or down.
In metaphorical terms, the US economy is conceived by our Keynesian central bankers as the equivalent of a giant bathtub. When the latter is full to the brim or overflowing with “aggregate demand”, inflationary pressures intensify until the Fed drains off the excess in what amounts to a Phillips Curve based blood-letting operation.
And, contrariwise, when the water-level is low, the Fed purports to “stimulate” the lethargic business and consumer slugs meandering along the bottom of the tub with a view to restoring full-employment. And it so energizes the slugs without worry about the inflationary consequences of too much money-printing because, well, the Phillips Curve again.
Alas, this is all bunkum, baloney and nonsense. The macroeconomy is driven by billions of prices for discreet units of goods, services, labor, capital, land, technology etc, not by abstract aggregates like household “consumption” or business “investment”.
The Fed’s attempts to manipulate these billowy aggregates, therefore, inherently involves a huge amount of slack and slop in the steering gear. The flows attendant to $27 trillion worth of economic activity in the US bathtub are deflected, channeled and modulated somewhat unpredictably by billions of economic factor prices and transactions; and are also subject to the machinations of other major central banks, which, in turn, are mediated though the global flow of traded goods and services, as well as capital and finance.
More specifically, the problem in terms of short-run inflation rates is that the overwhelming share of durable goods are imported, whereas most services are supplied domestically and reflect largely domestic wages and costs. Accordingly, the Fed’s aggregate demand pumping operations should presumably impact services prices heavily and imported durable goods prices far less, and in some cases (like toys which are 100% imported) hardly at all.
Needless to say, there is no cigar on that front at all. The Fed has allegedly been slamming on the macro-economic brakes since March 2022 when it officially went into an inflation-fighting mode, but since then the PCE deflator for services (red line) is up by a pretty robust +8.7%.
Indeed, after seven quarters of the inflation-bleeding cure, the PCE deflator component most directly in the line of the Fed’s monetary fire has actually accelerated. That’s right. During the seven quarters before the Fed slammed on the brakes in March 2022, the PCE deflator for services was rising at a 4.23% annual rate, but in response to the Fed’s anti – inflation tonic the annualized rate of gain rose to 4.88% during the similar span ending in Q4 2023.
Nor is that the only ooops! When it comes to the PCE deflator component that the Fed’s aggregate demand toggling can reach only obliquely—that for durable goods (blue line) manufactured in China and other low-wage export economies—-the inflation index has gone into violent reversal. That is, after rising at a +7.09% per annum rate in the seven quarters through Q1 2022, it has since reversed into a -0.92% per annum decline.
Or as the man in the big chair at the Eccles Building might have said, “did I do that?”
Alas, he did not!
Furthermore, the PCE deflator for nondurable goods (purple line) ended-up in between, rising at a +3.27% per annum rate during the last seven quarters. This component includes energy, foodstuffs and other commodities that are also largely sourced and priced globally and beyond the Fed’s aggregate demand control footprint, but also were obviously subject to different forces than the apparent deflationary fact0rs impacting the global durable goods market.
In short, we are talking here about in interim period of 21-months that lies directly in the footfall of the Fed’s abrupt pivot to monetary restraint. Yet the
resulting 3.83% annualized rate of gain in the overall PCE deflator (black line with diamonds) during this period was essentially the random math product of—
high domestic services inflation that the Fed failed to materially reduce.
flattered by durable goods deflation originating in foreign export economies where the Fed’s purported aggregate demand curtailment was only a minor factor in the equation.
So the chart below puts the lie to the Fed’s alleged victory over inflation. Most of the improvement in the headline PCE deflator (black line) was due to imported goods, not the purported shrinkage of domestic demand versus domestic supply per the Phillips Curve baloney.
To be sure, the Fed heads would like to claim credit for a mildly dipping PCE deflator owing to falling durable goods prices. But then again, to our knowledge they have not yet established any kind of inflation swap-line with the Peoples Bank of China!
Or with any of the other central banks, such as those of Vietnam, South Korea, Mexico etc. whose economies host the production of the durable goods deflation imported into the United States during recent quarters.
Stated differently, the Fed did not suddenly get either resolute or smart with respect to the pace of inflation after March 2022. It just got lucky!
And yet, that’s not the half of it. Not only are the Fed’s “tools” not fit for purpose when it comes to inflation and the other forces which course through the nation’s $27 trillion GDP, it is dubious as to whether its inflation dashboards are measuring anything more than price noise in the first place.
After all, the PCE deflator chart below is damn hard to explain. The purple line says that the price level for durable goods in the US economy is now 28% lower than it was in Q1 1991!
We are not making this up. The factor that has continuously assured our monetary central planners that inflation is no sweat—-the durable goods component of the PCE deflator—literally defies common experience and common sense. There is not a snowball’s chance in the hot place that durable goods prices are nearly one-third lower today—after years of rampant central bank money printing here and abroad—than they were one-third of a century ago.
PCE Deflator For Durable Goods Versus CPI Index For Durable Goods, 1991 to 2023
And while we are at it, we might note that the ex-Florida swampland salesmen who run the BLS apparently believe there is no limits to the gullibility of their users. The above chart also shows a related sheer impossibility: Namely, that over this 32 year period the CPI for durable goods rose by +8%, while the measuring stick for the same durable goods favored by the Fed money-printers shrank by –28%.
The fact is, neither of these lines could be remotely true. The single largest weight in the durable goods inflation indexes is for new and used cars, which over periods of decades necessarily move in lockstep.
So the well regarded, Mannheim used vehicle index, which reflects honest-to-goodness auction prices for tens of millions of vehicles every year, is about as good as it gets when it comes to measuring vehicle inflation. And it is self-evidently far superior to the massaged, imputed, guesstimated and algebraically-tortured indices published by the BLS.
Yet the chart below says that real world vehicle prices have risen by 102% just since 1998. And that was a span in which the CPI for new vehicles rose by barely 20%!
Can you say hedonics? And yet that’s not the half of it. The vehicle price component of the Fed’s preferred PCE deflator for durable goods implicitly plunged deeply southward— a phenomenon that not one single American auto buyer has experienced over the past three decades.
So two questions recur: 1) should the Fed be printing money based on an allegedly tame PCE deflator? and 2) should the Fed be in the Phillips Curve trade-off and macroeconomic management business at all?
Answers of no and no obviously suffice. And loudly so.
Reprinted with permission from David Stockman’s Contra Corner.
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