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Posted: January 26, 2009

Since ‘54

Smallest rise in inflation in over half century

Jeff Thredgold

The enormous decline in consumer inflation pressures of the past six months continued unabated in December. The Consumer Price Index fell another 0.7 percent during the month, the third major decline in a row. November's larger 1.7 percent decline in consumer prices was the largest since monthly recordkeeping began in 1947.

The upward spike in energy and other commodity prices during 2007 and through July 2008 pushed inflation to painful levels. The CPI rose 4.1 percent during 2007, the largest annual rise in 16 years. As recently as six months ago, the year-over-year rise in consumer prices was approaching 6 percent.

As it turned out, the CPI rose just 0.1 percent during 2008, the smallest rise since 1954, a period of (you guessed it) 54 years. The CPI actually contracted at a 12.7 percent annual rate during 2008's final three months. Most forecasters see the CPI rising between 1 percent and 2 percent during 2009.

Inflation expectations during the next few years are all over the map. Some economists see the impact of massive U.S. Treasury spending and unprecedented monetary stimulus from the Federal Reserve leading to much higher levels of inflation in coming years.
Other forecasters see deflation being the more likely scenario, tied to ongoing home price deflation, declining raw land prices, declining commercial real estate values, soft commodity prices, weak wage gains, and ongoing poor U.S. and global economic performance.

CPI details
As noted, the plunge in energy costs led the way last year. Overall energy costs were down 21.3 percent during 2008, the largest decline since such recordkeeping began in 1958. Prices at the pump fell 43 percent last year, the largest decline since 1937.

Many other prices were soft as well. Average new car prices declined 3.2 percent last year, the largest drop since 1971. Food and beverage costs rose 5.8 percent last year, while apparel prices fell 1 percent. Medical care costs rose 2.6 percent.

The "core" CPI, which excludes volatile food and energy prices, was unchanged during December, matching November's result. Core prices rose 1.8 percent during 2008, the smallest rise since 2003.

Wholesale prices
Of concern was the actual 0.9 percent decline in the Producer Price Index (a measure of wholesale prices) during 2008. Such prices declined at a 24.3 percent annual rate during 2008's fourth quarter. The decline followed a worrisome 6.2 percent rise in such prices during 2007.

What the Fed wants
It might seem that the Fed would want consumer inflation, as well as broader inflationary measures, as close to zero as possible. Such is not necessarily the case.

The Fed's desired inflation target is typically around 1.5 percent to 2 percent. Such minimal levels of inflation allow for the needs of a rising population and allow modest price increases, and subsequent wage gains, to occur. As noted in recent days by Federal
Reserve Bank of San Francisco President Janet Yellen, it is "not acceptable" for policymakers to allow inflation to fall "to levels that are unhealthy." (Bloomberg.com)

What the Fed fears
Aggressive monetary stimulus from the Fed will continue under the new Administration. Fed Chair Bernanke is fearful that deflationary forces could become more pronounced this year and next. History tells us that dealing with inflation is a problem for consumers and businesses. However, dealing with deflation is worse -- just ask the Japanese.

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Drop trade
A major surprise announced last week - one containing both good news and bad news - was the sharp decline in the nation's monthly trade imbalance with the rest of the global community. November's trade deficit (the net difference between what goods and services
Americans buy from the world as compared to the goods and services we sell to the world) declined sharply to $40.4 billion, versus $56.7 billion in October. The latest deficit, down 29 percent from the prior month, was the smallest in five years.

During November, U.S exports of goods and services to the world declined by $8.7 billion (5.7 percent) to $142.8 billion, an ominous sign of a weak global economy. U.S. imports of goods and services fell by $25.0 billion, roughly 12 percent, to $183.2 billion, a sign of much lower oil costs and a weak U.S. economy.

The major contributor to the declining U.S. trade imbalance was the 27 percent decline in the average imported oil price to $66.72 per barrel. Current prices around $35-$45 suggest our oil import bill as reflected in upcoming monthly trade reports will continue to decline.

Not so bad
One positive aspect of the smaller trade deficit is that the U.S. Commerce Department's first official estimate of fourth quarter U.S. economic weakness may not be as bad as feared. The estimate, to be released on January 30, may be closer to a 4 percent to 5 percent real (inflation adjusted) annual rate of decline rather than some forecasts of GDP declining at a 6 percent or worse real annual rate. Most forecasters still expect the recession's worst quarter to be the one just ended.

Net imports from China fell sharply to $23.1 billion in November, versus $28.0 billion the prior month. This decline will temporarily reduce pressure on the new Obama Administration to pressure the Chinese to boost the value of their currency.

The smaller November trade imbalance will also lessen pressure on the new Administration to engage other nations in extensive trade discussions. For the moment, the U.S. and all other major nations have bigger fish to fry, i.e. economic and financial stabilization

So blue
Economists argue until blue in the face about the implications of large U.S. trade imbalances with the rest of the world. Critics of such imbalances note that as we obtain goods from the world we pay for them with dollars, which many other countries then send back to the U.S. to buy stocks, bonds, real estate, etc. These critics suggest that as Americans, we buy more foreign-made cars and TVs, assets that lose value over time. Other nations, on the other hand, obtain greater ownership of more critical U.S. assets.

The only thing that a room full of economists (heaven help us) will largely agree on is that promoting barriers against trade between nations is bad policy. Building bridges to trade is good policy. We will disagree on everything else.

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The Tea Leaf is a weekly economic and financial update by Jeff Thredgold, economist for Vectra Bank Colorado. He has been writing an economic update every week for the past 31 years and is the only economist in the world to have received the designation of CSP, or Certified Speaking Professional. Republished with permission from the Tea Leaf by Jeff Thredgold, whose site address is www.thredgold.com/html/leaf.html.
Enjoy this article? Sign up to get ColoradoBiz Exclusives. The opinions expressed in this article are solely that of the author and do not represent ColoradoBiz magazine. Comments on articles will be removed if they include personal attacks.

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