Following up on Bernanke’s ‘don’t blame me’ shtick last week, Federal Reserve Bank of Atlanta president Dennis Lockhart had this to say yesterday:
“The Fed, like every other central bank, is powerless to prevent fluctuations in the cost of living and increases of individual prices. We do not produce oil. Nor do we grow food or provide health care. We cannot prevent the next oil shock, or drought, or a strike somewhere —events that cause prices of certain goods to rise and change your cost of living.”
Given that individual prices are grouped together in the consumer price index and that the CPI has been relied upon since World War I to help compute basic ‘cost-of-living’ increases, Mr. Lockhart’s words are a little puzzling. Moreover, and as if to send the reader into a fit, he had this to say during his Q&A session:
“Emerging market central banks have the capacity to deal with inflation in their own economies.”
So, all central banks are powerless when it comes to individual prices but emerging market central banks can readily whip inflation?
Compelled to comprehend exactly what Mr. Lockhart was talking about I managed to make it through his entire speech. Heavily doused in needless jargon while at the same time avoiding common sense, Lockhart’s conclusion, first and foremost, is that inflation must be suitably defined before adopting an idea that suits you:
“Let's review what inflation is and is not. Inflation affects all prices. Inflation is not the rise of individual prices or the rise of categories of prices.”
On the above point Lockhart makes some sense, especially if you forget that it is the addition of individual prices that must be used to compute all prices. Lockhart continues:
“Cost-of-living increases are a result of increases in individual prices relative to other prices and especially relative to income. These relative price movements reflect supply and demand conditions and idiosyncratic influences in the various markets for goods and services. If some component of a household's cost-of-living basket goes up in price, the higher cost of living is not ipso facto inflation.”
Here Lockhart argues that there can be rouge price increases, adding, correctly so, that prices are also relative to income. And while Lockhart acknowledges that these price increases serve to raise a household’s cost-of-living, he denies they fit into his definition of inflation, Finally, Lockhart arrives at what appears to be his point:
“So monetary policy is not about preventing relative price adjustments dictated by market forces. It is about controlling the broad direction and pace of change of all prices across the economy.”
The problem with the above is that Lockhart seems to forget that the Fed attempts to control the broad direction of all prices via the manipulating of market forces. As per Bernanke’s frank statement last week:
“…the way monetary policy always works is through interest rates and asset prices -- that's how it always works -- by changing those prices in financial markets.”
Is it logical to take the position that the Fed controls the broad direction/pace of inflation but if specific price advances do not follow this trend they must be the result of natural market forces? In a word, no.
To be fair, Mr. Lockhart’s contention that the media has overblown the inflationary threat by focusing on individual price increases is valid. There is, save a dollar meltdown, little risk that traditional U.S. inflationary measures are about to rage uncontrollably higher. On this front Mr. Lockhart notes that ‘excluding energy’ producer prices are tame, and that ‘food inflation’ is a ‘narrow expenditure category’ that is being ‘misused’ by people to comment on ‘inflation’. Lockhart also adds that “about 25 percent of the consumer's market basket as measured by the consumer price index (CPI) showed declines in December.”
But where Lockhart errs is in his notion that individual price changes that differ from the rate of inflation are the exception rather than the norm (this assumes that Lockhart also believes an outsized decline in individual prices would not be a sign of widespread deflation). Quite frankly, not only is ‘inflation’ highly subjective from a statistical point of view, but rest assured that whatever inflation rate you care to conjure up, most individual prices will not be adhering to it.
The Fed’s Printing Delusions
Federal Reserve members are openly taking credit for sparking increases in individual asset prices (i.e. stocks) while at the same time contending their policies are not to blame for the broad advance in commodity prices. Given that commodity prices have more closely correlated the increase in equities than the broader inflation rate, Lockhart-logic dictates that equities and commodities are a part of the same asset price ‘category’. In this category sits anything that can be purchased with margin, leverage, or cheap money, and anything that could conceivably be regarded as ‘alternative’ to traditional savings. In the asset price category also rests an inflationary monster that has not been seen in decades…
Unlike previous asset-bubble-builds, today’s commodity price increases are arriving before the U.S. encounters any capacity concerns. As Fed printing continues ‘forcing investors into alternative assets’ and/or emerging markets outperform on a relative basis, this situation could prove exceptionally dangerous. To be sure, there may come a point when commodity price increases trickle down more broadly into U.S. prices and/or serve to nullify any stock market wealth effect. Under such an ominous scenario it is uncertain how the Fed would paint its money printing activities in a positive light.
Until then, expect the Fed to continue to justify money printing as the only action that can raise stock prices, stabilize home prices, and, hopefully, help create jobs. As for the idea that money printing is fueling the increase in food and commodity prices, please do blame China or, like Lockhart, ignore these increases completely. And remember, despite what the rest of the world thinks, the U.S. monetary unit is not headed to collapse. Rather, the U.S. remains in relatively good shape because the controlled devaluation of the dollar will translate into manageable cost-of-living increases.
“The Fed’s easy-money policies have helped to create inflation in commodities, foodstuffs and stocks. But given the high level of U.S. unemployment, incomes are unlikely to keep up with rising prices, so Americans will be forced to draw down personal savings to maintain their living standards.” Rosenberg