Core CPI: Blips or Trends

Here’s a plot of three measures of core m/m inflation. I don’t see hyper (or even high ) inflation on the horizon, as some do [0] [1]. Since one observation doesn’t make a trend, for good measure I include also 3 month inflation.

Figure 1: Month on month annualized inflation in Core CPI (blue), Chained Core CPI, seasonally adjusted (red), and Core personal consumption expenditure deflator (green). Chained Core CPI not-seasonally-adjusted series seasonally adjusted (on log values) using EViews X-12 routine (additive) over 1999M12-2011M04 period. NBER defined recession dates shaded gray. Source: BLS and BEA via FREDII, BLS, NBER and author’s calculations.

Figure 2: Three month annualized inflation in Core CPI (blue), Chained Core CPI, seasonally adjusted (red), and Core personal consumption expenditure deflator (green). Chained Core CPI not-seasonally-adjusted series seasonally adjusted (on log values) using EViews X-12 routine (additive) over 1999M12-2011M04 period. NBER defined recession dates shaded gray. Source: BLS and BEA via FREDII, BLS, NBER and author’s calculations.

I’ve included Core PCE as well as the BLS Chained Core CPI. It’s of interest that on the 3 month basis, both of these measures are below the official core CPI. As I’ve discussed before, the official CPI is a base-year (Laspeyres) index at the components level, so it tends to overstate the true price level [2]. The chain weighted series obviates this problem, as it approximates the Fisher price ideal index [3] (since the BLS chained series is not seasonally adjusted, I adjusted the log series using X-12; hence the graphed series is not the official series). Finally, the PCE is a chained series, but with different coverage (as discussed in [3]).

Daniel Thornton at St. Louis Fed has an interesting article where he investigates the rationale for focusing on the core measures. He observes that at the three year horizon, the forecasting performance of core is superior to lagged headline, but not statistically significantly so (at least after the mid-1980s).

I haven’t undertaken a formal analysis myself, but I do find that core CPI is weakly exogenous with respect of headline CPI, using a bivariate error correction model estimated over the 1985M01-2011M04 period:

(1) Δ p_t = γ₀ + ρ(p_t-1 – core_p_t-1) + γ₁ Δ p_t-1 + γ₂ Δ p_t-2 + γ₃ Δ p_t-3 γ₄ Δ core_p_t-1 + γ₅ Δ core_p_t-2 + γ₆ Δ core_p_t-3 + u_1t

(2) Δ core_p_t = θ₀ + φ(p_t-1 – core_p_t-1) + θ₁ Δ p_t-1 + θ₂ Δ p_t-2 + θ₃ Δ p_t-3 + θ₄ Δ core_p_t-1 + θ₅ Δ core_p_t-2 + θ₆ Δ core_p_t-3 + u_2t

Where p is log CPI, and core_p is log core CPI, and Δ is the first difference operator. This specification imposes long run cointegration between core and headline with unitary elasticity.

The adjusted-R² from equation (1) is 0.22, and the estimate of ρ is -0.01 (p-value of 0.19). This coefficient estimate is consistent with headline responding to a statistical disequilibrium; it’s hard to calculate a half-life of a deviation given the short run dynamics. Ignoring those dynamics, the half life would be 5-3/4 years. In contrast, the adjusted-R² from equation (1) is 0.36, and the estimate of φ is -0.002 (p-value of 0.62).

This finding is consistent with interpreting core as the object of interest; given the lack of statistical significance at conventional levels, it’s also consistent with finding the superior performance of core being statistically insignificant.

Market- and Survey-based Indicators of Expected Inflation

Even as headline and core measures rise (at least in the former case), the Treasury-TIPS spreads have fallen in the past half month.

Figure 3: Spread between ten year Treasurys and TIPS (dark blue), and five year (dark red), monthly averages of daily data. May observation for 5/16. Source: St. Louis Fed FREDII, author’s calculations.

It’s useful to remember what this graph implies: as of 5/16, over the ten year horizon, headline CPI is expected to average a little over 2.3%; over the next five years, it’s expected to average a bit over 2.1%.

The Cleveland Fed has come out with its latest estimates (May 13) based upon inflation swaps, market data and survey data:

The Federal Reserve Bank of Cleveland reports that its latest estimate of 10-year expected inflation is 1.86 percent. In other words, the public currently expects the inflation rate to be less than 2 percent on average over the next decade.

The Cleveland Fed’s estimate of inflation expectations is based on a model that combines information from a number of sources to address the shortcomings of other, commonly used measures, such as the “break-even” rate derived from Treasury inflation protected securities (TIPS) or survey-based estimates. The Cleveland Fed model can produce estimates for many time horizons, and it isolates not only inflation expectations, but several other interesting variables, such as the real interest rate and the inflation risk premium. …

The estimates are presented in this graph:

Figure from Cleveland Fed (May 13, 2011), accessed May 19, 2011.

Concluding Thought

My answer to the question posed in the title: No.

Additional thoughts, regarding money base and inflation here. Money stock and inflation here. Jim’s views here and here.

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Car trouble is so often the worst kind of trouble.

Few things can rip a hole in your budget so rapidly and so thoroughly. A new transmission (~$2,500) or rack and pinion (~$1,000) can wipe out a rainy day fund in one cruel clank or clunk. And it’s these types of unexpected problems that make mechanical breakdown insurance so tantalizing. (See also: 4 Tips to Save on Car Insurance)

The question, as with most forms of insurance — is the gamble worth it?

What Is Mechanical Breakdown Insurance?

Mechanical breakdown insurance (MBI) can insulate consumers against big-ticket car repair costs. This is not an extended warranty or anything of the sort. Instead, this is a typically inexpensive form of insurance that is subject to the same regulatory controls as other insurance products.

These policies don’t cover defects or issues that arise from standard maintenance issues, but they can be a financial lifeline if catastrophe strikes. Consumers tend to pay reasonable premiums (anywhere from $75 and up) and have deductibles ranging from $50 to $500 or more, depending on the details of the plan and the age of the automobile. Insurers favor consumers with newer vehicles or leased models. Those with older cars might be unable to procure MBI.

Some plans also cover things like towing, car rental, and trip interruption. Terms can range from a year to more than a half dozen, or span tens of thousands of miles. Some policies are even transferable, which car owners can use as a selling point when the time comes to unload their vehicles.

“We all have cars, and we all know they end up breaking down,” said Hank Coleman, managing editor at InsuranceQuotes.org. “Insurance is always a hedge against future problems, and MBI can be a really savvy investment depending on your car and your coverage options. There’s few policies that can match the universal need that MBI is setup to cover.”

How Does It Work?

While MBI has some built-in safeguards as a legitimate insurance product, consumers should still take great pains to ensure they’re getting a policy that meets their unique needs and covers theirs concerns.

Consumers should be able to take their ailing auto to a repair shop of their choice. Avoid policies that try to limit, qualify, or otherwise restrict decisions related to who completes repair work. There should also be clear language explaining that your deductible payments are for visits to the repair shop and not required for every single repair.

Remember, too, that this is breakdown insurance. Car equipment that becomes defective because of normal wear and tear over time isn’t covered. Unless you have a warranty or extended service agreement, things like brake pads, shocks, and other parts will require out-of-pocket outlays.

And what about warranties? Newer automobiles may come with a manufacturer warranty or service agreement that all but eliminates the need for MBI. It’s important to evaluate a potential policy in light of existing warranties and their expirations.

Why Get Mechanical Breakdown Insurance?

For some consumers, it might make more sense to simply tuck away a few extra dollars each month in an auto emergency fund. Those who like having an added layer of protection can shop around for MBI. As an added bonus, those who purchase it when their car is new tend to enjoy lower rates as the years go on.

In the end, though, it’s typically one of those peace-of-mind purchases.

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All eyes in official Washington are on the debt ceiling, that self-imposed borrowing limit that was technically reached on Monday. By temporarily halting federal retirement-fund investments, the day of reckoning — that is, absent an increase in the limit, the day the federal government would have to decide whether to default on its debt or sharply slash Social Security, Medicare, and/or defense spending — can be pushed to August. What happens then, and just how likely the dire scenario is, depends on your choice of politicos and pundits. Suffice to say it might well be ugly.

The noise over the subject in Washington contrasts sharply with the a near silence on the matter in the formal disclosures of the country’s biggest companies. Publicly traded companies are supposed to disclose their litany of potential woes — their Risk Factors — each year in their 10-K filings, and update them at least quarterly, as changed circumstances warrant. But so far, we’ve noticed just two companies sounding the alarm.

MetLife is circumspect about its concerns, which it disclosed in the 10-Q it filed on May 10 by working them into a longer, existing risk factor warning that “Difficult Conditions in the Global Capital Markets and the Economy Generally May Materially Adversely Affect Our Business…” After noting that market and economic volatility can affect both the company’s investment portfolio and its claims payable, and pointing to concerns over European sovereign debt, the company continues:

“In the event political discord in the U.S. prevents agreement on a national debt ceiling or budget, the U.S. could default on obligations, which would further exacerbate concerns over sovereign debt of other countries.”

Then it goes on to warn about the Japanese economy in the wake of the earthquake, tsunami and nuclear crisis there, and the potential consequences of these various situations generally.

KKR is more specific in the 10-Q it filed on May 5, disclosing a new risk factor dedicated to the debt ceiling, titled “A failure or the perceived risk of a failure to raise the statutory debt limit of the United States could have a material adverse effect on our business, financial condition and results of operations.”  KKR continues that failing to raise the debt limit

“would increase the risk of default by the United States on its obligations, as well as the risk of other economic dislocations. Such a failure or the perceived risk of such a failure consequently could have a material adverse effect on the financial markets and economic conditions in the United States and throughout the world. It could also limit our ability and the ability of our funds and portfolio companies to obtain financing, and it could have a material adverse effect on the valuation of our portfolio companies and other assets held by our funds. Under such circumstances, the risks we face and any resulting adverse effects on our business, financial condition and results of operations would be significantly exacerbated…”

It’s a little curious that so few big companies seem to be concerned. While unique in their own way, both KKR and MetLife are squarely in the mainstream of the financial-services sector; presumably, anything affecting them would affect competitors. Nor is it like this is a new development that was off the radar screen until very recently, meaning some companies might just have filed before it became a big enough deal: The debt-ceiling debate has been heating up for weeks.

Of course, risk-factor disclosures are a curious beast: While they sometimes seem to include the kitchen sink, they don’t have to encompass risks that managers consider so remote as to be irrelevant. (We note, for example, that not a single company appears to have warned about much-publicized predictions by some religious groups that the world will end on Saturday. Though that might make for a pretty interesting going-concern clause.) So maybe everyone else thinks the threat is remote, and KKR and MetLife are the Chicken Littles of the stock market.

Then again, whatever the odds of an actual default by the U.S., at least a couple big companies with seemingly smart management are sounding alarms. What do the other corporations know that KKR and MetLife don’t? Or are other companies simply oblivious to the danger that lurks in the federal budget follies?

Image source: Architect of the Capitol

Designed for investors who want to dig into the details, but don’t have the time.

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Informed researchers are asking what happens to China based on the recent demographic shift from rural labour surplus to rural labour deficit. The answer may be slower growth and higher inflation, according to a paper released last month by China’s Center for Economic Research at Peking University. But other impacts may also be increased consumption and a deteriorating external balance.

The paper by Huang Yiping and Jiang Tingsong is a very technical and dense work based on macroeconomic modelling. But the results are clear: If China’s rural labour surplus evaporates (as seems to already have occurred), we are going to see savings drop and productivity collapse.

The paper is based on the work of Sir Arthur Lewis, an economist from St. Lucia.

What Lewis found is that industrial wages rise very quickly when the supply of excess rural labour is exhausted. This is called the Lewis Turning Point and is where China is right now.

This will have major implications for the Chinese domestic economy and the world economy. The first implication is inflation. Without the endless stream of excess rural labour, wages are going to go way up in China and this means inflation will be a problem.

Shortage of Labor? Now?

The situation Harrison describes is based on the document What Does the Lewis Turning Point Mean for China?

The thesis is interesting, but how probable is a labor shortage in China, and in what timeframe? I certainly see no reason to be concerned over a “Lewis Turning Point ” now or for that matter any time soon.

However, inflation can certainly happen for other reasons such as rampant credit growth and malinvestment in infrastructure. That said, the Chinese property bubble is likely to pop at any time, and with it China’s credit bubble.

Certainly China is overheating now, struggling to find useful work for its citizens. Malinvestment abounds because of it.

Michael Pettis Chimes In

Wanting another opinion, I pinged Michael Pettis at China Financial Markets about the Labor Shortage theory and Pettis responded …

I think there are many reasons to be concerned about the rapid decline in the Chinese working population over the next decade or two, but I wonder if the Lewisian turning point is one of them.

As I understand it, Lewis’ work was based on countries with very different demographic structures — much younger, rising population as well as rising work population, and “normal” age distributions (i.e. more younger people than older for nearly every age group).

None of this applies to china. This doesn’t mean that china might not see soaring wages per worker, and with it inflation, but it does suggest that we should be very skeptical about applying the Lewisian concept to china.

I always worry when economists apply highly technical econometric models to cases that are structurally very different than the cases on which the model was built. It may make for some great research credits, but it also makes for pretty random predictions.

Michael

Thanks for responding Michael!

Rebalancing Through Wage Increases

Also consider a recent post of Michael Pettis Rebalancing through wage increases

I worry about the reasons for rising wages – I suspect that demand for workers is driven primarily by unsustainable and unhealthy increases in the past two years in real estate and infrastructure development, and so is itself unsustainable.

There is one thing we can say with a little more assurance. If wages are rising and interest rates are declining, then there should be transfers of wealth within the economy. Specifically, wealth is being transferred from corporates to households in the form of higher wages, and is also being transferred from households to corporates in the form of lower interest rates. This means that labor-intensive industries are bearing more than the full cost of the adjustment and capital-intensive industries are bearing a negative cost.

If this is the case, we should expect to see a shift in China from labor-intensive growth to capital-intensive growth as the former get squeezed out and the latter profit. Unfortunately that is exactly what seems to be happening.

China isn’t yet rebalancing. The way that its growth model works suggests that it cannot happen except with a sharp contraction in investment growth, something we are not seeing, and the empirical evidence so far seems to support the theory. It will probably take a couple of years of this kind of unbalanced growth before this point is more widely recognized, but I suspect that another year or two of stagnant consumption as a share of GDP is finally going to convince policymakers. Until then, expect more of the same, and with it rapidly rising debt levels.

Interesting Questions and Replies to the Article

“RS” had three questions for Pettis.

1. Do you expect wage ‘give-back’ in China in the future if indeed home prices fall and input prices go down?
2. Do you feel that there is beginning to be growing acceptance among the mainstream economists and financiers/investors that China does have a “growth problem” and either growth must slow or the bubble must pop?
3. Do you think that the commodity markets a signalling anything about Chinese/world growth in the near future?

Pettis Replied …

1)Yes, but not yet. It will take a decline in investment growth to reduce labor demand.

2)Yes, an increasing if still-minority number of economists now recognize that the growth model is unsustainable, although I am not sure all of them fully understand why it is unsustainable and the role of rising debt. For that reason, I think they misunderstand the nature and difficulty of the adjustment process. I suspect that after another year or two in which consumption growth continues to remain below GDP growth, there will be much greater awareness of how intractable the problems are.

3)This is hard to say, but a Chinese copper trader told me that the recent decline in copper prices was caused at least in part by the decision by the Peoples Bank of China to go after the copper financing schemes.

Lewisian Model Incorrect or Premature

Even if the Lewisian model was reasonable, China’s structural problems are currently so great, its infrastructure building so excessive, and its property and credit bubbles so massive, that rather than running out of workers, China’s next concern will be how to rebalance and keep its population employed in the slowdown on the near-term horizon.

Global Economy Cooling

The entire global economy is cooling as noted in Huge Cracks in Global Recovery Thesis; Industrial Production Unexpectedly Drops in Germany, France; UK Weaker than Expected

China and the US will slow too. I believe a recession is highly likely, yet few see it.

Pettis has been calling for a Chinese slowdown as well. For details, please see China’s Real-Estate Developers Struggle with Debt; Servicing China’s Total Debt Load is Problematic; Dramatic Slowdown in China Coming

Scapegoating China

However, one reference in Harrison’s article caught my eye that I completely agree with. Please consider Roach: GD II awaits if China bashing rhetoric turns into protectionism.

Stephen Roach is pulling no punches now. After quipping “I think we should take the baseball bat out on Paul Krugman” regarding pro-protectionist statements Krugman made earlier this month, Roach has launched a blistering attack on the protectionist rhetoric in America.

In an opinion piece released today in the Financial Times, Roach blamed America’s problems on a deficit of savings and warned “scapegoating of China could take the world to the brink… [of a crisis which] would make the crisis of 2008-09 look like child’s play.”

Of course, Roach is entirely correct. The United States has been living beyond its means for a generation, running up enormous private sector debts and running large current account deficits as investment outstripped savings. America’s problem is America, not China.

As Roach points out, the US has a multilateral problem as it is in deficit with 90 countries around the world.

As for protectionism, Michael Pettis makes very good points when dissecting a recent US-China Business Council report. They validate Roach’s view that tariffs would just shift the US deficit to other producers. Pettis says:

The failure to recognize that adjustments are more likely to occur via shifts in multilateral trade than shifts in bilateral trade is, I think, the basic problem.

The tariffs or exchange rate change do not necessarily change anything about the US’s own aggregate trade imbalance except that the protectionism transfers wealth from domestic consumers to protected producers and decreases consumption demand. This is one reason why protectionism doesn’t work.

But the most important reason that protectionism is poison is retaliation. Tariffs, export quotas, subsidies, competitive currency devaluations via quantitative easing and low interest rates and the like all serve to erode the collective sense of mutual dependence. It ends in the kind of spectacle we witnessed in the 1930s with protectionism as a major contributor to economic and social upheaval which ended in a long depression and world war.

On that score I agree with Roach, Pettis, and Harrison. Tariffs, protectionism, and QE I through QE X will not solve a thing.

Nor will all the denials in Europe (Please see Trichet Goes Ballistic, Walks Out of Meeting Over the Term “Soft Restructuring”; Infighting Over Who Replaces IMF Chief; Some Suggest Trichet)

However, Roach’s suggestion of taking a baseball bat to Krugman certainly has merit.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
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Mike “Mish” Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.
Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

View full post on Mish’s Global Economic Trend Analysis

Whether you’re collecting credit card rewards or frequent flier miles, you probably already know that loyalty programs can lead to compulsive buying behavior.

Question is, should you participate – or shouldn’t you?

Full disclosure: I spend a lot of time covering travel-related issues, and for years, I have been a lone voice in the wilderness warning people against diving headfirst into frequent flier and frequent-stayer programs.

Why? Because at the end of the day, they’re better for the company than they are for you. They also force you to engage in what can amount to destructive purchasing behavior, in a pointless effort to gain coveted elite status.

But instead of treating you to a rant about loyalty programs, I thought I’d ask the experts what you should know before jumping into the loyalty game. Here’s what they told me.

Do the math.

Loyalty program expert Bill Hanifin says you have to run the numbers to make sure membership is right for you. Pay close attention to the rate at which you can earn value in the program, earning velocity and the attractiveness of the rewards.

Make sure it’s the right company for you.

That’s an important, and often overlooked consideration in an era of dominant businesses. “Even if you are earning points, if you don’t like the products or services the company offers, you will eventually switch and take your loyalty elsewhere,” says Shep Hyken, author of the book, The Amazement Revolution. “That means you may lose what you have accumulated.” Better to find a company you like and do business with it, and consider the rewards a byproduct of that loyalty.

Don’t let it control you.

This merits repeating: “Don’t spend at levels you can’t afford,” says Daniel Olson, a managing director for Wunderman, an advertising agency that manages several high-profile loyalty programs.  “Don’t buying things you don’t need simply for the points.”

Make sure the program is listening to you.

A good loyalty program engages its members, says Mark Johnson, President of Loyalty 360, a loyalty marketing association. “I think consumers want and need to have programs that encourage participation and create engagement that leads to loyalty,” he says. “You have to find programs that you want to engage with as much as the brand wants to engage with you.”

Don’t do it if it complicates your life.

Tom Burgess, the CEO of the loyalty program developer Clovr Media, says you should look for simplicity in a program. “For example, adding another credit card or loyalty card to your already full wallet, or adding another step to your transaction or purchase, adds complexity,” he says. “Join the loyalty programs that have a clear focus on making your life easier, while still empowering you to develop a mutually beneficial relationship with your chosen company or brand.”

Read the privacy policy.

That’s the advice of Neil Raphel, author of The Complete Idiot’s Guide to Loyalty Marketing. “You don’t want to be bombarded by third-party advertising,” he says. Trust is important, and the privacy policy is the first indication of whether a company can be trusted. If it isn’t a long-term relationship based on mutual respect, “the point accumulations may become worthless.”

If you’re an infrequent customer, just say no.

A lot of businesses will pressure you to become part of their loyalty program on your first purchase by offering a discount. It’s a terrible idea, says Michael Zipursky, co-founder of Vancouver-based Business Consulting Buzz. “It probably isn’t in your best interest,” he adds.

Remember, loyalty can be a one-way street. “Just because it’s called a loyalty program doesn’t mean that the company is loyal to you,” says Leslie Kossoff, founder of The Kossoff Group, which advises executives and entrepreneurs. “They want you to be loyal to them so that they make money. It doesn’t work both ways.”

Personally, I’m still not keen on most loyalty programs, even with these expert warnings. A hard look at most of them will reveal they’re intended to turn you into a compulsive customer who is blindly loyal to a company and its products.

And while that may be great for the company, it isn’t necessarily the best thing for you.

Christopher Elliott is a consumer advocate who blogs about getting better customer service at On Your Side. Connect with him on Twitter and Facebook or send him your questions at On Your Side or by email.

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The world is headed for an economic slowdown, according to the Economic Cycle Research Institute’s (ECRI) Long Leading Index of global industrial growth.

“It is not country specific, but imagine if you could add up all the activity in factories around the world and see if it was accelerating or decelerating, that is what this indicator is focused on,” says Lakshman Achuthan founder and managing director of the research center. “And it has been telling us very clearly, unambiguously, that we have a peak in global industrial growth this summer.”

I commend Achuthan for a good interview and for insisting last year that a double-dip recession was not in the cards.

Many of you know that I got into a spat with the ECRI a while back. The issue was not that on the merits of the ECRI’s indicators, but rather their claim the indicators never missed a recession call and never predicted a false recession.

Inquiring minds may wish to consider ECRI’s Lakshman Achuthan Still Blowing Smoke

However, the ECRI and I now see things alike.

On Monday May 16 I wrote Huge Cracks in Global Recovery Thesis; Industrial Production Unexpectedly Drops in Germany, France; UK Weaker than Expected.

That is consistent with what Achuthan said to Aaron Task yesterday in that Tech Ticker interview.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
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Mike “Mish” Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.
Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

View full post on Mish’s Global Economic Trend Analysis