By John L. Chapman, Ph.D.                                                                                                                                             Washington, D.C.                                                                                                                                                                      December 14, 2011

The U.S. Department of Labor’s Bureau of Labor Statistics announced  the November installment of its “U.S. IMPORT AND EXPORT PRICE INDEX” series today.  Overall, import prices were up +0.7% last month, below consensus estimates of +1.0%, and year-over-year through November, they are up 9.9% (though having moderated substantially in the last six months).  Export prices advanced +0.1% in November after a -2.1% drop in October.

General summary of the data:

The Labor Department summarized the new data on imports as follows:

Overall:  Import prices were up following declines of 0.5 percent, 0.1 percent, and 0.4 percent the three previous months. The November advance is the largest monthly increase since a 2.6 percent rise in April.

Fuel Imports: A 3.6 percent rise in import fuel prices drove the November increase in overall import prices. The November increase followed declines in five of the six previous months. Fuel prices rose 31.6 percent over the past 12 months despite declining 7.2 percent between April and October. Both petroleum and natural gas prices, up 3.6 percent and 5.3 percent respectively in November, contributed to the increase in overall fuel prices. Petroleum prices increased 33.4 percent over the past year, while natural gas prices advanced 5.8 percent for the same period.

All Imports Excluding Fuel: The price index for non-fuel imports declined 0.2 percent for the second consecutive month, the first monthly decreases since a 0.3 percent drop in July 2010. The November decrease was led by lower prices for non-fuel industrial supplies and materials imports as well as for imported foods, feeds, and beverages. In contrast, prices for each of the major finished goods categories edged up in November. Despite the recent declines, non-fuel prices advanced 3.8 percent for the year ended in November, led by an 8.1 percent increase in non-fuel industrial supplies and materials prices.

Export prices continue to behave much more steadily, with less variability and magnitude of change than the fuel-dominated import prices:

  • Overall export prices rose +4.7% for the November 2010-11 period, the smallest year-over-year advance since a +4.1% increase between August 2009 and August 2010.
  • Agricultural exports were strong and their pricing was up: agricultural prices increased +1.5% in November (albeit after declining -6.5% in October).  An upturn in corn and soybeans prices which rose +9.0% and +4.7%, respectively, primarily drove the November advance. The price index for agricultural exports increased +5.3% year-on-year.
  • For all exports ex-agriculture, prices decreased -0.1% in November after a -1.5% decrease in October.  Falling prices for both industrial supplies and materials and consumer goods contributed to the November decline. Ex-agricultural export prices increased +4.8% over the past year, led by a +10.2% increase in non-agricultural industrial supplies and materials.

Our friend Steve Hansen of Global Economic Intersection captured the year-on-year magnitudes in the St. Louis Fed graph of import and export price indexes:

 Chart I.  Import and Export Prices (All Commodities) from January 2008 to Present, 2000 = 100

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The Import Price Index stood at 142 on November 30 (2000 = 100), re-approaching its all time high of 148.4 in June of 2008.  And while the 9.9% year-on-year increase is steep, it should be kept in mind that it was dominated by an increase of over 30% in petroleum product prices.  Further, there has been a slight decline in the last seven months due, we think, to a relative dollar firming.

To put the import price changes in historical context, it is useful to look at the index going back to 1988:

 Chart II.  Import Prices (Log Scale, All Commodities) from January 1908 to Present, 2000 = 100

The reason this graph is of interest is that it depicts, in almost perfect inverse fashion, dollar strength on a trade-weighted basis. We prefer logarithmic scales for this kind of analytical review because it shows the amount of time it takes to reflect equiproportional changes in the statistic (in this case, of 10.6%).  Note that it took more than 16 years, from 1988 to mid 2004, to confirm a 10.6% nominal price increase for imports without reversion.  But then it took just 18 months to go another 10.6% higher, and less than two years to rise the same amount again. And then just months later for another 10.6% jump, albeit the latter increases due to the incredible run-up to $148 oil in the summer of 2008.

This more than anything else is a damning indictment of a Fed policy that was way too loose beginning in the fall of 2001; even though the domestic price level was not rising much in the 2000s, and instead asset bubbles were being inflated, import inputs and capital goods prices were rising in bubble-like fashion (compared to the domestic price level) because of dollar recycling from abroad.  Indeed Alan Greenspan has shamelessly defended his policies after 2000 by decrying the “global savings glut” that he claims flooded the United States with new investment and thus pushed interest rates to world-record lows for an extended period (2002-2007).  But if that were true, savings rate increases would indeed have brought down interest rates but also real import prices, because a savings glut that formed into capital investment in this country would have led to a stronger dollar buying more (mainly consumer goods) imports at lower prices thanks to the new strong dollar (note the long stretch after 1988 of tame import prices thanks to a stronger dollar).  Of course this graph shows the dollar was weakening dramatically after September 11, 2001, in spite of global growth of demand for dollars as the international safe haven.

Note finally, however, the curve turning downward again at its end, in the last seven months.  The question is, will this trend, which signifies a stronger dollar, last?  See below on the Federal Reserve.

Trends of importance in the import/export pricing data

  • The six-months’ consecutive swoon in fuel import prices was broken in November, with an increase of +3.6%.  This decline, while good for the consumer after strong increases in gasoline prices earlier in the year, was something of a mild concern to some, since oil has hovered in the $95-100 range for several months, and weakening import prices could be indicative of slackening global demand.  We say “could be” because we have no knowledge of OPEC or North Sea or South Asian production increases, but also know of no let-up in domestic U.S. consumer demand that would evince a price cut.  This will bear watching, as will forthcoming PPI and CPI numbers out later this week and consumer spending data out in the next two.  Our view is this is less about slackening global demand (though we concede that is happening in both the Eurozone and China at the moment), and everything to do with a dollar firming in international trade: ergo, with the dollar, one can now buy more with less.
  • Non-fuel industrial supplies and materials import prices fell -1.8% in November after a -1.4% decline in October.  Both decreases were driven by falling unfinished metals prices, which fell -5.0% in November after dropping -4.1% in October.  Despite those recent drops, prices for unfinished metals rose +5.7% for the November 2010-11 period.
  • Major finished goods categories recorded increases in November. The price indexes for consumer goods and capital goods each ticked up +0.1% for the month. Automotive vehicle prices rose +0.2% in November driven by a +0.3% advance in parts, engines, bodies, and chassis.
  • Food, feeds, and beverages prices edged down -0.1% in November, following a -0.7% decrease in October.  The November drop was led in part by falling prices for fish and shellfish.
  • The price index for imports from China increased +0.3% in November after rising +0.4% the previous month. Import prices from China advanced +3.9% year-on-year.
  • Import prices from Canada also rose in November, up +0.3% following declines in each of the previous three months.
  • Prices on imports from the European Union, Mexico, and Japan all ticked up barely in November.
  • Import air passenger fares decreased -0.7% in November following a +1.9% increase for October. The November decline was driven by a -3.5% drop in European fares which more than offset a +2.5% advance in Asian fares. Import air freight prices declined -1.7% in November after a -2.3% drop the previous month.

The Fed meeting this week

The Federal Reserve’s Open Market Committee met for the final time of 2011 on Tuesday, and as expected, there were literally no changes to current policy:

  • Interest rate targets for fed funds remain at zero to 25 basis points, and this will remain in place until mid-summer 2013 at least.
  • The balance sheet will remain unchanged, and Operation Twist will continue in an effort to hold down long rates
  • No changes to its current policy of paying interest on excess reserves.
  • No third round of quantitative easing was endorsed, though Chicago Fed President Evans wants QE3.
  • The Fed acknowledged growth was still very anemic, and unemployment “elevated”, though inflation expectations are contained.  Some Fed watchers will read the language of this month’s press release (post-meeting summary) and no doubt claim it is “less harsh” in its tone than November 1-2; that is true to the extent that the last two reports have been unusual in their dour outlook, which we noted at the time.  The Fed is back this week to its usual degree of sullenness.
  • No mention was made of selling off the mortgage backed securities the Fed holds now — more than $1 trillion worth.  There is of course high risk of loss on this sub-prime and Alt-A debt, but for those who argue that this should all be swapped back to the Treasury for straight Treasury debt make a distinction without a difference.  For to argue that is to assume, as the textbooks still do, that the Fed is an “independent” organization divorced from the political whims extant inside the Beltway.  Practically speaking this is incorrect: the Fed would be 100% bailed out by the US taxpayer if it ever became insolvent, and should be thought of now, we regret to say, as an arm of the US Treasury.
  • The one passage from the Fed statement worth digesting verbatim is the following:

The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.   To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.

This is code for the Fed being what can only be called anti-deflationary.  With all due respect to our monetary solons, who are they to say what the level of inflation is that is “consistent with the Committee’s dual mandate?”  And how can they know, when the Fed’s institutional history is that of getting things wrong, repeatedly?  This is precisely why astute investors such as the legendary Jim Rogers are quite certain QE3 has effectively started and higher prices, malinvestment, Treasury bubbles and recession are in our near future.

So what does all this mean for the dollar, for inflation, and for asset prices, including gold, at least in the near term?

We have been longstanding critics of the Bernanke Fed, and actually agree with Mr. Rogers in the long run.  The Fed has not been in the same league as its counterparts in Switzerland or Germany, say, in terms of maintaining the currency’s store of value, though all fiat currencies shred purchasing power over time.  But we think the hook downward at the far right end of the curve in Chart II above, emblematic of a dollar firming the last seven months, will be sustained well into 2012, in spite of continuing Fed ease.  Gold, which for us is always the primary metric to gauge dollar strength, has moved below its 200-day moving average for the first time in three years; and, it’s now off 18% from its September 6 high of $1921.  Part of the reason for this is the continuing elevated level of the demand to hold dollars globally; price inflation, while up +3.5% in the last year overall, has declined the last six months and shows no signs of a run.  And equally likely, part of the gold buying in recent months was psychological, and defensive against Europe.

Additionally, from the point of view of equity investors who like QE, both the ECB and the Fed have not obliged in the last several months; that is bearish for inflation-sensitive commodities.  These inflationists may well (or, will) get their way eventually, but it may be into 2013 before it happens.  This is not least because the extraordinary situation in Europe shows no hint of being resolved soon.

And regarding the Eurozone, this is where the Fed may be drawn in in harmful ways.  Rumors abound in Washington of deep Fed and/or Treasury involvement in IMF lending into Europe, and we can only infer that is because the Fed knows details of European bank balance sheets that have escaped us.  Europe has $46 trillion in bank assets for what in the aggregate is a $13 trillion economy (the U.S. by contrast has $13 trillion in banking assets); over $2 trillion of these are non-performing loans.  Their higher leverage, high levels of asset “toxicity”, and sclerotic economies have us fearing that the EU’s recent new projection for growth next year at 0.6% is too optimistic.  But for the Fed to ratify Europe’s kicking-the-can-down-the-road can only be called another Bernanke-led error, were it to happen.

What all this likely adds up to — assuming Europe does not go into a deep tailspin next year or suffers a banking shock — is continued low-grade inflation and a bond market bubble brewing in the U.S. even alongside 2.5-3% growth in 2012 (Note: Goldman Sachs now says 2012 growth will be half that due to Eurozone blow-back here, and they also predict a weakening dollar more immediately than we can see), but bad tidings beyond 2013 when interest rates in the U.S. will begin a sharp climb.  It is quite plausible U.S. equity markets will trade higher in the next year from current levels, and capital-intensive firms who understand rates must begin to rise in 2013 may well forward new investment into 2012, further buoying asset prices next year.  As always, we remain vigilant to brewing challenges in Europe and China, and hopeful of better policies in the United States in the time ahead.

For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, John Chapman can be reached at john.chapman@4kb.d43.myftpupload.com

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Alhambra Partners Disclaimer:  The information contained in this note comes directly from U.S. government sources (such as the Federal Reserve Board, U.S. Commerce Department, or U.S. Census Bureau), or from financial news websites or the print press (such as Bloomberg, Reuters, or the Wall Street Journal).  The data contained herein are generally believed to be accurate, but Alhambra makes no implied or express warranties in this regard.  Our aim with this commentary is to provide insights that could allow for the formation of investment strategies by individuals and firms, but forward-looking assertions again come with no express or implied warranties, and the purchase of investment securities comes with high risk.  The opinions expressed here are those of John L. Chapman, and do not necessarily reflect those of colleagues at Alhambra Investment Partners, LLC or any of its affiliates.