By John L. Chapman, Ph.D. Washington, D.C. December 16, 2011
More economic news was released yesterday and today signifying the durability of the current expansion, if not its robustness. We comment here, in seriatim, on producer and consumer prices, and weekly jobless claims. The net of the analysis shows a steady albeit understated expansion, and low-grade inflation that, we fear, may well be a harbinger of more to come in the years ahead.
Producer Prices for November
The U.S. Department of Labor’s Bureau of Labor Statistics released the November report for producer prices yesterday. As a gauge for future inflation — and hints at latent consumer price trends of course — the Producer Price Index (PPI) is preferred as a tool to the Consumer Price Index (CPI). This is because the PPI sectors are interest-rate sensitive and will always be responsive to increases in the quantity of money and credit. This is less true of consumer goods; modern competition can hold consumer goods prices down even in the face of an inflation in the supply of money and credit, which is then manifested in distortive international dollar flows, or flows of new credit money into financial assets. But an increase in the money supply that artificially lowers rates will axiomatically lead to dollar flows into early-stage goods, causing the PPI to rise.
Indeed, in an unhampered market economy, the PPI should slowly decline over time, as per Moore’s Law being in force for computer chips. Technology may come in non-linear waves, but will put pressure on prices over time. Thus a secularly rising PPI episode usually means inflation, a lack of technological or productivity improvement, or both. A flat or slightly declining PPI would mean sound money and technological gains are being made through investment.
Our methodology for examining producer prices is to always look at total (group-wide) price changes, and then those for core goods (all except food and energy, which the U.S. government statisticians have singled out for their volatility), and non-core items (food and energy). And, we review finished producer goods, intermediate (in-process) producer goods, and crude (early-stage) goods. On core versus non-core items, our view is this is detrimental to the analytical process because the Fed’s economic staff-members attempt to absolve themselves from inflation in food or energy per se, when indeed increases in the supply of money and credit can be channeled into these immediate consumables. But now the entire U.S. government apparatus has picked up on the distinction, and it is important to follow this framework as an investor because these data do move asset markets.
Finished Goods. The PPI Index for finished goods increased 0.3% last month (consensus expectation was +0.2%). Year on year, producer prices for finished goods are up 5.7%. Finished goods prices had fallen 0.3% in October and moved up 0.8% in September. Food prices dominated the gain, up 1.0% (the sixth consecutive monthly increase), while energy and core prices were up 0.1%. Over half of the November advance can be attributed to the index for fresh and dry vegetables, which rose 11.5%. Higher prices for processed young chickens and meats were also up sharply. The notable mover in the other categories was a 9.4% jump in home heating oil prices (in finished energy goods).
Intermediate Goods. The PPI for intermediate materials, supplies, and components moved up 0.2% in November, after declining 1.1% in October. Year on year through November 30, the intermediate goods index increased 7.7% (the smallest year-over-year rise since a 6.2% increase in January 2011). Leading this increase, prices for intermediate energy goods rose 1.9% (following a 2.6% decline in October). The index for intermediate “foods and feeds” also contributed to the advance, moving up 0.6%. By contrast, prices for intermediate materials less foods and energy decreased 0.4%.
Intermediate energy goods were volatile in November due to a big (+7.5%) increase in the diesel fuel index. Higher prices for industrial electric power and jet fuels also were factors in the November advance in the intermediate energy goods index. Intermediate foods and feeds increased 0.6% in November after falling 1.5% a month earlier. Here the big reason for price pressures were prices for processed young chickens, which accounted for over three-quarters of the advance, moving up 8.0%. Higher prices for natural cheese also contributed to the increase in intermediate foods and feeds. Prices for intermediate goods less foods and energy fell 0.4% in November, the second consecutive monthly decline. The November decrease was mostly due to a 4.1% drop in basic organic chemicals.
Crude, early-stage goods. Crude materials for further processing moved up 3.8% in November. This increase in the crude goods index is mostly attributable to prices for crude energy materials, which jumped 10.5%; crude foodstuffs and feedstuffs were up 0.5%. By contrast, prices for crude core goods (less food and energy) decreased 2.5%.
Crude energy prices are highly volatile; the November increase was led by a 22.7% jump in the crude petroleum index. Higher prices for coal also were a factor. Crude foods were up due to advances in slaughter cattle and poultry. Core prices fell due primarily to a 6.6% drop in prices for iron and steel scrap.
An historical look look at the PPI is illuminating because there is an inverse correlation between the PPI and economic growth:
Chart I. Producer Price Index (All Goods), 1913-Present, Log Scale (1982=100)
We prefer a logarithmic scale for data such as these because it shows equiproportional changes in movement of parameters across time. In the case above, the intervals increase 65% in each case. What this graph tells us is that long periods of flatness in this curve are coincident with strong economic growth because they incite strong profits. Thus, the 1920s, the period from 1950-70, and the 1982-2000 period are marked by little rise in the graph, and these were the best periods for growth in the last century. Conversely we see a big arc in producer prices in the 1970s, and again though less starkly, interestingly, after 2002. Relative profit levels are not as strong in such periods, but sharply declining producer prices are usually indicative of a downturn.
Why might producer prices rise faster than consumer prices? In the age of the Internet and ubiquitous competition, fueled by more open trade, competition in product markets almost guarantees this. Consumers seemingly have endless choices and thus will not tolerate price increases foisted upon them easily, but capital good industries, always very interest-rate sensitive, have to absorb price increases that come with more money and credit in the economy chasing those low rates (in the 1970s inflation, however, trade was not as competitive, and union bargaining was able to force up wages repeatedly — this was bound to affect consumer prices; the demand for dollars has skyrocketed in recent years as well, allowing the U.S. to “export inflation” more than in the past, as well as now add to cash balances domestically due to fear).
Nonetheless, we do see latent consumer price inflation in play now. Year over year, crude/early stage, intermediate, and finished goods prices are up 15.3%, 7.7%, and 5.7%, respectively. Without steady consumer demand for end-use goods, supply will drop off and consumer prices will rise in the years ahead. And zeroing in on crude/early stage and intermediate goods, respectively, year-on-year price increase totals in the last 12 months ranged from 11.3%-26% and 6.1%-11.3% respectively — this might be considered as tantamount to future fuel for inflation, especially once US interest rates begin to rise.
Wholesale/retail trade, transport, and general service industries (e.g., medical insurance processing) showed negligible price movements last month.
Consumer Prices for November
The Bureau of Labor Statistics released data for November’s consumer prices today, and the CPI for all urban consumers — the “headline number,” and the second most important statistic in political economy after the unemployment rate — was unchanged in November. Year on year, the CPI jumped 3.4%. The energy index declined for the second month in a row, and offset increases in the indexes for food and the core number (which is all items less food and energy). As in October, the gasoline index fell sharply and the index for household energy declined as well. The food index rose slightly in November, though the index for food at home declined as four of the six major grocery store food group indexes fell.
Looking out over the last twelve months, energy and food prices are indeed driving CPI advances: energy prices across all categories are up 12.4%, while fuel oil alone is 25% higher than a year ago. Home-based food is up 5.9%, while other important categories include housing (1.8%), apparel (+4.8%) and medical care (+3.4%). We remind readers that Richard Nixon panicked and implemented price controls when general price increases hit 4% — it was not so long ago when there was a more prevalent wisdom of the danger to an economy through persistent inflation.
Weekly Jobless Claims
The Labor Department’s Employment and Training Agency announced that weekly new claims for unemployment insurance declined by 19,000 during the week ending December 10, to 366,000.
Said the ETA:
In the week ending December 10, the advance figure for seasonally adjusted initial claims was 366,000, a decrease of 19,000 from the previous week’s revised figure of 385,000. The 4-week moving average was 387,750, a decrease of 6,500 from the previous week’s revised average of 394,250.
The advance seasonally adjusted insured unemployment rate was 2.9 percent for the week ending December 3, unchanged from the prior week’s revised rate.
The advance number for seasonally adjusted insured unemployment during the week ending December 3 was 3,603,000, an increase of 4,000 from the preceding week’s revised level of 3,599,000. The 4-week moving average was 3,666,250, a decrease of 5,000 from the preceding week’s revised average of 3,671,250.
To put the weekly claims number of newly unemployed who are eligible for insurance payments into perspective, note below this graph depicting weekly claims going back 44 years:
Chart II. Weekly Initial Claims for Unemployment Insurance (1967-Present)
The data show a steady if unspectacular improvement. Note that during the 1980s-90s expansion, weekly unemployment insurance claims averaged 350,000 and were highly variable; that number might be expected to register a little higher now, with 30 million more Americans than there were in 2000. But the downward trend is the important thing, and at 366,000, the new claims number is at its lowest in 3 1/2 years, and well down from the recession peak of 659,000 in June of 2009.
The other aspect to the good news here is the pick-up year on year; this time a year ago the weekly number stood at 427,000, and was 404,000 as recently as three weeks ago. In terms of individual states, three of the top four hit hardest last week were California (-27780; service industry jobs), New York (-15427; transportation, construction, and service jobs), and Pennsylvania (-13,634; construction, healthcare and social services, and service industries). Across all states, leading categories for layoffs were construction, manufacturing, and textiles and apparel.
One interesting aspect to that historical chart relates to a furious debate going on inside the Beltway over the efficacy of policy currently. The two high post-war peaks to the weekly claims occurred in November 1982, at 694,000, and June 2009, at 659,000, and both were almost exactly coincident with the declared ending of the two recessions in question. Across 1983 the weekly claims number fell by more than half (-360,000), in just 13 months, in what was the beginning of a very robust investment-led expansion.
However in the current case, 2 1/2 years after the peak unemployment claims and the end of the recession, the weekly claims number is finally approaching a cut of 300,000. Why the lag time, this time around?
Defenders of the current policy mix point out that the US economy as a whole is more highly leveraged now, that it is more capital-intensive, and hence not prone to re-hiring idle labor, and that the tax rate regime in place now is much less onerous than that which the Reagan program replaced beginning in 1983, and hence the bump due to incentives would have been expected to be much greater then than now.
In contrast, defenders of the 1983 result and the Reagan program argue that the policy mix contrast is definitive: in 1983 the mix included a strong dollar, permanent tax rate cuts in marginal income and capital that were large enough to be meaningful, and a commitment to lower federal spending, reduce the burden of regulation especially on small businesses, and encourage unrestricted free trade for the most part. The 1983 policy proponents also argue that debt levels should not matter per se in a free market, because for every debtor there is a creditor, and that a more capitalistic (or, capital-intensive) economy should in fact produce investment that raises the demand for capital — and more labor too, in a virtuous circle.
Economist Robert Higgs, formerly at the University of Washington, put the matter well in September:
Every Keynesian seems to believe that because consumers are in a dreadful funk, only government stimulus spending can rescue the moribund economy, given (to them, at least) that investors will not spend more because the Fed, having already driven interest rates to extraordinarily low levels, cannot use conventional policies to drive them any lower and thereby elicit more investment spending…….
According to [Fed] data, real personal consumption expenditure recovered from its recession decline by the fourth quarter of 2010. Continuing to grow, it now stands (as of the most recent data, for the second quarter of 2011) even farther above its pre-recession peak……Real government expenditure for consumption and investment is also running higher than its pre-recession level [more than 2 percent higher].
The economy remains moribund not because consumption spending has failed to recover and not because government spending has failed to increase, but because the true driver of economic growth—private investment—remains deeply depressed. Gross private domestic fixed investment fell steeply after the second quarter of 2007, and through the second quarter of 2011 it remained 19 percent below its pre-recession peak. This figure fails to show how bad the investment situation really is, however, because the bulk of the investment spending now taking place is for what the accountants call the “capital consumption allowance,” the amount estimated as necessary to compensate for the wear and tear and obsolescence of the existing capital stock.
The key variable is net private domestic fixed investment—the investment that builds the productive private capital stock. …. [A]n index of its real amount peaked in 2006, fell substantially in each of the following three years, and recovered only slightly in 2010, when the index showed net private domestic fixed investment was running about 78 percent below its level in 2005 and 2006. Here is the true reason for the recession’s persistence.
Private investors, despite the full recovery of real consumer spending and the increase of real government spending for final goods and services, remain apprehensive about the future of new investments, especially new long-term investments. I have argued repeatedly during the past three years that an important reason for this apprehension and the consequent reluctance to make new capital commitments is “regime uncertainty”—in this case, a widespread, serious fear that the government’s major policies in areas such as taxation, Obamacare, financial reform, environmental regulation, and other areas will have the effect of depriving investors of control over their capital, or diminishing their ability to appropriate the income that the capital generates.
For our part, Mr. Higgs makes sense, and as adherents of classical doctrine in economics, we yearn for a policy mix conducive to saving and capital accumulation, which fuels the investment that yields productivity-enhancing technologies. Given the headwinds in the macro-economy, we are amazed at the level of investment such as it is in the present moment. But more permanence to investment incentives is a necessary condition of sustainable recovery and a more vibrant jobs market.
Having said that, we think it is possible investment will be up in 2012 in the U.S., potentially dramatically as the spike in interest rates that must per force happen is slated to begin in 2013. Front-loaded economic activity may make 2012 a decent year in the U.S. next year, with the caveat of an opaque Eurozone banking system being stabilized as well in the months ahead. Beyond this, the data above point to growth and higher stock prices next year. After this, the list of our fears is not a short one: tax increases, the consequences of an end to “easy” money by the Fed and its spiking interest rates, consumer and investor retrenchment, the second wave of Alt-A foreclosures, and another round of global monetary instability due to a wave of bank collapses could all play out in 2013. But so might a game-changing policy regime in the United States.
For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, John Chapman can be reached at firstname.lastname@example.org.
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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.