For the 55th consecutive month, the PCE Deflator came in under the 2% inflation target for the Federal Reserve’s inflation mandate. The Bureau of Economic Analysis reported last week that inflation in November 2016 actually decelerated slightly from its meandering pace set more by oil price base effects than $4.5 trillion on the Fed’s balance sheet. Year-over-year the PCE Deflator was up just 1.37%, slightly less than the 1.44% in October, and once more showing that inflation is in no hurry to be restored.
While that is welcome news for actual Americans, it also demonstrates that there is currently a lack of urgency unlike what is experienced during periods of actual economic improvement. Despite nine months distance from the bottom in oil prices, the 2-year change for the PCE Deflator remains also less than 2%. In what should be a clear sign of a clear monetary issue, the 2-year comparison hasn’t even registered 2% since August 2015 (let alone 4.04%).
While there is a complete absence of actual reflation in inflation statistics, the idea remains wedded to its non-specific future. “Reflation” proponents, or at least commentary describing the proposition, have argued that it is not about what we see today but rather what will happen tomorrow when things start to go right. There is a fair amount of evidence that the belief is widespread, and thus current statistics won’t matter unless and until they fail to demonstrate a harder basis for the optimism.
Consumer sentiment, for example, has exploded in the wake of last month’s election. The University of Michigan’s Index of Consumer Sentiment had been as low as 87.2 in October, the most pessimistic reading since the summer of 2014, only to explode upward all the way to 98.2 for the flash December estimate. That level was fractionally higher than January 2015, and the highest in almost thirteen years.
The surge in confidence unfortunately matches the same in the latter half of 2014. Only two years ago that jump was based on economic statistics that appeared to justify the optimism rather than hope for future economic statistics that might someday seem to support “reflation.” Thus, the problem with such uncovered confidence is obvious; in 2014, the BLS statistics suggesting the “best jobs market in decades” were and proved to be entirely irrelevant to the immediate economic course (if not overstated greatly).
Where there was a fair amount of enthusiasm for that economy at least in the overall index, inflation expectations betrayed a far different sense of direction (that was ultimately proved correct). The survey results projecting inflation 1 year into the future actually peaked in July 2014 and then began to fall. The longer-term 5-year expectation similarly started dropping that August.
As if to be done all over again, to end 2016 the UofM surveys record a similar discrepancy; though overall sentiment is the highest since 2004, inflation expectations have dropped to new lows. The 1-year expectation declined to just 2.2%, the lowest since a brief dip in 2010 and really more consistent with recession periods. The 5-year expectation fell to the lowest on record. At just 2.2%, the initial December estimate is significantly lower than at any time during either the dot-com recession or Great “Recession.”
How do we reconcile these two very different attitudes? The answer is almost surely money and more so the same great misunderstanding of it in the eurodollar sense. Inflation is a monetary phenomenon, and the lack of it despite so much QE is being “felt” in various ways, from the CPI and PCE Deflator to consumer surveys. That is the baseline for the economy as it actually is (a fact proven several times in the last decade, if not decades). Since, however, there is very little awareness (if any at all) about the eurodollar system, it is entirely divorced from conventional economic expectations.
Instead, consumers see on TV and the internet the unemployment rate proclaimed repeatedly and emphatically as the chief measure of economic performance, and, like 2014, become enthralled by it – at least until the actual monetary baseline asserts itself.
Therefore consumers see improvement, or more specifically a potential path to improvement, but also at the same time feel but don’t fully appreciate the continued drag. They know “something” is wrong, but because there isn’t an actual explanation for it they are susceptible to these bouts of unconnected almost euphoria.
Part of the reason that pessimism remains despite more outward approval is certainly income. Even in 2014, the idea of a vastly improving unemployment rate (and for two quarters GDP) wasn’t necessarily a reflection of the economy of 2014, it was one possible indication (one that was taken very seriously) that there would be meaningful improvement in 2015. It didn’t happen, of course, which is why UofM’s sentiment index peaked in January 2015 as oil prices started to suggest all the ways in which the unemployment rate was wrong and misleading.
Despite the BLS employment statistics then and now, incomes and wages never accelerated. Again, it was all hope that they would in the immediate future, but as incomes in the current sense remained depressed, so, too, did baseline economic expectations (inflation).
Though income growth had improved throughout 2014, it was never more than relative to contraction in 2013. Since that time, however, income growth has only decelerated in both nominal as well as real terms. Nominal DPI Per Capita, for example, has remained stuck at just 3% year-over-year expansion since April 2015. That is an unusually weak level consistent with the past three official recessions declared since the end of the Great Inflation. Thus, there was no visible “benefit” in terms of incomes as oil prices fell since nominal income had decelerated sharply, too.
Real income, as calculated inflation rates rise once more, is in November 2016 lower than at any point since 2013. The BEA estimates that Real Disposable Personal Income Per Capita increased just 1.5% in November as the CPI meanders higher without any acceleration for nominal income. Similarly, Real Personal Income Excl. Transfer Receipts has also slowed to the weakest growth rate since 2010 (outside of 2013) at barely 2%.
I believe that is the full basis for the discrepancy. Consumers know (knew) all-too-well that incomes remain(ed) especially and unusually constrained but have no specific knowledge as to why (economists have been particularly unhelpful not just for their ignorance of money but also because they had so often refused even to consider and project anything other than normal recovery). Thus, periodically they are given hope that something, anything will change so that this spell of malaise is broken and the actual recovery, complete with meaningful improvement in incomes leading to meaningful and historically conforming acceleration for calculated inflation, will at long last commence.
In late 2014, it was the unemployment rate; in late 2016, it is the (assumed) looming Trump “stimulus” that includes (assumed) differences across a great number policy channels. Therefore, like markets, as noted last week, there isn’t a whole lot more than non-specific hope and a great deal of visible conflict between that more optimistic take and the nagging doubt that appropriately remains. Consumers, like markets, hope that the Great “Recession” will finally end, but know on some level that they have been fooled (several times) before, even if they still don’t know why.
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