Expected Inflation, Demographics and Sticky CPI

It’s the last week of trading.  New York is getting pelted with snow, and both of their football teams came to the Midwest and lost.  The New York Giants will be overnighting in beautiful Green Bay, Wisconsin.  There is no Mario Batali’s Eatily in Green Bay.  Only Fish Boils and cheese curds.  After a couple of days the whole team will be on Lipitor.  The Jets are stuck in Chicago.  They should enjoy themselves.  A tip to Coach Ryan, we don’t have any good “foot” dungeons here.

With the massively bad weather on the east coast, my expectation is that market volume will remain light.  This gives the guys that actually can make it into work a chance to muscle winning positions higher.  I expect that the sectors that have done well all year will continue to push higher through the 31st.  They will paint the tape where they can.

There was a terrorist attack in Pakistan overnight, and the Chinese hiked interest rates again to fight inflation.  That didn’t scare the markets though.  They are up.  All the politicians are in their home district, so we can expect no news out of Washington for a change.  That is actually a welcome relief.  Most of the traders that I know are extremely sick of watching committee rooms.  Never sell a quiet market.

Over the week end, I read a very interesting piece by David Altig of the Atlanta Fed.    In it, he talks about why the Federal Reserve doesn’t see a lot of inflation right now.  The knee jerk reaction in March of 2009 was that all this government spending and issuance of debt would cause inflation.  I still believe it will, just not today or in the short run.  David cites the “sticky CPI index”, which is explained at this link.  Sticky CPI is a neat way to try and predict inflation.

Economists may look at these indexes and reach a conclusion.  But I like to look at other things.  Actual prices in futures markets and unemployment give better clues to future inflation expectations than indexes.  The US will not have any rampant armageddon like inflation until the employment picture improves.  Government transfer payments don’t stimulate an economy.  The private sector has to do the heavy lifting.  Over time, we could get stagflation, but that will not happen over the next couple of years based on the price data of futures markets.  Even commodities that can really inflate prices are relatively stable over time.  Crude oil for February delivery in 2012 is only $2 a barrel more than oil for delivery in February of 2011.   Corn for March delivery in 2011 is higher priced than delivery for the same time in 2012.  Of course, markets will move and prices can change.

However, virtually every steep rise in a commodities price over the past year can be explained by poor weather.   It wasn’t the government spending that caused cotton to rise to record levels.

The other idea that people are not pondering enough is demographics.  In 2000, we had 56 million people over the age of 55.  That was out of 281 million people, or 20% of the population.  In 2010, we have 308 million people.  2009 data says that 30% of the population is over 55.

Why does it matter?  Because once a person hits a certain age, they tend to consume less.  I arbitrarily picked the age of 55 since many people begin retiring from government jobs at that age.  As the population ages, it will consume less of the things that are in measures like the consumer price index.  But, the population will consume things that aren’t as heavily weighted in the CPI, like health care.  Since a lot of the health care market is price controlled, it doesn’t reflect the true market price. Inflation will remain in check longer than people think.

The real problem with the tactics of the government today is that all this borrowing crowds out the private sector.  When the private sector can’t borrow, GDP growth is slower.  This leads to higher unemployment.  Government’s answer is to borrow more.  This drives up interest rates.  Eventually, there is a tipping point and the government can no longer borrow.  It prints money like crazy that drives the value of its currency much lower.  That’s when you get inflation.

So, there is no doubt that we will have inflation.  The government spending at every level is too massive.  Politicians have hid it in cubby holes all over their budgets.  At the Federal level, it will be Obamacare, Medicaid, Social Security and pensions that put us over the edge.  At the state levels, it will probably be pensions-at least it is in states like Illinois.

Inflation will come if the opportunity cost of holding dollars becomes greater than the cost of spending them.  People will empty their piggybanks and buy everything, anything.

But, believe it or not, we still have a chance to stop rampant inflation from taking over.  Just have to slash government spending, the size of government, and the regulatory scope of government.  The private sector will quickly pick up the slack and we will be out of the woods.

welcome Doug Ross readers,  thanks for the link.


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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