The inflation indicator remains in the red.
Once again, the media’s haste to publish sacrifices interpretation, analysis, and comprehension. Therefore, 3% dominates the news.
Before delving into the most recent CPI report, review the conclusion of my inflation article from July 16, 2022, when 9.1% was the buzz number. (Underlining is mine.)
“Because the U.S. economy has so many moving parts, it is unreliable to fixate on a single issue or number. Inflation is particularly challenging because price changes are the result of specific supply and demand dynamics as well as “fiat money” inflation (also known as the loss of purchasing power).
“Therefore, no single measure of inflation is accurate. Conditions and forces differ from period to period, so subjective analysis is required to isolate a currency’s depreciation. Due to COVID’s ongoing effects, specific supply issues, and geopolitical effects (including Russia-related actions), the current period is exceptionally challenging.
“Add to that the Federal Reserve’s need to raise interest rates to the level determined by the capital markets. The 3-month US Treasury Bill will then yield at least the “fiat money” inflation rate at that time.
“What would the current rate and yield be if the Fed withdrew?” Based on an analysis of all CPI components and other inflation measures, the fiat-money inflation rate is likely around 5%. With the 3-month T-Bill yielding only 2.3% at present, the Fed has a long way to go before it can genuinely tighten money. (“Tightening” commonly refers to squeezing the financial system to halt economic growth.) This would increase the yield on 3-month Treasury bills above the inflation rate of 5%.”
In July, what is the story?
Start with food and energy, the two “non-core” items. The 12-month food price increase from June 2022 to June 2023 was 5.7%, compared to 10% last year. This year, energy is 16.7%, compared to 41.5% last year.
These comparisons demonstrate why many prefer the “core” CPI measure, which excludes those items susceptible to supply-and-demand fluctuations that can cause prices to fluctuate beyond the trend of fiat-money inflation.
However, a breakdown of the main category groups reveals the general inflation trend, which continues to be approximately 5%. Examining the areas where major corporations have the pricing power to maintain profit margins as costs rise is of utmost importance at this time.
For instance, fresh fruits and vegetables are up 1.1% over the past year, while processed fruits and vegetables are up 8.8%. Overall, food-at-home prices increased 4.7%, while food-out prices increased 7.7%. Putting everything together yields a rate of 5.7%.
Energy’s extraordinary price fluctuations are so large and frequent that they strongly support the case for excluding energy from the calculation of the underlying inflation trend. These two percentages, 16.7% for this year and 41.5% for last year, are prime examples.
Here is a comparison of the main composite levels:
CPI: All items = 3% CPI: All items minus energy = 5%
CPI: All items minus energy and food = 4.8%
The Federal Reserve must curb the 5% inflation trend in order to maintain price stability.
Recession is the only method to reduce the 5% fiat money inflation rate. To achieve this, the Fed’s primary tool is a reduction in the money supply. The term “tight money” indicates that money is more difficult to obtain.
Reducing the money supply constricts the financial system and raises interest rates. Raising the Federal Funds rate is unnecessary, but it sends a message that the Federal Reserve means business.
How is the Fed performing? Mediocre to subpar. It is placing all of its bets on the Federal Funds rate while ignoring the money supply.
Consequently, the financial system, enterprises, organizations, and consumers have made adjustments. Even the effects of the Federal Funds rate increase have waned, as the 5% rate only matches the trend in fiat-money inflation.
The meager 0.25 percent increase anticipated in two weeks will likely be inconsequential. Continued positive economic reports, a rising stock market, and an increase in confidence survey results are evidence.
How terrible is it that the Federal Reserve is not tightening the money supply? Very! They created trillions of dollars to fill the void left by the COVID shutdown, then failed to rescind the money creation when the economy recovered. Worse, their claims that they have effectively reduced the money supply are inaccurate. The strategy of not reinvesting a portion of the bond interest and maturity payments is minimal and ineffective.
Additional distressing news
James Bullard is resigning as president of the St. Louis Federal Reserve Bank. Because he is one of the few economists who incorporates the real world and common sense into his financial system analysis, I have followed him for years.
He has written thoughtful, critical pieces on such topics as the Fed’s switch from the CPI-Core Inflation Rate to the PCE-Core one and former Fed Chair Greenspan’s allowing banks to shift demand (checking) account balances into savings accounts overnight to reduce the bank’s required reserves (a questionable action that killed the long-standing, key money supply measure, M1—it included demand deposits but excluded savings deposits).
In order to shake things up, he continually advocated for faster and larger interest rate increases. He also published a paper explaining why an interest rate greater than inflation was likely necessary.
His absence increases the likelihood that the Federal Reserve will do too little, too late, to do any real good. The outcome? Unhappiness followed the initial optimism. It has occurred in the past, and it could occur again because human nature takes over when inflation occurs.