Today the CPI was published by the BLS with a 12 month increase of 2.1%. The classical pattern of economic recovery is that unemployment goes down, workers get more pay, they spend their pay by signing up for a loan which increases the money supply and creates inflation. The knee-jerk reaction is to assume a recovery, including full employment, will result in an increase in inflation.
However this recovery is very different from any post WWII recovery because it has been very slow, it has not recovered lost jobs for the hidden unemployed who are 3.5% of the population. The number of jobs last week reached the same as the old 2007 high – except if one adjusts for population increase then the number of jobs, to be equal to that of 2007 (on a population adjusted basis), needs to be 3.5% higher. Since the unemployment rate has been improving by roughly 1% a year then it may be another four years in 2018 before a true full employment economy exists.
The qualitative nature of employment is that the bottom 80% are trapped in stagnant wages and society collectively has 345% ratio of debt to GDP, double that of the long run average. If you show me a working class consumer with stagnant wages who has too much debt and may have maxed out his borrowing capacity (especially with today’s tighten underwriting) then I’ll show you someone who is trying to cut costs by shopping carefully, which can lower inflation.
Bernanke said he was worried that there is no way to know exactly what is the correct rate for inflation, so if he tightened the economy it could accidently be tightened excessively. An interesting explanation of the CPI is here where the article mentions it may be overstated by 1%. The problem with CPI is that a bored clerk at the BLS asks a bored clerk at a company to fill out a boring questionnaire. Guess what gets put into the questionnaire? The official posted price, not some hidden discount that a savvy shopper gets because they secretly asked for a discount.
The people with stagnant wages with dead end jobs will make it a part-time additional job to go shopping carefully so as to cut their costs. If wages are stagnant and inflation is driven by excessive increases in borrowed money (which need wage increases to happen) then I don’t expect to see much inflation.
We live in a multi-tiered society. The bottom 80% can’t cause inflation due to their job and debt load. Those between the 80th and 95th percentile are making some progress and the top 3% or 5% enjoy big raises and enjoy buying hard to mass produce luxuries which cause this group to experience an 8% CPI. This group then complains in news interviews that CPI is wrong. CPI is designed to serve the common man, not someone who is living in Manhattan and making $300,000 and buying groceries only at Whole Foods.
The mistake economists make is to assume we are in a normal, but slow, recovery and that eventually there will be a rerun of the traditional pattern of full employment correlating to rising inflation. However, we have been in a new era since the crash of 1987 where a culture of TBTF (To Big To Fail and To Big To Jail) Fed bailouts has encouraged investors to assume there is no downside risk. Add to that a massive increase in debt some of which went into stocks and you have new era. Unfortunately the excess debt at some point can’t be made more palatable with restructurings, stretched out amortizations, lower interest rates, etc. When consumers simply can’t pay the excess debt they will have no choice but to consume less and then we could tip into a Japan-style Soft Depression. A prominent Austrian economist said “Debt today is future consumption denied” since the debtor must cut costs to make the mandatory debt payments. The pattern of debt fueled booms is they first fool people into thinking that the economy is expanding so people gear up business investment and consumption and personal investment. Then they find out the debt boom was unsustainable and massive layoffs, factory closing, etc. occur. This occurs after most people have signed up to borrow more. Thus people end up being worse off because they have more debt to service yet lower income.
Inflation is far less of risk once people understand that the bottom 80% are not in a position to create inflation. Most of the joblessness is associated with low to middle-skilled people. Yet those people typically find a new career in a field that only requires a year of training instead of having to go back to college and become a lawyer. If it was so easy for unemployed middle-skill people to get retrained in a new paraprofessional career then they would have done so by now. One must conclude that the masses of moderately skilled people are simply too unmotivated or intrinsically not bright enough to learn new skills despite being scared by the great crash of 2009. If so then presumably they will be stuck in the new era of stagnant wages and debt servitude where they can’t get an inflation causing bank loan.
The risks of a serious stock crash are greater than the risks of a sudden burst of inflation that would hurt bonds. If inflation surprises to the upside then corporate borrowing costs will rise, reducing profits, lowering earnings and hurting stocks, so stocks won’t be a refuge from inflation.
Investors need independent financial advice about the risk that inflation could cause interest rates to go up. They need advice that is independent from Wall Street product sellers and independent from traditional uncreative “groupthink”. I wrote an article “Employment report will inflation increase and hurt bonds?”