Inflation: Believe the Government Numbers.

This post is another response to the Village Whisperer with respect to recent writings on inflation. My position that the government statistics are reasonable will not go over well with those who would rather feel superior by knowing "truths" that the masses are oblivious to. Oh well.

No doubt driving around to visit friends and family you took time to fill up your gas tank.

If you live in Greater Vancouver, your jolly spirit will have been tempered by gasoline prices which have touched north of $1.20 per litre ($1.22 at some stations).

Whoa!

Gas has gone back to the highs we experienced when oil was at over $140 per barrel, whereas right now oil is at $90 per barrel. What gives?

Even better, government statistics tell us that inflation has fallen to 1.3%.

Uh-huh.

Across Canada average gasoline prices reached $1.39/litre in June 2008 while they are currently $1.10/litre.

Statistics Canada reported inflation for November indicate a yearly increase of 2% with core inflation, which excludes more volatile components, increasing by 1.4%. The report is transparent in that it breaks apart the individual components. For instance gasoline prices increased by 7.2% while clothing and footwear has decreased by 3.2%. I'm sure with recent gas prices they will accurately report another increase for December. In other words no conspiracy.

Bloomberg reports beef prices increased 6.2% above last November, with steak prices up 5.4% and ground beef prices up 7.4%. Pork is up 12.9%. Poultry prices (including turkey) up 3.2%.

Egg prices increased 4.7%. Dairy 3.8%. Cheese 5.4%. Ice cream and related product prices 32.1%.

Cereal and bakery product prices are down 0.3%, but rapidly rising wheat futures mean prices can only be held in check for so long.

Meanwhile coffee, sugar, and wheat are up over 35%.

From the highlighted items in the blog post it would appear the Bloomberg report contradicts the reports of low inflation. However, by reading the article it is apparent the opposite is true. With inflation statistics aggregate results are more important than cherry picked outliers. Also a closer look at the data suggests yearly volatility for specific categories. For instance dairy has increased by 3.8% but only after a decline of 6.4% the previous year. While it is true there has been increases in the selected items above overall food prices have increased very little.

In 2010, the Consumer Price Index (CPI) for all food is projected to increase 0.5 to 1.5 percent--the lowest annual food inflation rate since 1992. Food-at-home (grocery store) prices are also forecast to increase 0.5 to 1.5 percent, while food- away-from-home (restaurant) prices are forecast to increase 1 to 2 percent.

The blog entry continues with McDonalds, Walmart and China:

That's why businesses like McDonalds are already letting consumers know they plan on raising prices next year. As noted by the Wall Street Journal:

• "Timing and executing price increases can be tricky as McDonald's and other companies are caught between paying more for key materials such as meat and wheat, and keeping prices low to attract price-sensitive customers in a still-weak economy."

McDonalds is raising prices for the first time in over a year. There was hints of cost push inflation with commodity prices "soaring" by 2-3% per year. However, the evidence also suggests demand pull inflation with earnings up 10% and strong sales.

Even that bastion of low prices, Wallmart, has been forced to hike prices. Inflation is raging in China and their costs are soaring. Wallmart simply cannot procur products at the same low wholesale costs.

The reference to Walmart is a survey for a single store for a single month. In China inflation is due to domestic credit expansion combined with their currency not being allowed to appreciate vs. the U.S. dollar.

Take another look at those price changes above. Which statistic do you believe... inflation at 1% or inflation at 7%?

"Four legs good. Two legs better." Couldn't have said it better myself, George.

I think the Animal Farm reference is more suitable to how those in power exploit the tea-party subjects through misinformation. This could be simply to enrich themselves or to gain political power as Paul Krugman explains out in a recent article.

So what’s really motivating the G.O.P. attack on the Fed? Mr. Bernanke and his colleagues were clearly caught by surprise, but the budget expert Stan Collender predicted it all. Back in August, he warned Mr. Bernanke that “with Republican policy makers seeing economic hardship as the path to election glory,” they would be “opposed to any actions taken by the Federal Reserve that would make the economy better.” In short, their real fear is not that Fed actions will be harmful, it is that they might succeed.

Since the political will of any government action is evaporating, and household debt deleveraging is not complete (or even started in Canada), I think it is likely inflation will remain below the target level of 2% in 2011.

A side note to this difference of opinion regarding inflation is interesting. After an interest rate shock subsides, inflation would support real estate prices due to higher costs of labour, materials and land relative to a devalued currency. In contrast deflation is negative for real estate in terms of nominal prices as everything depreciates. In the milder case of inflation in the 1% range, the possibility that overvaluation will be absorbed by stagnant nominal prices as real prices fall becomes unlikely.

Unknowns: Inflation, Deflation, Peak Oil, Climate Change...

This is just a little diversion from the main focus of this blog to look at the big picture.

A lot has been going on in terms of trying to prop up the world financial system and it is unclear what impact these actions will have going forward.

Google image search source lewrockwellblog

One thing that I cannot sort out is deflation vs. inflation. It is clear that deflation has been winning recently. Good news for me, my salary is in dollars and houses and stocks become cheaper. Saving for a downpayment in cash is working, even at low returns. Go bears!

However, I have anxiety over what I don't understand. I don't fully understand where this money is coming from to bail out banks worldwide and to 'provide liquidity'. Perhaps there will be a delayed reaction and inflation will return.

So in the short term it appears that the credit crunch is resulting in a reversal in leverage causing deflation. However the impact of the desperate solutions by those in power is a concern to me in the medium to long term. Are savers going to be coerced to invest through monetary policy?

Google image search some blog post I added to bloomberg LIBOR chart

There is a view that the energy industry, and specifically the tarsands, will keep Alberta's economy insulated to some degree. I think that some of this growth was the result of distorted demand from the United States living greatly beyond their means. There are those that have said American personal, government and trade deficits are sustainable with lines such as "America is the largest economy in the world" and "World reserve currency". I have my doubts.

Imagine a world where money is a method for trading goods and services and ignore for a moment the apparent permanent imbalances in US monetary policy. I know this sounds foreign and simplistic but bear with me. Extracting oil from the tarsands is expensive in terms of resources such as labour and capital. Consider the sacrifices made by people working long hours, living in camps far away from home. How much capital is being invested to retrieve this energy? If money is an exchange for goods and services what will Americans offer in the future to us for all this hard work? During the housing bubble they would remodel their kitchen, take out a home equity loan and buy a Hummer. Now what?

google image search Texas REALTOR

Google image search some Bloomberg article

In regards to oil there are two wild cards. Oil is a limited resource and therefore could use more of people's incomes to sustain marginal production methods such as the tarsands. At the same time policies to combat climate change could promote alternatives.

What impact will inflation, deflation, peak oil and climate change will have on the Alberta economy and nominal real estate values going forward? Any thoughts?