The Return of Inflation The Global Guru -
The Return of Inflation
After a deceptively benign couple of decades, inflation is back in the headlines.
JP Morgan estimates that the U.S. consumer price index (CPI) will hit 5.1% in August, its highest rate since 1991. Consumer prices in the 15 countries that use the euro rose 3.6% from a year earlier -- well above the European Central Bank's target of 2%. In the developing world, the fast-growth BRIC economies are leading the charge. Brazil's rate of inflation has risen to 5% from less than 3% early last year. Russia's newly minted Prime Minister Vladimir Putin has declared that Russia's 14% inflation rate is its #1 economic problem. India's wholesale-price inflation rate stands at a four-year high. Consumer-price inflation in China is at a 12-year high of 8.5%, up from only 3% a year ago. The inhabitants of Ukraine may have it the worst on the planet, as the cost of living there has leapt by a staggering 30% during the past 12 months. With prices up in 80% of the countries that Goldman Sachs tracks, double-digit percentage inflation is a reality for two-thirds of the world's population.
The Return of Inflation: Who's to Blame?
It wasn't supposed to turn out this way. With the lessons of the painfully inflationary 1970s seared into their collective brains, central bankers across the world were supposed to have adopted orthodox policies that reigned in inflation for good. And globalization, which was all about cheap labor and cheap goods, had aided their anti-inflationary quest. Recently, however, the globalization story has shifted from a disinflationary phenomenon to an inflationary one. The developing world's galloping rates of economic growth turned the world's fastest growing economies into rampant consumers of commodities. As a result, the prices of agricultural goods have soared, with oil more than doubling in price during the past 12 months.
Yet, until very recently, most central bankers have been in denial. That's largely due to the distinction policymakers make between "core" and "none-core" inflation. By focusing on "core inflation," a measure that eliminates products such as food and energy that are subject to price shocks and speculation, policymakers have been turning a blind eye to what's been happening at the world's grocery stores and gas pumps. This has led to a startling disconnect between policy definitions of inflation and the reality of what is hitting global pocketbooks. In China, food prices have risen by 22% in the past year, whereas core inflation (non-food) has gone up by only 1.8%.
Here's why the textbook distinction between core and non-core inflation is proving problematic in a global economy. First, food accounts for 30-40% of the consumer-price index in most emerging economies, compared with only 15% in the G7 economies. That means consumers in emerging economies are more vulnerable to rises in food and energy prices, as well as the inevitable protests that follow. Second, pressure is starting to seep beyond commodities into "core" inflation. UBS calculates that in Asia, Latin America and Eastern Europe, the core rate of inflation has risen by between one and three percentage points. Third, official figures understate the true extent of inflation, distorted as they are by subsidies and exclusions. If measured correctly, inflation in five of the 10-biggest emerging economies could soon hit rates of 10%.
But if inflation is, as Milton Friedman observed, 'always and everywhere a monetary phenomenon' then the blame for inflation lies at the feet of the world's central bankers. Statistics show that broad money supply has grown by an average of 20% during the past year in emerging economies. That's three times the rate of the developed world. Booming Russia's money supply has swelled by a breathtaking 42%. Whatever the niceties of "core" versus "non-core" inflation, central bankers need to put a brake on monetary supply.
The Return of Inflation: Statistics, Perception, and Expectations
But it turns out that inflation -- and how we calculate, perceive, and relate to it -- is much more complicated than it seems at first blush. Take the calculation of inflationary statistics. In the United States, several government agencies track competing measures of inflation. Among those agencies are the Bureau of Economic Analysis (BEA) and the Bureau of Labor Statistics (BLS), both part of the U.S. Department of Commerce. The Fed uses the Personal Consumption Expenditures (PCE) when setting economic policy. Nor are these methodologies etched in stone over time. Some analysts have calculated that by using the same methodology as was used in 1983, inflation in the United States today would be around 11.6%. And in 1998, the Clinton administration adopted yet another new methodology, employing "hedonic pricing." By moving the statistical goal posts, inflation bean counters have lowered the official rate of inflation at the stroke of a pen. Just imagine how meaningful statistics coming out of Russia and China must be.
And our own perceptions of inflation are woefully distorted. We have a tendency to notice price increases in more frequently purchased items more than a drop in less frequent expenditures. High-frequency spending items such as gasoline, food, education, and medical care make up 50% of the CPI. These prices are rising at a weighted average rate of 6.8%. But 20% of the CPI consists of low-frequency items such as furniture, appliances, and vehicles that are actually falling at a -0.7% rate. If you don't believe me, just check out today's price on the flat screen TV you bought a year ago on Amazon.com.
These misperceptions feed into crucial, inflationary expectations. If workers expect higher inflation and demand higher wages, firms will raise prices to compensate. And higher inflationary expectations threaten to trigger a wage-price spiral, as they did in the 1970s. U.S. consumers, on average, expect prices to increase 5.2% in the next 12 months, the highest level since 1982. But because the economy is weak and unemployment is rising, the conditions are not yet in place for a genuine wage-price spiral. But higher prices at the supermarket and gas stations across the globe have certainly put global policymakers on notice.
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