Consumer prices excluding food and energy

Danger: inflation ahead.

Later this week, Federal Reserve Chairman Ben Bernanke will present his semi-annual report on monetary policy to the Congress. In it he will probably go to great lengths to reassure policymakers that the Fed intends to keep flooding the economy with liquidity for a while longer.

But instead of keeping the pedal to the metal, Bernanke should be talking about hitting the brakes.

Even though unemployment is high and business has lots of spare capacity, inflation has returned -- although you wouldn't know it from a glance at the behavior of the consumer price index.

However, if you examine the CPI more closely, you will see a different picture altogether. Among other things, this means looking at the top-line number, which includes food and energy.

The so-called "core" rate of inflation, which excludes food and energy, is misleading. You know why? Because we all consume these items -- they are part of everyone's cost of living.....

Nouriel Roubini, the New York University professor who forecast the U.S. recession more than a year before it began, said sovereign debt from the U.S. to Japan and Greece will lead to higher inflation or government defaults.

Almost $1 trillion of worldwide equity value was erased April 27 on concern that debt will spur defaults, derailing the global economy, data compiled by Bloomberg show. German Chancellor Angela Merkel and the International Monetary Fund pledged to step up efforts to overcome the Greek fiscal crisis, after bonds and stocks fell across Europe in the past week.

“The bond vigilantes are walking out on Greece, Spain, Portugal, the U.K. and Iceland,” Roubini, 52, said yesterday during a panel discussion on financial markets at the Milken Institute Global Conference in Beverly Hills, California. “Unfortunately in the U.S., the bond-market vigilantes are not walking out.”

Credit-rating cuts on Greece, Portugal and Spain this week are spurring investors’ concern that the European deficit crisis is spreading and intensifying pressure on policy makers to widen a bailout package. Roubini’s remarks underscore statements by officials such as Dominique Strauss-Kahn, managing director of the IMF, that the global economy still faces risks......

Taleb, whose book “The Black Swan” is about how unforeseen
events can roil markets, said that risks are greater now than
before the financial crisis that led the U.S. economy to the
worst contraction since the 1930s.

“The same fragility is still there,” he said. “I have
detected fragility in the banking system and fragility in a lot
of areas of economic activity. The risk has in fact increased.
I’m extremely worried about government debt. The perception of
hyperinflation is going to penalize real estate, it’s going to
penalize the stock market, penalize companies......

“A year and a half after November 2008, the Obama
administration doesn’t still realize the magnitude of the
problem,” Taleb said. “The problem was debt, and you don’t
cure debt with debt......

.....“Use the stock market for entertainment,” he said. “The
stock market has disappointed people making retirement plans,
thinking that it would appreciate over the last decade. If you
have long-term treasury bonds, get out of it. A good collection
of metals would work, or agricultural land.”

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(Money Magazine) -- Now that Europe's financial markets have hit a giant speed bump, raising fears that the U.S. recovery could also stall, inflation probably isn't something you're worried about today. But when it comes to the threat of rising prices, there are a couple of things you should know.

The first is that the planet's smartest investor is worried about inflation. I recently had the pleasure of attending the annual meeting of Berkshire Hathaway in Omaha. Normally at these events, Warren Buffett balks at making broad macroeconomic pronouncements -- he once called economic forecasts a "distraction" for investors. But this time the Oracle of Omaha came out and said "the prospects for significant inflation have increased, not only here but around the world."

Did he predict when inflation would rear its ugly head? Nope. But the other thing you need to know about inflation is that if you wait until steep price jumps actually show up in the economy, it will be too late and costly to protect your portfolio.....

Warren Buffett shortened the duration of bonds held by his Berkshire Hathaway Inc. after warning that deficit spending could force inflation higher.

Twenty-one percent of holdings including Treasuries, municipal debt, foreign-government securities and corporate bonds were due in one year or less as of June 30, Omaha, Nebraska-based Berkshire said in a filing Aug. 6. That compares with 18 percent on March 31, and 16 percent at the end of last year’s second quarter.

“It may be a sign that Buffett expects interest rates to start rising, maybe sooner than the conventional wisdom,” Meyer Shields, an analyst in Baltimore at Stifel Nicolaus & Co. who has a “sell” rating on Berkshire, said in an interview.

Inflation has fallen to a 44-year low even as the Federal Reserve more than doubled its balance sheet in two years to $2.33 trillion to help draw the economy out of recession. A U.S. jobs report last week showing that companies hired fewer workers than forecast in July pushed the two-year Treasury yield to a record low. Bill Gross, founder of Pacific Investment Management Co., advised investors to buy longer-dated maturities.

Buffett, 79, urged Congress last year to guard against inflation as the U.S. economy returned to growth. In an August 2009 op-ed in the New York Times, the Berkshire chief executive officer said government must address the “monetary medicine” that was pumped into the financial system after the 2008 crisis......

When Fed Chairman Ben Bernanke admits to seeing an "unusually uncertain" economy ahead, it's pretty terrifying to imagine what he's really thinking. What John Williams envisions—and he's by no means looking to the far horizon—is a systemic collapse, a hyperinflationary great depression and the cessation of normal commerce. Despite that bleak outlook, however, when the economist and editor of ShadowStats.com sat down for this exclusive Energy Report interview, he also had some good news.

The global economy is like fried ice cream: If you don’t act fast, it turns into a mess.

American pundits, Nobel laureates included, are predicting Japan-style deflation for the U.S. and Europe. They are urging the Federal Reserve to pursue another round of quantitative easing to stop the onset of an Ice Age for Western economies. The Fed didn’t oblige at its last meeting, but it threw a bone to the deflation crowd by promising not to pull money out of its previous round of asset purchases to stimulate a recovery.

On the other side of the world, consumer prices are surging. Emerging markets as a whole now have an inflation rate of more than 5 percent. India is registering price increases of more than 13 percent. China’s are more than 3 percent. But it surely feels a lot higher for average Chinese.....

Europe’s sovereign debt crisis seems to have gone on holiday along with most of the rest of the Continent during August. But many economists warn that the underlying debt problem is merely in remission and could recur at any moment, once again upsetting world markets.

Joachim Fels, co-head of global economics at Morgan Stanley, talked Thursday about how Europe is ultimately likely to deal with excessive debt in Greece, Spain, Portugal and several other countries. His answer boils down to one word: inflation.

What’s more, though Mr. Fels did not go so far as to say that inflation would be a good thing, he also did not make it sound as if a modest rise in prices would be such a bad thing, either.

Over coffee with a handful of journalists at the Morgan Stanley offices in Frankfurt, Mr. Fels argued that the European Central Bank and United States Federal Reserve are already exporting price pressures to the many countries in Asia, Eastern Europe or Latin America that peg their currencies to the dollar or euro.

The central banks’ record-low official interest rates, designed to help European and American banks recover from the financial crisis and to stimulate growth, are too expansionary for fast-growing developing countries, Mr. Fels said. Inflation there will ricochet back to Europe and the United States in the form of higher commodity prices......

The Fed voted two weeks ago to print money as much money as they think is necessary to fight deflation, economic decline, and rising unemployment. It is a major policy change little noticed by the media.

There has been a lot of noise in the media lately about deflation. While a few of us have been forecasting deflation and a decline in the economy for some time (your truly since December, 2009), it is as if most economists had just discovered it.

The reason for all this concern is the weak economic data coming in:

Jobless claims jumped to a 9-month high which forecasts rising unemployment.
Consumer spending is softening.
Disposable income is flattening.
New manufacturing orders are declining and inventories are rising.
Durable goods orders are falling.
Credit continues to shrink, both for consumers and businesses.
GDP was revised downward for Q2.
The Consumer Confidence Index took a big slide.
Commercial and industrial real estate is still declining.
Home sales continue to decline.
Some of the leading indicator indices are falling, such as the ECRI and the Consumer Metrics institute.

There are two more data points that really have the Fed concerned. One is that the Consumer Price Index is very low. While you would think that low rates of inflation are good, the Fed wants inflation......

The U.S. has a “realistic possibility” of falling into a Japanese-style economic slump, said David Wyss, chief economist at Standard & Poor’s.

U.S. consumer prices, excluding food and energy, increased less than 1 percent for a fourth month in July, Labor Department data showed, while Japan’s so-called core inflation rate has remained mostly negative since September 1998.

“I think there is still a realistic possibility in the U.S. that it’s slipping into this pattern like Japan has -- 10, 20 years of stagnation,” Wyss said at a seminar in Tokyo today hosted by the Securities Analysts Association of Japan. “A rising population in the U.S. creates more need for capital, more need for housing, which makes deflation a little less likely, but I’m not sure if that makes it impossible.”

Deflation, or a drop in general prices, increases the value of fixed payments from bonds. Prices for U.S. debt have surged this year, driving yields on 10-year Treasuries to 2.53 percent on Aug. 20, the lowest since March 2009. Rates on similar maturity Japanese debt are near the least since 2003.....

A report by the Federal Reserve Bank of New York last week showed that consumers are having difficulty climbing out of the debt hole they dug for themselves before the credit bubble began to deflate in late 2007. The report gives support to the fears of those asset managers and economists who believe the U.S. is facing deflation.

Bill Gross, manager of the $239 billion Pimco bond fund, is one. His evidence is that the Consumer Price Index (CPI), annualized over the last two years, has fallen slightly.

Since deflation, in simple monetarist terms, means too little money chasing too many goods, with a consequent fall in prices, the remedy should be easy. Can't the Federal Reserve create as much money as it wants with just a few key strokes? Well, there are some things money can't buy. In political circumstances like today's, one of them is public confidence.

In fact, the Fed has been fighting deflation for nearly two years. It began pumping new money into the economy after the September 2008 stock market crash to restore liquidity in the financial system. It has kept the pumps running by maintaining a near-zero interest rate target. Its net purchases—with newly created dollars—of government and government-agency bonds have totaled some $1.4 trillion, expanding its balance sheet to $2.3 trillion. As the Fed pumped out new money, member bank reserves ballooned and now exceed $1 trillion. That means a vast amount of money is on deposit in Fed accounts, ready to be flooded into the economy if loan demand increases.

So what's the problem? Here it is best to depart from monetarist terminology, with its heavy emphasis on the magical powers of the central bank. Those magical powers are highly overrated, as almost anyone who has ever run a central bank will likely tell you. The Fed can flood the banks with liquidity in an effort to stimulate economic growth (if it is willing to run the very serious risk of inflation). But that will not necessarily stimulate a demand for this money.

What's missing in these times is a strong desire among businesses and consumers to take on new debt, low rates notwithstanding. Corporations can't even decide what to do with all the surpluses their businesses are generating; they are sitting on vast amounts of cash even though it is earning them minimal investment returns. Because business's "animal spirits" are suppressed by caution, private-sector hiring is weak, which means the unemployment rate is likely to remain high. As the New York Fed report shows, householders on balance are struggling to pay off the debts piled up during the 2003-2007 credit binge and are building up savings. Consumer spending is relatively flat.

The key word here is "uncertainty." The Obama administration and Congress have dumped a huge load of highly dubious new legislation on Americans, much of it unread even by the legislators who voted for it. ObamaCare is an attempted federal takeover of a vast and complex industry. No one really knows how much chaos the financial sector "reform" act will generate. Hyperactive zealots in federal bureaucracies such as the Environmental Protection Agency have been unleashed to do silly things like attempt to reduce the planet's supply of carbon dioxide.

A massively expensive federal "stimulus" program failed to stimulate for the easily predictable reason that the money the government spends on its political projects robs the rest of the economy of resources. Opinion polls show that the soaring federal deficit is of major concern to voters, as it should be.

State and local governments are, on the whole, in terrible financial shape, which means that they will likely be shedding employees and adding to the ranks of the unemployed. The only remedy the Democrats have for cutting the deficit is higher taxes, which in a weak economy likely would be counterproductive.

As a rotating member of the Federal Open Market Committee, Dallas Fed President Richard W. Fisher helps guide national monetary policy. He addressed the uncertainty issue in a recent speech to the San Antonio Chamber of Commerce.

The prevailing sentiment among business leaders he surveys monthly, Mr. Fisher said, is that "the politicians and officials who craft and enforce the rules are doing so in a capricious manner that makes long-term planning difficult, if not impossible. They are increasingly distressed by the lack of consistent direction coming from Washington. . . . So they are calling time-outs and heading for the sidelines while they wait for the referees to settle the rules of the game."

He added that no amount of further monetary accommodation can offset the retarding effect of heightened uncertainty. Indeed, it would make matters even worse if the private sector concludes that the Fed has become "politically pliable and is prone to substitute such accommodation for fiscal discipline." Who would ever think that?

Getting back to Mr. Gross and his fears of deflation, it should be noted that he stacked the deck in referring to a two-year average, since that includes the brief period after the 2008 crash when the CPI fell. The index began climbing sharply at midyear 2009 and was showing nearly 3% inflation by the end of the year. A 0.3% rise in July still signals rising prices.

Since U.S. prices correlate inversely with the dollar's international purchasing power, and since the massive U.S. budget deficit puts downward pressure on the dollar in international markets, inflation surely remains a more serious danger than deflation.

But deflation and inflation predictions could both be right in a sense, if you aren't too fussy about strict definitions. In the late 1970s, the last time Americans suffered from manic interventionism from Washington, we had "stagflation," a combination of minimal economic growth and double-digit inflation. It wasn't pretty.

Stagflation was cured by a set of policies that reversed the Keynesian nostrums then in vogue and that are again the core basis for federal economic policy. In the early 1980s, the Fed tightened money, tax rates were cut, economic regulation was pared sharply and an effort was made to curb nondefense spending. It worked quite well, producing 25 years of economic growth. It will be much harder to repair today's damage, but the need to make another try is becoming urgent.

By Darius Dale, Hedgeye

One question we've been wrestling with lately is: "Where do we go from here?" – particularly as it relates to the commodity inflation you've been reading about for the last few months.

There's a compelling case that the boat has left the dock with regards to global inflation trends. As we've seen with accelerating "Core" CPI readings, particularly in Asian economies like China, Indonesia, and Thailand, companies globally are taking advantage of recent robust global growth trends and bullish growth forecasts to pass price increases through to consumers.

The US, China, Japan, India, Brazil are just a few major economies where consensus growth forecasts for 2011 are much, much too high relative to our models and the current global macro backdrop of accelerating inflation and higher interest rates.

Irrespective of the tired argument between the importance of "Core" vs. "Headline" CPI, the key takeaway here is that even if commodities start to back off their current highs (i.e. if MENA conflict stopped today and crude oil went back down to the $80-$85 range), there is a very high and underappreciated possibility that global inflation readings will continue to accelerate for two main reasons:

May 18 (Bloomberg) -- Investment spending in emerging markets is outpacing expenditures in developed economies for the first time, as a surge in infrastructure supports global growth and profits at companies from Siemens AG to Caterpillar Inc.

The “biggest investment boom of recent decades” will help boost expansion worldwide about 4 percent this year and next, compared with a long-run average of just below 3 percent, according to Michael Saunders, Citigroup Inc.’s chief European economist. International Monetary Fund data show investment will top 24 percent of global gross domestic product in 2012, the most in more than two decades, and then rise above 25 percent, the highest since records began 30 years ago.

Saunders calculates that developing nations will probably secure the largest share of it this year.....