Friday, November 24, 2006

More, Less Cute, Stories about Inflation

A reader once suggested this blog should be called “Cute Stories about Inflation.”

That was his response to multiple pieces over an extended period of time in which I had pointed out the decoupling of government-reported inflation statistics from the actual rising cost of gasoline, heating oil, natural gas, steel, copper, concrete, glass, plastic resin, zinc and other industrial inputs, not to mention health insurance, car insurance, flood insurance, homeowner’s insurance and medical malpractice insurance, plus housing related items such as homes, lumber, appliances, asphalt shingles, cable television—well, you get the idea.

My point was not unique or particularly insightful—after all, many observers had discussed the same thing for some time.

Indeed, some of the more grumpy, perma-bear, gold-bugs I know took it all as yet one more dark sign that the entire system is rigged; that the government puts out whatever statistics it wants to put out in order to make the maximum number of market participants wealthy; and that Alan Greenspan and his successor are nothing more than pawns in a giant game of Squeeze-the-Shorts.

And for a while it looked like the Conspiracy Theorists might be right, because despite the persistent rise in the cost of all those aforementioned items, the various price indices—particularly when “adjusted” to exclude food and energy, which the government as well as bond buyers deem too volatile to pay attention to—stayed at or near historic lows for longer than it seemed possible

All the while, the consensus in The Market held that as long as America’s 100 Million Dollar CEOs could keep outsourcing not only manufacturing but also, as in recent years, telemarketing, contract research and anything else that didn’t threaten their own bloated pay structure, then the wage growth of working stiffs in the U.S. would remain close to zero, and the “core” inflation rate—unlike the South—would never rise again.

Now, for the record (and for those who grew weary of my “cute stories about inflation”), I actually posted the last of my inflation updates in May—six months ago.

It was called “Don’s CPI,” and it reported on the fact that Don, my car guy, had raised his prices by 6%. This meant two things: it meant that instead of costing us $700 every time we take in a car to Don's, it was now going to cost us $742; and it told me that inflation was real, it was happening, and it was here to stay.

(It’s true: no matter what we take a car in for—oil change, wiper blade, tune-up—it used to cost $700, which is now $742. But Don does great work, and the way I see it, cars are life-or-death conveniences, not toaster-ovens. So I don’t screw around when it comes to keeping them in shape, nor do I begrudge Don sending his several fine children to college on us.)

Around the time of that piece there was a coincidental awakening of the bond market and the Fed to higher inflation rates creeping into government statistics, adjustments or no adjustments. This spooked the markets and led to an extended and hopeful debate as to when the bursting of the U.S. Housing Bubble might ease the upward price pressure.

Since everybody else was talking about inflation, I decided to let sleeping dogs and “cute inflation stories” lie.

But now that the Housing Bubble has been burst in a far more spectacular manner than generally expected, markets appear convinced all is well and inflation is contained, and I feel the time is right to pass on another, not-so-cute inflation story.

It comes from a private equity guy whose firm owns several companies in the heartland of the American industrial supply chain.

And one of his companies with operations in the still-hurricane-rebuilding Gulf Coast recently raised wages 12% in order to retain workers it was not otherwise able to retain, owing to the many better offers they were receiving.

This was not, I should make clear, a 12% wage increase for a CEO or a CFO, which nobody at the Fed or in the bond market or at the White House would blink an eye at.

This was a 12% wage increase for hourly American workers whose jobs can not be outsourced, no matter how fast the T-1 line between Bangalore and Chicago.

I should also note that according to my contact, the company in question was able to raise prices to cover that wage increase, “no problem.” Lest you think this data point should be dismissed because it covers just one company in one region of the country, my private equity contact tells me all his portfolio companies have likewise been able to put through price increases with no resistance.

For the record, the current 10 year rate is 4.6%.

A year ago August—in response to a snide question about when I was going to put my negative views on the U.S. Housing Bubble into the form of a market call on homebuilding stocks, which is something I am not in the business of doing here—I wrote that ‘anybody who buys a house they don’t need is an idiot.’

I don’t think that was bad advice.

And while I am no more inclined to make a bond market call today as I was making a homebuilder call back then, I'll say this: given the accelerating rate of wage increases in the U.S., the rising cost of products sourced from Asia, and the global call on natural resources that's keeping prices high despite the collapse in spec housing in Reno Nevada and condos in Miami Beach, I have now come to think—for what it’s worth—that anybody who buys a bond they don’t need is, down the road, going to regret it.

Perhaps, some day, those grumpy, perma-bear gold-bug friends of mine are going to be right.

Jeff Matthews
I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.


russell120 said...

I like the stories. You shouldn't be so sensitive.

This article shows the difference between the nominal and real profits of distributors. It goes a long way toward explaining the illusion of our "strong" economy. I would be very careful with the idea that the current demand for construction materials is real. It has much of the earmarks of inflationary driven demand.

Logicalthought said...

I'm not so sure I agree. I think the current wage pressure is mostly due to businesses' ramping up for demand that is about to no longer exist, thanks to to a delayed reaction from the ongoing housing crash. Thus, I think our economy is about to fall off a cliff, and this-- combined with a resulting slowdown to at least SOME extent in the rest of the world-- will relieve the worldwide pressure on commodity prices. The only domestic caveat I see to this is the inflationary effect of a falling dollar. If the dollar really tanks (which has been a distinct possibility for a long time, but even a stopped clock is occasionally right), the Fed will wind up between a rock and a hard place, interest rate-wise.

Aaron Koral said...

"...anybody who buys a bond they don’t need is an idiot."

I wonder whether, given the rise in prices across various industrial goods and personal services, investors need longer-dated TIPS (Treasury Inflation-Protected Securities) as opposed to needing 'junk' bonds? I think, given the yield spread between junk bonds and Treasuries , one would be an "idiot" buying "junk" in this economic environment, but my opinion could be wrong.

CurmudgeonlyTroll said...

UPS to hike base rates by 6.9%, reduce fuel charge 2%.

No inflation to see here, move along.

Jeff Matthews said...

That was noted in "Goldilocks Napping."

Laurent GUERBY said...

An email exchange with the BLS economists on the way inflation is measured and why raw price data is kept secret.

RichL said...

Earlier this year I had a glimpse of the future, and it was next to my doctor’s office. I needed to get blood drawn for a regular physical, so I went to the office early in the morning. The waiting room was FULL. The wait was long because the office couldn’t get enough medical technicians to do the work.

The baby boomers are getting older, and the demographics suggest that there will be fewer med tech workers in the workforce relative to the number of retired babyboomers. My belief is that in the not-too-distant future the nurses and other service employees will be in a much better position to demand wage increases. That cannot be positive for inflation, or bonds.

slackful said...

gee, i wonder if anyone in the Chinese financial hierarchy reads this...nah, besides, they don't own that many US bonds

Shooter21 said...

My "Real World" Inflation Indicator

My best anecdotal inflation indicator is my barber, who has been cutting hair on the same street corner, in the same town, in the same non-descript building, with the same partner for almost 40 years. When I first starting going to this barber ten years ago in 1996, the standard cut was $6.00 (This barber offers two haircuts: 1. short and, 2. extra short!). Grudingly, prices were raised to $7.50 about three years ago. After a few month hiatus, I recently visited my barber for my typical "short" haircut. Prices? Now it is $9.00. This is from a barber that bitches and moans about raising prices partly because it means he'll have to re-write his abbreviated price board. A haircut is about the most basic service provided in our economy. This means that despite, what I am sure are attempts to hedonically quality-adjust this inflation downward, the price of the same haircut today has gone up 4.1% annually (from $6.00 to $9.00) over the past ten years, and about 7.0% (from $7.50 to $9.00) over the past 3 years.

Perhaps the reason why this has not registered with the Fed is that both Greenspan and Bernanke don't need much in the way of haircuts!

walterwego said...

Is the industry the 12% wage occurred in a secret?
Hmmm - gulf coast, high oil prices - let me guess - oil drillers!!! Any prize?

And yet the Katrinians still can't find a job.

Sam S. Park said...

Here's some hard numbers to back up your wage pressures, but don't really support the idea that the Fed moves in-line with wage growth. Year-over-year weekly earnings growth was over 4% since June ‘06. The last time wage growth hovered above 4% was back in 1997 into 1998.

The thing is... the Fed didn't raise rates at this time. They actually lowered rates late 1998 but started raising rates in 1999 to 2000. Then again, year-over-year wage growth does have almost a 75% correlation to effective fed funds rate over the past decade.

Wage growth on core CPI didn’t react as you would think through mid-90s. However, the relationship is showing some high correlation over the past four years. Perhaps that whole productivity factor isn’t as strong anymore.

Computers and technology did wonders in the 90s, but how much more can we really expect tech to improve productivity? I doubt Microsoft’s Vista will do much for me regarding further productivity. The dollar has been falling, which won’t do any good for import inflation. Also, I hear more and more about protectionist-like policies coming out of Washington. No inflationary pressure… right. Hopefully, things won’t be that bad.