Wednesday, March 07, 2007

Fed Big Flunks Eco 101

Globalization hasn't had a significant impact on reducing inflation in the U.S. and may have raised it, Federal Reserve Chairman Ben Bernanke said.
—Wall Street Journal

During the market swoon early last summer I defended the new Fed Chairman while he was being roundly blamed by frustrated investors for everything wrong with the world, short of global warming (see "Shooting the Messenger," June 6).

Things settled down shortly thereafter, and until recently Mr. Bernanke was looking pretty good, what with the relentless melt-up in global equity markets and the evaporation of risk premium in the global credit markets.

But a recent speech—quoted above—makes me wonder if Mr. Bernanke has spent too much time reading his press clippings lately and too little time listening to earnings calls from American corporations.

Is there a CEO in America who believes the following?

Mr. Bernanke... said increased trade with China has reduced U.S. inflation, now running at about 2%, by only about 0.1 percentage point. And he noted that while these emerging economies have added to the global supply of manufactured goods, they are also adding to the demand for oil and other commodities.

"There seems to be little basis for concluding that globalization overall has significantly reduced inflation in the U.S. in recent years; indeed, the opposite may be true," he said.

If you quoted those words to my friend who runs a supplier of office products to Wal-Mart and other Big Box retailers, he'd probably spit out his coffee all over his Wa-Mart invoices.

Those invoices, at least on a per-unit basis, did done nothing but go down for the last decade, after Wal-Mart abandoned its “Made in America” campaign and began to enforce a constant price squeeze on its vendors, aided and abetted by the opening up of dirt-cheap manufacturing capacity in China.

That virtuous circle of Big Box retailers pushing down consumer prices and taking greater market share, thereby acquiring even greater pricing clout and greater market share, was the single biggest driver of disinflation ever witnessed in our lifetime. Wal-Mart executives even make presentations to analysts showing how they've helped force down prices of everyday, humdrum products such as vacuum-cleaners and microwave ovens by as much as half over time.

How Mr. Bernanke could dismiss it out of hand is beyond me.

In any event, this is all, unfortunately for our own consumer price index, ancient history. The Chinese labor arbitrage began coming to an end two years ago, and most companies are reporting higher, not lower costs out of that country now.

Which means yesterday’s eye-popping 6.6% unit labor cost increase here in the U.S. might not have been simply a fourth quarter investment banking bonus one-off.

Still, if I were an Economics 101 professor I’d give Mr. Bernanke a D- for this thesis on inflation, or the lack thereof.

Jeff Matthews
I Am Not Making This Up

© 2007 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.


hundredyearstorm said...

I saw that and was confused as well. He's basically saying that cost input inflation on the commodity side outstrips cost deflation on the labor side. Given the high proportion of labor as % of unit costs, I find this hard to believe.

He also said that he too believes that CPI regularly overstates true inflation by 50 - 100 basis points. This is just wrong. I challenge ANYONE in America to prove that their personal consumption expenditures are growing at less than 2.5%. For instance I just got a lease renewal from my landlord and my rent is due to rise 11%. Just one anecdote, but there is no way that inflation is being systematically understated.

jmf said...

oh boy.

myybe he should adjust the "core rate" to "core ex china"

here is a good quote on tweking the numbers

"How sad. All governments find it tempting to tweak the numbers they are judged by. But in doing this they deprive themselves of the best guide to future policymaking. And they also create a self-defeating spiral of distrust in which even the numbers they have not tweaked are disbelieved"

Siggyboss said...

Ben believes, or wants us to believe, that what drives up prices is limited supply due to China's appetite. In reality, consumption of resources in China mostly displaces consumption elsewhere and the vast majority of the Chinese are still impoverished. The Fed’s printing of dollars to set multi-decade low interest rates inflated the demand for goods, which then ‘pulled’ prices upward – imagine an auction where a bidder can print money as needed.

Wal-Mart and others kept costs/prices down, but long-term the increased demand from printing dollars overcame such benefits. Ben believes, or wants us to believe, it’s normal for houses to double or triple in value within five years. A typical house should lose value over time because of greater maintenance costs – not vice versa.

Bruschettaboy said...

[If you quoted those words to my friend who runs a supplier of office products to Wal-Mart and other Big Box retailers, he'd probably spit out his coffee all over his Wa-Mart invoices.]

Yeh, but if you had a friend who ran a steelworks, or a capital-goods factory or a coal mine or an oil well, he would say "yeah, about right, China's been good for us", and Bernanke's point is that the two more or less balance out.

David Corna said...

This is just one man's experience but globalization has cost me more money to maintain my backyard badminton court. I have two halogen work lights that are used to light a badminton court in the back yard during the warmer months. The oldest stand-alone light was made in the U. S. and was purchased at a low and reasonable cost. The second stand-alone light was purchased more recently and was manufactured in China. I was motivated to purchase the second light because of the low price. I cannot remember the relative prices of the two lights but they were both quite reasonable. The halogen light bulbs are now made in China. The newer light that is made in China has been the cause of a lot of frustration. The Chinese engineers did not design their lights well. The tripod that supports the light cannot be adjusted so the light has only one height adjustment to the tripod. The older U. S. light is a much better design providing a multitude of adjustments. The original light bulbs for the U. S. light would stand outside all day and night and last at least two (2) Summers (stored in a shed during the Winter). The new light bulbs that are made in China do not burn out, however, the ceramic that is attached to the glass bulb is brittle. The ceramic crumbles easily and then the light bulb has to be replaced. I find it necessary to replace these bulbs twice a season. At $5.00 to $7.00 a copy the cost of the bulbs have matched the cost of the light. I understand that China is graduating 100,000 engineers every year and is gaining on us by leaps and bounds, however, the lamp that was designed by an American engineer over 15 years ago is still a superior design to what the Chinese are doing. I am not aware of any Chinese space shuttle so it is safe to assume that U. S. ceramic engineers are the standard of measure for World Class. In the case of my backyard badminton court, globalization has increased my costs.

David Corna

Tony said...

This self-serving distortion is another Bernanke myth in the making, like his savings-glut thesis. Thanks for bringing this out in the open.

To suggest that China and India coming online has not significantly decreased inflation is ludicrous, and designed to shift blame from the Fed's actions. Those new factories and back-offices must be consuming more than they produce. Yeah, right!

Unfortunately, this kind of falsehood is eagerly lapped up by an financial industry as they profit from the Fed liquidity barrage. The only thing I can't figure out is whether Bernanke is misguided enough to believe it himself.

spikedblood said...

"And he noted that while these emerging economies have added to the global supply of manufactured goods, they are also adding to the demand for oil and other commodities"

I think you're completely ignoring the second half of Bernanke's argument. In the same time period that we were all lucky enough to buy a 30 dollar microwaves the amount of dollars spent driving around to buy all that cheap crap (I agree, it has gone down in quality across the board), has doubled. And only speaking for myself, I spend considerably more on gas or energy in general, than I do on all my price eroding consumer goodies by a large margin.
One million barrels of crude a day in this market can make a substantial difference in the price. True china isn't the sole cause, but a good arguement could be made that if chaina wasn't making the 'stuff' for the world they would be using much less oil.

Jeff Matthews said...

But the Fed leaves food and energy out of the CPI equation.

So the very cost increases he talks about are not included in the numbers.