Fears of inflation in the United States are justified if you ask the European Central Bank

Whilst considering the position of inflation linked securities in the United States and their recent performance a thought occurred to me about the differing views on the subject of inflation of the heads of two of the worlds main central banks. These are Ben Bernanke of the US Federal Reserve and Mr. Trichet of the European Central Bank. My contention is that the inflation performance of the two underlying countries/regions is much more similar than you might think from reading the mainstream media. I wrote on this subject on the 2nd of July when I discussed the inflation indices used in the United States and pointed out that the Bureau of Labor Statistics in the US does calculate an inflation index on the same basis as the Consumer Price Index used in both the UK and Europe. This is called the HICP or Harmonised Index of Consumer Prices.

Mr.Trichets View

At the latest Press Conference for explaining the policy decisions of the European Central Bank Mr. Trichet expressed satisfaction that the latest figure for Consumer Price Inflation was 1.9% in the Euro zone and he went on to say that not only was this on target but he expected this situation to continue. In his answers to questions he went further.

Well, there are German citizens in this room. They can say that the euro has given the 330 million citizens of the euro area, including their compatriots, price stability, with inflation standing at 1.97%. Nobody ever challenges this when I say it. In Germany, the figure is even better. For Germany, inflation has stood at around 1.5% since the inception of the euro, the best result for Germany and indeed the euro area as a whole in 50 years. Frankly, for an institution that was called on by the citizens of Europe to have a primary mandate of delivering price stability, I think this is worth repeating.

Although the ECB website does not make this entirely clear he was referring to the inflation performance in the Euro zone since the inception of the ECB as well as current figures. There is of course a danger of hubris in concentrating on slapping oneself on the back about inflation performance at a time when some of the consequences of the decisions which helped to achieve it have caused such financial distress in some of the peripheral Euro zone countries. However UK citizens would be much happier if their central bank was capable of hitting its inflation target in the way that the ECB has and over not dissimilar time periods the ECB’s inflation performance stands out in recent years as being far superior. However my main point today is to say that the head of the ECB is very happy with an inflation rate of 1.9% and an average over the ECB’s life of 1.97%. As an aside it is quite refreshing to have a central banker concentrating on the day job!

The American position on inflation: Ben Bernanke and the Federal Reserve

Rather than being happy with the inflation performance in the United States Ben Bernanke has expressed himself to be unhappy with it. He wishes to raise the level of inflation in the US economy as measured by its own Consumer Price Index. I discussed what I consider to be the main flaws in this index back on the 2nd of July in my article on it. At this time it is rising at 1.2% on an annual basis and Mr. Bernanke has embarked on a policy to try to raise it to more like 2%. He and the other members of the Federal Reserve have committed themselves to spending an extra US $600 billion on asset purchases (of US government debt/bonds) to try to help this happen. They have also discussed more aggressive policies such as attempting to catch up on the period where US inflation on this measure has been below 2% which would involve a boost of around 8% to the overall level of CPI.

Measuring US inflation the European way

If we do this we come up with some surprising results. The latest figure calculated by the Bureau of Labor Statistics is for October and it was for an annual increase of 1.8%. So not only is this very near to the target but it is also very close to the figure that Mr. Trichet at the European Central Bank considers to be such a success he crows about it. This gives us a somewhat different inflation picture to the one painted by Ben Bernanke but let me give you the figures for the rest of 2010 to ram the point home. In the first quarter 3.6%, in the second quarter 2.8% and in the third 2%. It seems even less like a number that needs to be boosted now.

Comment

As you can see from the figures I have quoted above measuring US inflation the European way gives a very different picture of the situation. It also puts a very different emphasis of the expansionary programme of asset purchases that he has embarked upon as on this measure they cannot be for the purpose of raising inflation to its target as it has been above it for most of the year and is now only just below it. We also see a most extraordinary divergence in policy between the US and the Euro zone from what are currently similar figures and in fact in 2010 have shown a higher performance in the US! They cannot both be right.

I also wish to point out that in my experience the HICP or European measure of CPI has led to an under measuring of inflation in the UK since it was introduced in the UK. It has been persistently below the previous measure called Retail Price Inflation and as I type this it is running at 1.4%. I will leave you to draw your own implications as to the possibility of this being also true in the US and the link to the Federal Reserve’s policy.

There is an American economist John Williams who calculates his own inflation indices based on the way that the United States used to calculate inflation before changes were made to it ( mostly in the Greenspan era). On his measure US inflation is in fact over 8%. Should he be right then Ben Bernanke is embarking on a very dangerous experiment, as a policy to raise inflation above 8% looks potentially suicidal. I will be interested in American readers thoughts on what the level of inflation is in their experience.

UK Producer Prices: more problems at the Office for National Statistics

Here is todays report from the Office of National Statistics.

Output price ‘factory gate’ annual inflation for all manufactured products rose 3.9 per cent in November. Month on month the output prices measure for all manufactured products rose 0.3 per cent between October and November, mainly reflecting price rises in petroleum products, food products, and computer, electrical and optical products.

But we also got.

Quality assurance by ONS revealed potential errors in some input prices in the Producer Prices dataset.

This is at best very embarrassing for the Office of National Statistics. It was only last month we found it making methodological changes to its calculations of these numbers and now suddenly it has such problems it cannot publish part of them. To use their own words “Figures for PPI this month are the first based on Standard Industrial Classification 2007”. There was an obvious problem immediately as I highlighted on the 19th of November in that this new classification has led to a reduction in the recorded numbers. Having looked back at them my estimate of producer price output inflation for November on the old basis is 4.5% or some 0.6% higher than the new measure. I will leave you to your own thoughts as to why and how this has happened. Throughout 2010 producer price inflation has proved to be a persistent problem on both its measures in the UK and has been a signal for problems with consumer inflation, in spite of the efforts of the ONS to use methodology to change this, it looks as though we have a continuing problem.

I try to be nice to the Office of National Statistics as I feel that in many respects it has a difficult job as it tries to do it as best it can. But as time goes by it is having ever more problems both with the way it presents numbers and the way its methodology changes which always seem to act in the same direction. Much more of this and it is in danger of being regarded as something with very little credibility at all and it does nothing for confidence in the UK economy.

UK Trade Statistics

Regular readers will be aware that in my experience trade statistics are perhaps the set of figures which are most volatile and unreliable over time. They are often heavily revised and the revisions which can happen some years later can completely change the message sent by them. For example many years after the event of the devaluation of the pound in the UK in 1967 it was discovered that the trade figures were in fact much better than the ones which led to the devaluation and accordingly that it may not have been necessary!

Accordingly I place very little weight on monthly trade statistics. However if you look at the UK’s overall performance since 2007 and then consider the depreciation of around 25% that took place in the early part of the period then you would hope, I think, for our trade performance to be better than it is now. The recent improvement in the UK economy with stronger growth figures appears to be leading to a rather familiar achilles heel of a rise in imports. Let us hope that the recent suggestions of an improvement in UK manufacturing will help with our export performance. Although on a conceptual level I am left with the troubling thought that at this time almost everyone is trying to export more and that unless we find some extraterrestrial trading partners it is a zero sum game, for every winner there is a loser.

Across the other side of the world China has produced  a strong set of trade figures. Now their figures are unlikely to be any more reliable than ours but again we appear to be returning to known trends. And in a linking of the components of todays article it is leading to more inflationary fears in China as we await her latest inflation figures which are due tomorrow and I am aware that this means they will be released on a Saturday.

The Deflation/Inflation Conundrum

In recent times economics has polarised itself in something of a deflation/inflation debate. My contention here is that there are inflationary forces at play in the world and if you use the methodology of the European Central Bank, the United States with the asset purchases of its central bank and its latest fiscal stimulus from its government is taking something of a risk with it. Should Mr. Williams be right with his figures for US inflation then the policy moves start to look outright reckless.

In my view that does not mean that there are not deflationary influences too at work. For example there is plainly evidence of deleveraging in many of the worlds banking systems and problems in several parts of the Euro zone. Accordingly going forwards I expect the world to suffer from both and feel that the polarised world of economic textbooks and theoretical economics will be a very poor guide to what is likely to happen next and to imply that there is a choice between deflation and inflation is only one of many alternatives facing us and too much time has been spent on it already.

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11 thoughts on “Fears of inflation in the United States are justified if you ask the European Central Bank

  1. Hi Shaun
    So, some themes going forward from this week are : rising long term interest rates in tandem with western deleveraging ; inflationary trends on the upside with Chinese inflation influencing import prices as well as commodity highs. What intrigues me is why we have equity rallies – is it a case of lessening risk quality of equities over bonds or better forecasted future economic growth? Or, are we floating on a QE bubble?

  2. Hi Shaun, I sense that with a number of your points made today, you are ceasing to be quite as condescending and placid as you have tried to be for some long while with US, UK and EU politicians and their antics, tinkering, manipulation, deceit and downright tricks and conjuring; everything they can think of to try to avoid the inevitable and necessary macro-economic correction?

    “I also wish to point out that in my experience the HICP or European measure of CPI has led to an under measuring of inflation in the UK since it was introduced in the UK.”

    “On his measure US inflation is in fact over 8%. Should he be right then Ben Bernanke is embarking on a very dangerous experiment, as a policy to raise inflation above 8% looks potentially suicidal.”

    “This is at best very embarrassing for the Office of National Statistics. It was only last month we found it making methodological changes to its calculations of these numbers and now suddenly it has such problems it cannot publish part of them.” Yet again of course, since this is not by any means the first time!

    “I try to be nice to the Office of National Statistics as I feel that in many respects it has a difficult job as it tries to do it as best it can. But as time goes by it is having ever more problems both with the way it presents numbers and the way its methodology changes which always seem to act in the same direction. Much more of this and it is in danger of being regarded as something with very little credibility at all and it does nothing for confidence in the UK economy.” At last the nice man’s patience seems to be running out, as he sees that the tinkering is all one way – to attempt to make facts look much better than they really are?

    “My contention here is that there are inflationary forces at play in the world and if you use the methodology of the European Central Bank, the United States with the asset purchases of its central bank and its latest fiscal stimulus from its government is taking something of a risk with it. Should Mr. Williams be right with his figures for US inflation then the policy moves start to look outright reckless.”

    Well, it had to happen! Soon you will be reporting it like it really is rather than as an apologist, modern economic specialist, who partly acknowledges that it is OK for politicians to continuously distort economic realities to keep their form of enforced Socialism going nicely? You could be getting more like Max Keiser soon, I suspect? (Don’t take me too seriously, but it is good to see.)

    • You bring this up the one time there is a compliment-re: ECB’s inflation target. Though the last time I can remember an explicit compliment was when happened was when seemly Ireland was acting decisively to avoid the crisis, so maybe not a good omen.

  3. My own very gut feelings is that the US faces far greater problems than the EU mainly because their approach to their problems doesn’t make any sense in that they appear to be attempting to reestablish a failed system.
    Then there are things normally regarded as strengths by more competent people. For instance: single leadership, which might be a myth in view of recent events; the fiscus which is under this leadership; the ability to print money and apply it to all regions of the US,similar in fact to Europe and its piglands, but without debate; and finally the strongest case is the control of the major international reserve currency. This last strength, when it goes, will go quickly, and I believe we are seeing the beginning of this unwinding with bilateral agreements between countries to pay in their own currencies. In fact the only thing keeping the US financial system together is the fact that too many countries have too many USD in their reserves. How long will that take to unwind? I have heard respected economists here in S Africa suggest that the government stop exporting gold because of their fear for USD stability.
    Maybe British blog sites talk so much about the Euro and the EU is brought about by proximity. I do believe that a more critical eye should be turned towards the US.

  4. Again, thank you Shaun for your excellent, daily thoughts. I first stumbled across your blog from a comment made on Stephanie Flanders’ blog at the BBC, and haven’t gone back their since. However, I have today admit that I visited the “dark side” (sorry, won’t happen again!), and would welcome others thoughts on her latest article. It was quite apposite as she was discussing the ONS.

    In it, Stephanie asks if there is anything unusual in the GDP data released by the ONS throughout this year, where it was reported that the construction industry has powered ahead. If I’m not too mistaken, most commentators believed that this was due construction projects being delayed at the beginning of the year, due to the bad weather. Then people were surprised that the figures, again, increased in, I believe, Q2 or Q3.

    One sentence that did catch my eye in her article was, “Construction has accounted for 40% of the UK’s economic growth in the past two quarters, even though it accounts for just 6% of the economy.”. If these two figures are correct, how can construction be motoring the economy along? I would be grateful for anyone’s thoughts.

    Thanks very much.

    Robert

    • Hi Robert
      Thank you for your compliment. As to other blogs I decided when I started that I would not get involved in discussions about them good or bad, and as to links on here as I am sure you have seen I am relaxed about regular contributors posting them if they feel they add value. So please feel free to read what you like!

      I did write on the subject on the 27th of August.
      “Whilst I have been typing this article the revised figures for growth in the second quarter of 2010 for the UK have been issued by the Office for National Statistics and they indeed show a rise to 1.2% from the originally reported 1.1%. My suggestion is for UK readers to smile and enjoy the numbers for a moment and hope we can keep such growth going. As to the breakdown of the numbers they do rely on construction spending growth which was revised upwards from 6.6% to 8.5%. At the time of the initial estimate there were questions about the 6.6% growth rate which I suspect will be repeated with more force now. Should the numbers be true it hardly represents a rebalancing of our economy away from housing does it? But in these times we should be grateful for any scrap of growth and then enquire as to how such exceptional numbers for construction can be explained.”

      So my position this was a some skepticism but also an adoption of my principle that you accept numbers until you have good reason not to. When I did a little checking the reports I got back were that construction had indeed done well but still an element of doubt if it had done that well.

      However if one stops and thinks for a moment I think that there is a bigger fish to fry as the real question to my mind is what growth we will get going forwards. It is unlikely that construction will continue to expand at the rate recorded in Q2 and Q3. Also bigger influences on our economy are not looking quite so good. For example of the 0.8% growth recorded in Q3 around half of it or 0.4% was from net trade which after the recent trade figures may be in doubt going forwards ( in so far as you can tell anything from monthly trade figures….).

      I remember writing as one of my first posts about the unreliability of growth statistics as represented by GDP figures. My point then was that we are engaging in something of a false debate as the spot number should come with a range as to where we expect the number to be. For example if we had 0.4% to 1.2% it would look quite different to 0.8%….

      As a final point we are never actually certain that the numbers ever become completely accurate merely that we hope that more information over time makes it more likely to be so. Also looking back at my articles from a year ago one or two appear to have disappeared so I will check with wordpress as to what may have happened.

    • Hi Robert,

      Out of interest what you think the role of the BBC news editors should be?

      Flanders, Peston and Nick Robinson all act differently which can be seen in their respective blogs.

      Regards,
      Fletch

  5. Have no pearls of wisdom or even apposite questions to contribute. However I wanted to post to say thank you for your informative and clear daily articles.

    A few decades or so ago I remember a teacher trying to persuade me that an ‘A’ level in Economics would be just the thing. I had a quick look at the text book and then clutching the Complete Works of Shakespeare in one hand and a paint brush in the other took off, at speed, towards the art department to experience the delights of oil painting.

    I have never regretted the decision but was often left completely puzzled at what on earth is going on out there. Finding your blog has been a delight and a revelation. I am an addict. I can now shake my head in despair with the best of them at the antics of central banks and mutter ‘ah, but what about the bond yields’ when intimidating types attempt to squash me conversationally.

    Brilliant!

    • Hi Clare
      Welcome to my part of the blogosphere and thank you for the compliments. I do see it as a success when lurkers emerge from lurkdom and reply….
      As to Shakespeare you probably made a very wise choice after all if you are as popular some 400 years later as you were at the time then you have obviously made your mark. If you can write well about human nature then your work may last as long as we humans do! Perhaps his image of a turning wheel of fortune is required in economic theory, although if it is then we have problems yet to come as where we stand now is clearly not the nadir of our fortunes.
      Put another way good literature is one of lifes pleasures just like music.

  6. Surely the Feds actions are on purpose, the crash happened because asset prices simply got to high relative to the general price level and investors bailed. The only way to fix it is either for all assets to fall in value and write off debts or to inflate the general price level to bring it back to equilibrium and inflate away the debt.

    The US/UK have chosen to inflate and the EU has chosen to deflate.

    It all ends in the same place, it just results in a different set of winners and losers…..

    • Hi Ian,

      You are clearly correct in your assumption that the Fed and other western central banks are acting as they are very deliberately (mainly to protect the banksters). As Shaun has observed a few days ago, this is largely because the so-called credit crunch has resulted in politicians taking away any independence which those central banks may have originally had, and they are now using them for political purposes.

      But surely there is a stark difference between the two options which you highlight? One is honest, straightforward, responsible and genuine – an attempt to maintain and preserve civilized values; the other is despicable, deceitful, fraudulent, dishonest and debaucherous. If the unit for measuring distance were significantly debased year by year, a 30 mph speed limit would soon allow drivers to progress at 60 mph in built-up areas, and so on! Money is the unit used in an economic system to define and measure real wealth.

      We also surely should remember when choosing from these options, although many modern economists seem not to understand it or discount the effect, that as even Lenin and Keynes observed, inflation is ultimately destructive. It destroys the very real wealth-creating process. This is because the real wealth-creating process, particularly in the modern world, requires ever larger investments of capital, as technology advances. Inflation destroys the real value of capital, thus impoverishing enterprises and directly resulting in them failing. Significant inflation therefore always ultimately destroys any civilization. It may seem an attractive short-term way out of fiscal and political difficulty, but the ultimate penalty will be paid eventually, and that penalty is economic destruction. The advantage to politicians is that they are not accountable and will be out of office when the results of their deeds are suffered by their electors and taxpayers!

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