Friday, December 14, 2007

CPI Report Confirms Rising Inflation

The economic reports released today are pretty hard to ignore, and no political spin imaginable can downplay the inflationary numbers consumers experienced in November. The Consumer Price Index (CPI) was up 0.8% in November and now stands at 4.3% yearly. Core CPI (which excludes food and energy costs) was up 0.3% in November and is 2.3% yearly. (International Herald Tribune: New figures show prices rising on both side of Atlantic.)

The yearly numbers only tell part of the story, however. The CPI in August was only 2% yearly. Energy costs in the fourth quarter soared, however, with oil hitting $100 per barrel and actual gas prices at the pump topping $3.00 per gallon with no sign of backing down. In just one quarter, the rate of inflation effectively doubled.

The housing and credit problems have placed FOMC (Federal Open Markets Commission) in a rather difficult bind. In the last quarter, FOMC has clearly adopted a policy aimed at calming credit fears and softening the blow to the nation's largest banks. This policy has manifested in several interest rate cuts, the most recent of which came on December 11th. Unfortunately, that policy is diametrically opposed to combating inflation. An increase in interest rates is required for inflationary control, and it does not appear that FOMC is prepared to do that anytime soon.

One must wonder if we have forgotten the lessons of the late 1970s and early '80s. Have we forgotten the "misery index" popularized in the Reagan - Carter Presidential campaign in 1980? Lest we forget, the nation was faced with double-digit inflation and double-digit unemployment; something virtually all economist thought was all but impossible to achieve. We could be headed in that direction again, for the economic situation is frighteningly similar.

Today we have numerous economists predicting an economic slow-down leading to recession. A recession always implies lay-offs, leading to higher unemployment. At the same time, we have a brewing banking crisis lead by the housing market collapse (also seen in the late 1970s) and the imminent collapse of the credit card industry. These pressures are preventing the Fed from implementing measures to control inflation. At the current rate of inflationary growth, double-digit inflation could be less than a year away.

The real question is which way FOMC should lean. Should the monetary policy be geared at easing the credit crisis or easing inflation? Either path could easily lead to a recession. It would appear that FOMC is concerned that controlling inflation would be the faster route to that recession since it is automatically designed to slow economic growth. A rise in interest rates coupled with the credit collapse could be enough to move growth into the negative column. But allowing inflation to spiral out of control could force the same thing. When consumers no longer have enough discretionary cash to make major purchases, the economy essentially grinds to a halt. We're either at or past that breaking point right now.

At the very least, FOMC needs to adopt a policy that halts further interest rate cuts. There will be a short-term hit on the stock market, especially considering the disappointment investors displayed over a 25 basis point cut on Tuesday. Holding firm on rates would not help lenders reeling from the housing and credit crisis, but it will at least not exacerbate inflationary pressures already fueled by the price of energy. It may buy enough time to allow a controlled increase in interest rates in an attempt to get inflation back on the short leash.

What FOMC cannot do is continue down the self-destructive path that has brought us to this point. The next couple of years look pretty grim from an economic viewpoint. We really don't need FOMC to reenact the economic debacle of the late 1970s. I remember it well enough from the first time around. I'm pretty sure we can all live without the sequel.

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