| Inflation is Dead | ||
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I wanna take us back in time... all the way to February 2, 2018. It's just four weeks ago, not that big of a journey.
It was a Friday. The Dow Industrials fell 494 points that day. On Monday, February 5, the Dow was down nearly 1,600 points at one point. Two days later, on February 8, the Dow had another big 1,000-point down day — 1,033 to be exact.
In total, the Dow dropped about 12% from the highs it had achieved just a few days before. Any decline over 10% is called a correction. That's a nice way of saying that maybe stocks had run a little too high, too fast, but the "mistake" has been corrected.
What's more, the term "correction" carries a connotation that nothing has really changed on a fundamental level. The economy, employment, and earnings are still trending as they were before the correction. It's just that stock prices got a little out of whack. But, now that prices have come down, everybody is free to buy stocks again.
And, as I write, the Dow has recovered about half of those correction losses.
I'm happy to tell you that most of the fundamentals that have been driving stocks higher appear to be in fine shape. The economy is chugging along at speeds equivalent to roughly 2.5% GDP growth. Jobs numbers continue to move in line with expectations. And corporate earnings are doing very well.
Careful readers will notice the word "most." And there is one aspect of fundamentals that is decidedly undecided. I'm talking about inflation and interest rates.Is Everything More Expensive?
The classical definition of inflation is "too much money chasing too few goods." In theory, it's a supply and demand situation. You can think of the Fed's job as making sure there is always enough money out there to keep prices rising, but not so much money that prices rise too fast.
According to the Fed's mandate, the Fed is supposed to maintain price stability. That is, keep inflation at 2%. If inflation runs too much below that, then companies don't see revenue and earnings grow, which means they don't invest in their business, and they don't give their employees raises. That's been the U.S. economy for the last decade.
If inflation runs over 2%, then prices get too high, and people can't afford stuff.
Ultimately, the goal is to keep us all spending at a steady clip.
If you think about it, there's a fundamental flaw in this view. It has to do with productivity. Productivity tends to push prices lower.
I've used the example of a pair of Levi's jeans before, like in my February 2017 award-winning article “My Blue Corduroy Levi's.”
I was 12 years old in 1976, when I got my first pair of Levi's. No idea why I went with light blue corduroys. I remember my mom freaking out a little because they were $25 a pair. 42 years later, I bought a pair of Levi's for $52 at Macy's.
You see this phenomenon all over the retail space. Clothes are cheap. And clothing stores are struggling because they didn't see it coming.
There are a lot of reasons why this is true. I seriously doubt the Levi's of today have as much cotton in them as they did when I was 12. And those blue corduroys were made in the U.S. Not so today. But the worker making them today is likely making about the same hourly wage as the American employee of Levi's did in 1976.
Now, I have a confession to make. When I started this article, it seemed obvious to me that Levi's prices have underperformed inflation since 1976. But you know what $25 compounded at 2% a year for 42 years is? $57. Believe it or not, the price for a pair of Levi's almost perfectly tracks the Fed's target inflation rate.Is This Actually Helpful?
I seriously doubt the Fed had Levi's in mind when it formally adopted a 2% inflation target in 2012. What's more, there's simply no way the Fed could have foreseen the conditions that led to Levi's tight correlation with 2% inflation. I'd say they got lucky on this one.
If you're my age, you saw computing power change your productivity dramatically in the early 2000s, but probably not so much over the last 8–10 years. Computers have been standard operating equipment for years. Same with smartphones. Maybe there was a productivity boost during the first few iPhone years, but it's leveled since.
Still, the Fed measures the inflation impact of an iPhone not by the price of the phone, but by "unit of performance." So you can get a new iPhone X with 256 gigs for $1,149. But, in terms of inflation, the iPhone X is way cheaper than the iPhone 4 that cost $600 but only has 4 gigs of processing power. And so we get charts like this:
This chart shows that the price index for personal computers and peripherals has dropped ~60% over the last decade.
But I ask you: Has your actual spending on anything computer-related been cut in half over the last 10 years? I would guess no, even though the Fed would say yes, you are spending less.
The CPI for new cars has been flat for five years. But I'm pretty sure new car prices rise every year. College tuition and health care costs sure do.
My point here is that the Fed's calculations for inflation are completely arbitrary and do virtually nothing to account for actual spending in dollars of actual American households. Heck, Levi's might be the only item in America that's priced in line with Fed expectations.
And we're supposed to believe the Fed will make accurate decisions on interest rates based on its measures of inflation?
I don't find this comforting at all. And apparently, judging by that recent "correction," the stock market doesn't, either.
Until next time,
Briton Ryle
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