When analyzed as a whole, the principal
economic data that emerged this week, including “higher than expected??? retail sales, CPI numbers, housing
starts, and unemployment claims, and “lower than expected??? industrial
production and capacity utilization figures, further buttress the notion that
Americans are simply living beyond their means. Consuming more and producing
less is a recipe for inflation not growth, and anyone concluding otherwise
simply doesn’t understand the difference.
As I predicted Wall Street has
embraced evidence of higher inflation as good news, a victory over deflation
(the Fed’s falsely conjured phantom menace).
This is exactly the outcome the Fed envisioned when it created that straw man
in the first place, as it allows them to continue being “patient” before
raising interest rates. However, just as you can not be a little pregnant,
you can’t have just a little inflation. The question is how much of a “good
thing” will Wall Street perceive as too much. In a few more months it
will be obvious that the Fed has let the inflation genie so far out of her
bottle that it will be impossible to put her back in.
The Fed likes to point to the low
rate of capacity utilization at our nation’s factories as evidence that inflation
is not a threat. The argument contends
that the underused capacity can easily be brought on-line to meet growing demand.
This delusion fails to understand the true nature of American manufacturing
in the 21st century. In the past, when America’s factories were operating at
less than full capacity, it was simple to ramp up production. However, the
vast majority of today’s manufactured goods are imported. What the government
counts as excess domestic capacity is really nothing more than antiquated factories
that no longer have any hope of being spontaneously engaged. The time and cost
to bring this supposed excess capacity back on line would be enormous, and
In the current environment of steeply rising oil prices, the Fed routinely
underestimates the impact these costs will have on America’s price structure.
It is a fallacy that because energy represents a much smaller component of
American’s GDP than it has historically, that any inflationary impact of higher
oil prices will be minimal. In fact, energy is a smaller part of GDP mainly
because industrial production, which requires significant amounts of energy,
has become an increasingly less significant component of GDP. But the cost
of that energy indirectly feeds into the price of imports. In addition to the
energy expended in production, because of the great distances that these goods
must now travel to reach American consumers, the energy expended in transportation
is significant. Remember, not only do the Chinese need to factor in the costs
of importing raw materials and shipping finished goods to the U.S., but they
must also factor in the costs of bringing those ships back empty. As a result,
I would argue that energy prices will have a greater impact on the general
level of prices in the U.S today than at any time in its history.
Finally, the extreme volatility in the currency markets, together with the
dollar’s failure to post any significant gains against the euro, despite what
is generally perceived as strong economic data, is evidence that the counter-trend
rally in the dollar may have peeked. If true, inflationary pressures will only
accelerate, putting additional upward pressure on interest rates, further exposing
the fallacy of the Fed’s strong growth, low inflation scenario.