09 Nov Everything, Everywhere, All at Once – Part 2

“Last week it was immigration. This week, inflation.” – The Lonely Realist

Is inflation coming baaaaack?

As TLR wrote last week, “everybody’s distraught. No one likes the way things are going. Many are overwhelmed by immigration, inflation…, etc.” What does it mean to be overwhelmed by inflation?

“Inflation” is a fluid term. It’s unpredictable, running in starts and stops, which is destabilizing. Once it begins, its variability leaves an unknowable hole in everyone’s pocket. No one wants “inflation” and it’s therefore good that recent statistics have suggested that inflation is receding. Will that continue?

Inflation is defined as the increase in prices and, therefore, the upsurge in the cost of living and the consequent decline in the purchasing power of money. Its rate – the rate of inflation – is calculated by reference to the price increase of a basket of consumables over a given time period. There is no agreement, and no objectively determinable means, of ascertaining what that basket should be, what weight should be ascribed to each component, which categories of persons are the appropriate consumers, or which geographical locations should be the reference locations for pricing. That makes “inflation” a subjective determination. In the U.S., inflation most often is defined in terms of the Consumer Price Index (CPI), a measure of the average change over time in the prices paid by consumers for a government-selected basket of goods and services in government-selected locations. That basket is updated periodically by the government to reflect perceived changes in government-directed outcomes consumer spending habits.

The methodology for calculating CPI is … you guessed it … fluid. It has been revised numerous times over the last several decades. Many view the changes as purposeful government manipulations intended to underreport the rate of inflation. Doing so not only makes inflation more politically palatable, it also reduces government outlays based on CPI adjustments for Social Security, tax deductions, entitlements, etc. According to the Bureau of Labor Statistics (BLS), the changes of course are benign and intended to compensate for changes in the quality of goods and services so that the CPI more accurately reflects a changing reality – for example, changes wrought by technological advances and lifestyle choices. The weights accorded to various goods and services accordingly are based on the BLS’s perception of their relative importance to an average American household at any given time. That makes sense since the relative importance of energy, food, housing, etc., necessarily changes over time. However, the fact is that those changes lead to CPI adjustments that are manipulated arbitrary. Those adjustments in fact have shielded the impact of sharply rising prices of certain core items (including homes). Their overall effect therefore has been to lower reported CPI.

Inflation can be categorized in one of three ways: as demand-pull inflation, cost-push inflation, or built-in inflation. Demand-pull inflation is triggered by an oversupply of money and credit that stimulates demand for goods and services. This was a primary driver of the post-pandemic inflation triggered by massive Federal stimulus spending. Cost-push inflation occurs when there is a supply shock and the cost of goods increases and leads to higher consumer prices. This was another COVID-cause of post-pandemic inflation. The residual effects of both demand-pull and cost-push inflation remain with us, though they are have been receding. Today, it is built-in inflation that is exerting the greatest price-increase pressure. Built-in inflation is caused by expectations of continued inflationary pressures. Consumers respond to the perception of ongoing inflation by buying now in order to avoid higher prices later, increasing demand and therefore pressuring prices to move upward. This often results in a wage-price spiral as workers seek wage increases to “keep up” with rising inflation…, evidenced today in recent wage settlements. Dockworkers, for example, secured a 61% salary increase from $39 per hour to $63 per hour, characterized as a catch-up for years of perceived underpayment. The increase, however, was far in excess of the inflation rate since the last dockworkers’ contract. The large raise demonstrates that dockworkers today have both the motivation and the leverage to receive outsized pay increases…, an early sign of an incipient wage-price spiral. A similar outcome was negotiated by workers at Boeing where machinists will see their average annual incomes increase from $75,608 to $119,309, a 38% pay rise over four years, again well in excess of inflation. According to Bloomberg, union contracts negotiated in 2023 increased wages by 6.6% in the first-year, the highest average pay raise for any year since 1988 when Bloomberg began tracking union wage settlements. When signing bonuses and other incentive payments are added to the calculations, the national average for 2023 was 7.3%, also a record high.

The increase in inflationary labor power is likely to be magnified by the surge in military spending driven by expanding international conflicts and by America’s reshoring policy (currently a Biden Administration initiative and soon to be magnified by the America First policies of the incoming Trump Administration), both of which increase production and labor costs. Military spending and reshoring also create jobs that fuel wage-price spirals. This at the same time as bond market interest rates are rising, evidence of market fears of rising inflation (and of potential Trump Administration challenges to the independence of the Federal Reserve). Added to these inflationary pressures is the fact that President-elect Trump has pledged to implement mass deportations that would increase wage pressures in the bottom quartile of the labor market (and add to the Federal deficit), impose gargantuan tariffs that economists warn would be highly inflationary, and legislate further tax cuts that would increase the Federal deficit and add fuel to demand-pull inflation. And let’s not forget annually-mandated benefit increases for entitlement programs (such as Social Security and Medicare where there are increasing numbers of aging Americans).

Brace yourselves for inflationary challenges (and higher interest rates), further fallout from today’s “everything, everywhere, all at once.”

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Prior TLR commentaries can be found here.

Finally (from a good friend)