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Author: EconWatcher Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 10560  
Subject: Inflation fears are overblown Date: 3/1/2011 10:39 PM
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(Hello all -- below is my attempt to play econ pundit):

It seems as if things get more expensive every time you go shopping these days. Right?

Wrong, actually. There are plenty of scary headlines about inflation, and certainly oil and gas prices have jumped in the wake of Middle Eastern turmoil. But overall, inflation is unlikely to accelerate out of control anytime soon. And if you're making investment decisions based on the idea that raging inflation is on the way, then you're likely to be disappointed.

Yes, agricultural commodities like corn, wheat, cotton and coffee have soared in price in the past year. Cotton has more than doubled. Coffee prices reached a 14-year high last month. Horrifyingly for caffeine addicts like me, Starbuck's has said it will have to raise prices on some of its drinks. McDonald's and Sara Lee, among other food companies, have said they will both raise prices this year.

Some non-food companies have made similar announcements. Apparel makers are boosting prices to offset rising cotton costs. Whirlpool is too, due to rising steel costs.

Still, inflation isn’t that big a threat, for a number of reasons:

_ Rising commodity prices mostly affect goods. The U.S. economy is dominated by services, and service firms aren't impacted nearly as much by rising commodity prices. An insurance company, a bank, a law firm or a hair salon doesn't care if corn or oil are getting more expensive. It doesn't force them to raise prices. This was the theme of a recent Wall Street Journal article, which noted that prices of many services are either falling or rising at a slower-than-usual rate.

Incidentally, this is almost certainly a big reason why the Federal Reserve isn’t particularly worried. The Journal article was co-wrtitten by its Fed reporter, a sign the Fed pushed that story line to the Journal. No doubt Ben Bernanke is getting tired of all the stories about rising prices that imply he is being complacent.

_ Some things are getting cheaper. Apple is going to introduce a cheaper iPhone. Prices for computers, networking equipment and telephone services are falling steeply, according to government data. Furniture and cars also fell in price last month. This reflects an important point: Inflation means a broad, sustained rise in prices. When it's out of hand, it touches everything.

_ All the Fed's new money isn't going anywhere. When you hear someone talk about "hyperinflation" or "debasing the dollar," chances are they blame the Federal Reserve. By cutting rates to nearly zero and injecting nearly $1.5 trillion into the economy, the argument goes, the Fed is setting the stage for rampant price increases.

But there's a catch: much of the money the Fed has created is just sitting on the Fed's balance sheet as reserves. For inflation to take off, the money needs to be circulated. Banks need to lend it to companies, which then pay it in salaries to workers, who then spend it. It's what economists call "the velocity of money," and right now the velocity is slow. As a result, the impact of the extra money is limited.

_ There won't be a wage-price spiral. Inflation isn't just about prices rising. Salaries need to rise too, in order for consumers to afford the more expensive goods. And as wages rise, companies continue to boost prices to help pay for the higher wages, and round and round it goes.

Right now, though, with unemployment at 9 percent, this is unlikely to happen, to put it mildly. What would your boss say if you went and demanded several raises over the next year or two? Incidentally, this type of vicious circle was more common when more workers belonged to unions and could successfully demand higher pay. Despite what’s happening in Wisconsin, that’s much less common now.

_ On a related note, the economy is too slow. We're still recovering slowly from a deep recession. As mentioned previously, unemployment is 9 percent, in case you haven't heard. It's rare for inflation to take off with so much slack in the economy. Economists at Goldman Sachs recently noted that the core inflation rate, which excludes food and energy, has never increased during a year that began with unemployment above 8 percent.

In fact, a little inflation is a good thing, actually, as a sign that the economy is picking up. Not so long ago, the concern was that we would have deflation, which in many ways is much worse and arguably harder to cure.

Prices will likely rise a bit this year, but that partly reflects how low they fell in the recession and its aftermath. And the rise is also a sign that the economy is recovering, which remember, is a good thing.
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Author: IcyWolf Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10483 of 10560
Subject: Re: Inflation fears are overblown Date: 3/2/2011 11:36 AM
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Howdy Econ,

Nice post .... thanks .... Of course I have a few observatiosn / questions for ya <g> ...

You say it only seems like things are getting more expensive .... well ... as I am finishing my taxes, I have a pretty good handle on what it cost us this past year overall for basic living expenses vs past years ... I can tell ya we cut some corners to reduce costs and still spent approx 20% more this year vs the previous one on just basic living expenses (not including vacation and one off things ie had to replace a heat pump) ... and in chatting with other folks we don't seem to be unique ... Add to that the current unemployment and under-employment picture ... Me thinks sometimes a 3 mile high view leads to an overly simplitisic 2D view of a 3D problem ... But I do hope I am wrong and you can point out items I need to reconsider ...

You mentioned we are a service economy etc. .... well ... I had thought that the US economy was somewhere between 60-75% non-business (consumer) spending focused? In which case looking at the Fed or even business balance sheets offers a view of just one layer (veneer?) of our economy. So while you allow goods may be generally rising, maybe you are discounting that rise too much relative to your more business and gov't view? Or hopefully I am doing the opposite?

Now, I am NOT a fan of the Fed, but neither am I an ardent supporter. I believe they try their best but are in part held captive by direct and indirect political priorities, plus their own perspective and bias. So I am not as confident that any "message" they are promoting is as much a true reflection of reality as possibly a tactic to try to manage perceptions and or expectations ... Probably a bit of both? ...

This is probably too nit picky but even computers and wireless telephony ... yes the cost seems to be coming down on individual units but the replacement cycle is decreasing even while the "need" for additional devices (ie laptops, smartphones, tablets, readers, NFC devices, etc.) is quite pronounced ... Being a data-focused user that requires wireless mobility, my costs are more likely to increase than decrease going forward as I think is likeley to be the case for most ie providers are projecting increased revenues vs decreased which ultimately will come from us users ...

I do think you make a strong point re: money on the sidelines .... but from my admittedly biased pov it seems to cut both ways ... History seems to tell me when things go south they do so generally more quickly and dramatically than the upside or recovery side, and too often we don't know we have gone too far until its too late to do much about it. So I don't take much comfort from your perspective there, but I have to admit that just might be me ...

The wage price sprial is a great point and like you, I tend to see more downward salary pressure in the near term than upward ... but ya know ... while thats a good thing in terms of the wage price spiral, unless prices drop along with salaries I don't see that as an overall positive for the economy ... But again, I may be missing the true import of your point on this one also ...

As for the speed of the recovery etc. ... I have to wonder whether we are actually in the midst (or mist <g>) of some more fundamental changes beyond the obvious recession - recovery thing? For example, our manufacturing base and those salaries continues to erode as the rest of the world "catches up", but it seems this erosion strikes right at the heart of a controlling (economically and more than that too) middle class in the US. I suspect its been our middle class that has been balancing the more extreme positions that the top and bottom might mandate, and until we can establish a reasonably stable service-focused resevoir of middle class salaries to replace those from manufacturing that don't seem likely to come back any time soon, I think there has to be some uncertainty as to what sort of Standards we will be recovering to .... I offer that view within the context of an increased realization and sensitivity to an unsustainable position with regard to our deficit and debt ...

Trying to put all these moving pieces into perspective is probably well beyond me ... but I try anway <g> .... I think it at least means increasing uncertainty vs any confidence about anything economic as maybe the only thing clear is the US is no longer (if we ever were <g>) masters of our own economic destiny ...

Thanks again for a wonderful and thought-provoking post!

Take care,
IcyWolf

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Author: jerryab Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10484 of 10560
Subject: Re: Inflation fears are overblown Date: 3/2/2011 1:13 PM
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I am finishing my taxes, I have a pretty good handle on what it cost us this past year overall for basic living expenses vs past years ... I can tell ya we cut some corners to reduce costs and still spent approx 20% more this year vs the previous one on just basic living expenses

My basic living expenses have been pretty flat for the past couple years. The only real increased spending was in one-time purchases or expenses, not ongoing stuff.

The price of pasta (in all forms) is up from 50-cents per lb (2-3 yrs ago) to about 75-80+cents per lb today. But that is a wheat product, so no surprise there. Hence, the same situtation with cereals, etc.

Chocolate is up (bummer). I *was* able to stockpile a year's supply of coffee ON SALE (*less* than half price) over the 2010 summer <G>.

Gas was down, went up, went down, and is now going back up. And guess what farms use a lot of? Gas/fuel. So, with gas prices up, it is no surprise certain commodity food prices are also up. Plus with increased demand by China and India driving higher prices--it is not just problems in the Middle East. It will likely become higher permanently because the demand IS there and is not going away. Thus, unless the US reduces its own demand for oil, that higher price will impact the consumer directly. Reducing demand for oil in the US (esp gas) will lessen the impact on consumers and boost the economy as a whole.

I have to wonder whether we are actually in the midst (or mist <g>) of some more fundamental changes beyond the obvious recession - recovery thing?

There is fundamental change occurring--but the economy has not yet figured out what that change is/will be. Which is why it *is* in flux (left out the capacitor <g>). Until the boomer retirements begin in earnest (by 2015, but starting in 2012), businesses won't move forward. Once that happens, then major changes will begin to take place--especially where they NEED people (and can NOT automate those jobs out of existence).

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Author: ziggy29 Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10487 of 10560
Subject: Re: Inflation fears are overblown Date: 3/4/2011 12:50 PM
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I think we are experiencing "biflation" where the price of stuff you need to buy rises, and the stuff you *own* falls -- and where the price of things people *need* rises and the price of what they *want* falls.

This is how the CPI can be basically flat despite food, energy, health care and educational costs showing substantial inflation.

Basically, the person who gets hit hard by buying only the "necessities" listed above is canceled out in the inflation rate by those buying big screen TVs, computers and cruise vacations. Big ticket discretionary items are often indeed getting cheaper, but that's little help to someone who can only afford to buy the bare essentials (rising in price pretty strongly) who's getting no wage or income increases because there is "no inflation" thanks to deflation in discretionary "stuff".

#29

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Author: Jgrimm4 Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10534 of 10560
Subject: Re: Inflation fears are overblown Date: 1/16/2012 9:39 PM
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Help me understand the fed money sitting on the sideline? The fed did not have 1.5 trillion dollars in a bank that it used to buy bonds or MBS. They created dollars out of thin air or added a line item on the balance sheet and bought it from someone. That someone now has cash which they use to buy more stuff which increases the velocity of money. All that money did not exist before they handed it to someone.

With that said I agree inflation will not be an issue for a long time but IMHO it is b/c of the great deleveraging that has occurred which has erased a tremendous amount of dollars out of the economy.

Back to the fed, the out of thin air dollars they pumped into the economy will naturally be destroyed. MBS and us government bonds they bought will be slowly paid back as long as they do not buy anymore. To me this seems to be an ideal way to suck the dollars back out of the economy without killing liquitiy.

But I am no expert...

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