July 16, 2008 6:46PM

The Inflation Haymaker Comes A Cropper

By Elizabeth MacDonald

Both of the inflation numbers, the core and headline numbers, were higher than expected and beyond the Federal Reserve’s comfort zone. I’ve been warning readers since January that the Fed opening the money hydrants to save the financials would cause inflation to gush through the markets.

Now the core CPI is the number the Fed wants you to focus on, even though it’s a fake number as it strips out fuel and food prices. How was this number created?

After oil prices surged during the Arab embargo of 1973-1974 then-Fed Chairman Arthur Burns had the Fed’s economists strip oil out of the CPI, reports our senior editor Charles Brady. Remember, back then the Fed was put under enormous pressure to mint money fast to pay for the Viet Nam war. And back then, when food prices began surging, Burns had food prices stripped out as well, Brady says. The result was the “core CPI, a distorted view of inflation that underestimated the extent to which price hikes were ravaging the economy,” he notes.

Brady says that history seems to be repeating itself, as record-high oil prices and surging food costs put the squeeze on consumers. The chart below shows the difference between the CPI and the Core CPI. You’re looking at the core CPI index itself subtracted from the overall CPI; essentially the spread between the two. When the headline number rises more than the core reading, the line rises. With a CPI of 217.4 and a core CPI of 215.5 the spread is 1.9, which is the highest since June 1981, FBN editor Brady tells us. So what does this tell us about inflation and the economy? Look at this chart, which Brady pulled together:

The chart below shows this CPI-Core CPI spread compared with the Fed Funds rate. The correlation between the two is pretty amazing. On the left you can see where Fed Chairman Paul Volcker jacked up interest rates to whip inflation. As a result we saw a 24-year span where the CPI was actually LOWER THAN the core CPI (the spread was below zero). But now the spread is back up to where it was in the bad old days of the early 1980s, and rising. As was the case almost 30 years ago, it seems that the only medicine will be a sudden and sizeable increase in the Fed Funds rate.

19 Responses to “The Inflation Haymaker Comes A Cropper”

Comment by kelly smithe

July 16th, 2008 at 9:13 pm

A sizable increase in the Fed rate won’t help this time as most of the US
treasury debt is due within the next few years and will roll into the new
higher rate vastly increasing the interest due and raising the deficit.

This combined with the recession drop in US tax receipts will result in
a flood of yet more money being printed.
Comment by Hsub Egroeg

July 16th, 2008 at 9:21 pm

Well…

This sounds like a classic case of democratic pandering to the labor unions and special interests. If we would just stop funding all social safety net programs and only let people with perfect credit and at least 20% down on a house purchase property, we wouldn’t have this problem. People think it is their right to live in comfort, or to have health care, well I hate to tell you, that is something the government isn’t supposed to provide. The purpose of the government is to redistribute earnings from the lower class to the upper class. If the lower class was capable of managing their money they wouldn’t be in the lower class. It makes a lot of sense to remove any benefit that the government provides to 98% of people, so that resources are not squandered on the unwashed masses.

Just think of how great it would be if people couldn’t freely drive around because the roads were owned by private companies and the poor people couldn’t pay the tolls.

I really think this inflation thing is going to do wonders for the problem we have with these filthy people that cry about having to skip eating for a day or two. They are probably fat from eating that pasta, which is the only thing they can afford. Heck, the majority of the country is fat and maybe walking instead of driving and skipping some meals might do them some good. All I know is that I don’t see why we need to feed this filth, they only seem to get us in trouble.

All I know is that a friend of mine thought that we should just draft the baby boomers and send them to war in Iraq, Iran, and Afghanistan. Think about it, if we could just use the poor old baby boomers t in a few charges like Pickets last charge we might be able to get ourselves out of the medicare and social security mess that might hurt the economy that I really care about. Think of how much money we would save, if we didn’t have to pay out benefits to anyone that had to actually use the money.

We might also consider allowing the baby boomers to buy their way out of the draft by contributing $10,000 to their favorite political party

I guess what i’m trying to say is that we need an ownership society that protects the status of the property holders and limits the economic drag that the remainder of the population causes.

People that make the money should make the rules because we know whats best for people like us and without money, you really have no value.
Comment by Charles Peden

July 16th, 2008 at 10:18 pm

I never knew that! I thought that core CPI was useful for measuring consumer sentiment when commodity prices increased and people had to spend a greater percentage of their money on food and energy. I did not realize that it was simply “fake” and “distorted.”

It sounded like a useful tool to see how consumers are shifting away from less essential spending. But now I know it is just a fake and distorted number. Thank you Fox Business!

Now I am trying to figure out if Fox Business is a tool, or is it just fake and distorted.
Comment by Justin

July 16th, 2008 at 10:26 pm

It tells me we are in a bear market and this bounce will be short lived and similar to the one we got after the bear stearns bail out. We might see 11,800-12,000 on the Dow, but don’t let that fool you people. This is nothing but a dead cat bounce and bear trap. We still have a long way to go before hitting a bottom and until someone addresses the dollar crisis we have, we will continue to go lower (although nominally, the Dow may not fall much lower than 10,000). We may end up going the way of Japan during the 1990’s or worse (Argentina just a few years ago). I don’t know, but I’m still super bearish on the US economy. I look foward to shorting the financials again after they make their contrarian bounce. When everyone jumps in long thinking they’ve got no where but up to go, that when I’ll buy SKF. It’s gunna be fun riding these suckers down to lower lows as we continue the American bear market of 2008 that could extend well into the next few years depending on the policies our government takes.
Comment by Russ

July 17th, 2008 at 12:07 am

Elizabeth,

I share your contempt for policymakers and beaurocrats who manipulate their performance measures to hide their incompetence. Alas, there is more to the first chart than simply the creation of the Core CPI.

Inflation is not an event, it is a process. Once the currency devalues for any reason, it will ultimately spread to all prices in the economy if left untreated. However, not all prices react quickly. Gold responds quickest, then other metals, then other commodities. Other prices may take years, even decades, to reflect the impact of the currency devaluation. The message of the first chart is that very high inflation is coming down the pipe, unless something is done to reverse it.

Your suggestion that the Fed will be forced to significantly increase the Fed Funds Rate is certainly the consensus outlook, but I suggest you consider an alternaive to your second chart. First, the correlation you claim is “pretty amazing” doesn’t actually exist. Sure the two the lines on the chart appear to move together, but statistically, there is no link. For an academic explanation, you might read “Open Market Operations and Federal Funds Rate” in the Federal Reserve Bank of St. Louis Review, Nov/Dec 2007 by Daniel Thornton. A more pedestrian explanation can be found in the Volker episode you mentioned. When the Fed Funds Rate rose significantly in the late 1970s, it was in response to Volker’s desperation move to abandon the Fed Funds Rate Target. In other words, only when Volker conceeded the Fed Funds Rate was not the proper mechanism for fighting inflation, did the inflation start to abate.

You are correct to warn of the current and pending inflation and you rightly criticize the Fed. However, there is no valid theoretical support for ending the inflation via a higher Fed Funds Rate in today’s environment.
Comment by Geoff

July 17th, 2008 at 9:57 am

It’s no mystery that Congress doesn’t want oil and food re-inserted into the index.. Those are 2 of the gargantuan industries that enjoy kid-glove treatment in the form of subsidies, tax adjustments, and price supports.. Look at the donor list.. Mountains of money flow from the farm and oil lobbies right to Congressmen.. How in the world can they ignore 2 of the largest culprits contributing to inflation ??
Comment by Jerry Attrix ..

July 17th, 2008 at 1:47 pm

Thank you, Professor Hsub… Our federal politicians have already found a way to finance the impending crash of the Social Security system.. More and more of them seem to be turning towards open borders and amnesty.. If the pols let the millions of illegals that are already here and the millions more they want to get amnesty and then join the SSA then there will be a huge flood of new workers paying into the system.. Voila !! Boomers are part of a huge reproductive wave right after WWII. Now the Boomers are retiring, and the new generation with a low rate of reproduction simply will not be able to fund all the services due the Bommers.. However, if the pols let in millions of immigrants get amnesty and suddenly become part of the system then the pols will have found a way to finance the shortfall without having to make the decisions now to rescue the system.. The politicians have squandered our money, but this is a scheme to evade the responsibility for it…
Comment by Mike Desmond

July 17th, 2008 at 1:47 pm

NOT be be negative here Ms. Liz but your opening line of “I’ve been saying since January”, well looking at my calendar it’s now July. 7 months and it finally happened. Hey, I think it’s going to snow soon (December is coming and my prediction is alot closer than yours.)

“Fighting the negativity one money correspondent at a time”
Comment by Matt R.

July 18th, 2008 at 8:18 pm

I second what Hsub said. I also second Platonic government ideals. Hsub is right. I am only 18yrs of age and even I can spot a problem when I see one. The men of Bronze have no idea what they are doing when they turn 18 and are given credit cards. When the House of Bush comes to an end so will the US Petrodollar and the Euro Petrodollar will be born. I always find it interesting that the same people who bicker about the poor in other countries believe they have a god given right to a labor free life just because they were born in America. And by life I mean a very prolonged labor free life (on our bill). Why are we called a consumer nation? Answer: the American people don’t know hunger. If America cant’ see this coming we are wasting our money on education. Are we so ignorant that we see our selves above history? I end with a Lyndon B. Johnson quote. “While you’re saving your face, you’re loosing your ass”.
Comment by Greedom

July 19th, 2008 at 8:10 am

Uh Ms MacDonald ?

I am still looking for Part 2 link ?

that just dropped me off a cliff

happy to see someone up front clarify CPI though.

I only started to look into money, matters about it, a good bit through Jacob Needleman at first - but - last year I learned this regarding CPI.

I think it was a character DryHeaves on marketwatch who made the post.

Interesting person at THAT !
Comment by Greedom

July 19th, 2008 at 8:25 am

Yeah,

ok

I just scrolled back up

Where - WHERE is the article here ?

On the other hand ?

I really look forward to ANY new material on this blog

so I can’t REALLY complain now can I !

Too much relativity in CPI ! more absolutism ! jk

Did I see Sr. Editor there Liz ? did I ? I expect more words ! heh

jk - I’m guessing this - it was a problematic day and low staff to otherwise cover - on the other hand you write you own matieral, so, nevermind on that.

I’m going to go with should have taken the day off rather then put this up !

and that REALLY is probably the best !

On the other hand that network FBN - does it get profits from the late night ads run on it ?

Does everyone get paid from the Food Dehydrator II ? ad revenue ?

I wonder.

Either way - that’s not mainstream corporate lobbyism - but I wouldn’t mind if the show’s ON the network Trumann Showed it up a bit and started to drop reference to the products themselves.

MacDonald: “And yes, as a guest you recieve one of our Black and Decker waffle makers !”

OK OK maybe not THAAAYAT blatent.

Try this on for subversive advertising “And today, the stocks might have well been on a black and decker workbench - up and down - by noon, the DJIA had everyone out for lunch to get waffles - just dead waters out there people !.

Perhaps that’s not so transparent as to embedding advertisements into the TV shows themselves

I think the master class is “Fear terror, live like there is no tomorrow” and then “hey, want to live in a 500k home with a mortgage that you’d have to really think there IS no tomorrow ? ” Call CountryWide

now - back to you Geraldo:

“Now… Geraldo, exactly how FAR was the telephone booth the runaway bride used from the 7-11 itself”

“Well, let me tell you - it looks to be about 14 meters away from the 7-11″

“thanks Geraldo, we’re out of time”

and on

and on

then CountryWide

DiTech

you got the greenlight Baby

Fox News was the LEADER in pushing these sub prime toxic waste products

where am I wrong ?

is it me ? am I wrong on this ? I am often wrong. Really.

I just intuit this, I recall the CountryWide ads -

Myself ? I love the ‘you’d have to think there was no tomorrow to borrow like this’

is REALLY ?

what - CW, but
‘you’d have to think there was no tomorrow to lend like this’

well - like the article - going to leave this one hanging
Comment by Greedom

July 19th, 2008 at 8:52 am

Liz,

I see you wrote about Citi is Dead

on dialup - atm - no video

I personally think citi was dead in November.

Now, when CW was taking it’s 2 billion hot beef injection from BoA

Citi also got a visit from Abu Dhabi iirc.

BoA wins the pot at 300 billion if that goes through

but Citi though - wasn’t bailed out by BoA

it got swf

I leave Citi with ‘Will anyone who has invested over 10 billion INTO citi’

let it die - as Reese Witherspoon as Tracy Flick says in the movie Election

‘Just like that’

????

Of course not, NOT that there are not camels that might race for less or not ?

Who knows.

I for one know I’ll never be attending a camel race in the desert - nor a race of the human race to disgrace itself

and now that I am sounding like Jesse Jackson, I’m closing this window- happy to see SOME new material, - short - and - unless you’re having a breakdown ? sheesh -

not acceptable !
Comment by TJ

July 20th, 2008 at 11:23 am

We are in a no win situation. Raise rates and completely crush housing or keep them low and let inflation soar. I have to say, Dr. Ron Paul told us this would all happen.

We should have left rates at 5% or 6% and let these idoits and their ARMs go under.

How does Bob Barr look to you. Another cause for this inflation is govt spending. McCain wants to cut earmarks, so about $40 billion off a 3.2 TRILLION dollar budget. Lets get real, if you want the govt to keep bailing out everyone, elect Obama or McCain.
Comment by Greedom

July 21st, 2008 at 6:39 am

Regarding the article though,

all in all I think I ‘get’ the intent.

I’ll just say when I learned not so long ago that CPI IS as you ask above “Just what IS this number ? ” - I found it less usable.

I still say - you seem to be someone who actually really cares to bring forward a better humanity, I just think, if it’s money, I bet you would be paid well in some greater humanities role, such as through BH or BMGF.

Hey - skip teaching, put out a good book - reach people - ?
Comment by Greedom

July 21st, 2008 at 6:45 am

I observe at the end of that chart

both lines start to go opposite directions

YIKES

that’s like 4x whammy loss - 2x JUST for going opposite direction and 2x for rapid rise yeast here (by the way, I do recommend a good cultured sourdough yeast).
Comment by Greedom

July 21st, 2008 at 6:49 am

Yellow is skyrocketing off the page on that chart

red curves down

the gap between them I’m SURE is directly proportional to a consumer saying “wow, bread, 4.29 ?”

BUT

will yellow follow red ?

and come down ?

OR ? will the gap increase until snapola time -

and the US consumer just loses out, or loses it ?

Strange gap though,

between red and yellow in that chart at the end.

direction wise.

bad timing for all the financials !
Comment by Greedom

July 21st, 2008 at 6:53 am

Ending that chart comment I see:

“it seems that the only medicine will be a sudden and sizeable increase in the Fed Funds rate.”

I do say

indeed- and I don’t get that we didn’t see immediate remedy -

Crazy larry’s low low rates

I can see Paulson’s hand shaking as he goes to put sugar in his coffee - at 6.75

on bid to announce a raise to 7.25 in one day

oh well

yeah - no doubt - as it says
….
“it seems that the only medicine will be a sudden and sizeable increase in the Fed Funds rate.”
Comment by Greedom

July 21st, 2008 at 7:04 am

SUDDEN and sizable increase

that’s what I’d like to see too

no doubt
Comment by Focus

July 21st, 2008 at 9:53 am

Dear Matt R., If you look at the statement from hsuB from every different angle, you may finally see that he was putting you on ….