Phorgy Phynance

Archive for the ‘Inflation’ Category

Quantitative Easing Explained

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Written by Eric

November 13, 2010 at 1:12 pm

CPI Weirdness

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I’ve never dug into the published CPI reports before, but a couple of articles have raised some questions about the numerical accuracy of the recently released CPI numbers, e.g.

This type of things is right up my alley, so I decided to have a look. First of all, here is a collection of some data tabulated from the CPI report:

The published percentage change in each constituent were only given to the nearest 10 bps, so I decided to grab the actual seasonally adjusted index values and compute the percentage changes myself for more accuracy. The numbers agree well enough, so there is nothing fishy here so far.

In fact, if you take the three percentage changes for Shelter, Fuels and utilities, and Household furnishings and operatiors (highlighted in yellow) and compute the weighted sum, it agrees precisely with the percentage change in the Housing number (as it should). Explicitly,

(32.289 \times -0.48 + 5.081 \times 0.51 + 4.59 \times -0.15)/41.96 = -0.32,

which is precisely the number you get by looking at the percentage change in the adjusted Housing index.

So far so good…

Now, if we dig a little deeper into Fuels and utility, we find

In other words, the weighted sum of the constituents agrees with the percentage change of the adjusted Fuels and utilities index to within 2 bps. I might expect closer agreement, but there is still nothing too shocking.

Things get weird when we look at the Shelter numbers

Here we see again that the published numbers agree well with the percentage changes in the adjusted indexes, but there is something odd. If we compute the weighted sum of the constituents as we did for Fuel and utilities and Housing, we get -0.10% as opposed to -0.48% as we’d expect. This is a 38 bps different that could change a negative CPI number into a positive one.

What is going on?

There are two primary possible sources of error: 1.) the weights are wrong, 2.) the index values are wrong. I do not list percentage change of each constituent as a possible source of error because I verified these against the index values provided.

Of course, the third (and not unlikely) possible source of error is that I am misinterpreting the data. If anyone has a good explanation for this apparent discrepancy, please let me know.

Written by Eric

February 22, 2010 at 1:23 am

Posted in CPI, Inflation

Physical asset inflation and/or financial asset deflation?

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Financial Armageddon points to the Reuters article:

Worried about inflation? Just wait

where he argues that deflation is the next big worry. I have to humbly disagree. Sort of.

I do agree that financial asset prices are due for a massive correction, but the economy is made of more than just financial assets. Financial assets will see deflation, but physical assets will see inflation.

During the “New Economy”, financial assets have soared in value and I believe, like Jeremy Grantham, that financial assets throughout the globe have experienced a bubble.

Like I’ve said in a comment or two on Panzner’s blog, during past corrections in the financial sector, China and India were absorbing inflationary pressures. That structural shift is what will make this time different. Today, China and India are net exporters of inflation and loose monetary policy in the US will create domestic inflationary pressures that have no where to go this time.

This is the rift I saw between physical and financial assets when David Richards asked me what I thought about the markets back in December of 2006. That rift has been partially corrected with the rise in commodity and energy prices since then, but I think there is a long way to go before things are neutral. As usual, things usually will not reach a nice equilibrium and stay there. Inertia will carry it through neutral and beyond. Significantly beyond.

Written by Eric

January 20, 2008 at 9:44 pm

FT: Moody’s warns on US sovereign rating

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A while back, I was sitting in a meeting with some bankruptcy attorneys that were helping the investment group understand some new bankruptcy laws. After the meeting, I asked one of the attorneys a pretty open-ended question that tends to get surprisingly honest answers:

In the long term, what is your biggest concern for the US economy?

Her answer was immediate and without hesitation:

I can’t see how the US is going to be able to afford healthcare costs for the coming wave of retiring babyboomers.

Not exactly what I was expecting her to say, but the apparent honesty left an impression on me. That is one of the reasons why, when I began voicing my gloomy opinions for the coming credit crisis (even though I’m an optimist!), I said some fairly radical things.

I’ve quoted part of the discussion here when I first learned of the amount of US debt held outside the US.

Looking out over the horizon, say 10 years or more, it was hard to imagine the US being able to pay its obligations. On July 26, Aaron Brown said:

I’ve never understood the argument that foreign ownership of treasuries is a threat to the US. If everyone who didn’t like me lent me money, I’d be happy. I’d be even happier if I got to pay them back with paper I wrote myself. In the 60’s and 70’s, the US sold a lot of debt to foreigners and inflated its way out of repayment. In the 00’s, the US sold a lot of debt to foreigners and devalued its way out of repayment. But people keep lining up to buy more. I don’t see that changing.

I admire Aaron a LOT. He is super knowledgeable AND super helpful. He has uncanny patience and is willing to walk even thick-skulled people like me through technical explanations. What he is suggesting above is that when the US’ obligation become unmanageable, we can simply inflate our way out of it. Sure. That is one solution, but when your obligations are both internal and external, inflating your way out of an obligation to a retired senior citizen doesn’t seem to be the most politically correct thing to do.

What is an alternative?

I suggested that, since much of the US’ obligation is to its retiring senior citizens as well as foreign debtors, one solution would be for the US to default on its external debt *gasp*

Here is my direct quote on July 26:

I’m not sure I’m so enthusiastic about the idea of inflating your way out of foreign debt obligations. That wouldn’t be so great for the domestic economy. Something like what Russia did, i.e. a flat out default, as crazy as it sounds, is seeming like more of a possibility to me though.

The deep and insightful comment from Skillionaire followed:

Eric, I’ve been disagreeing with your views for the past couple of days in this thread, but I believe with this statement you might’ve officially gone off the deep end with this apocalypse stuff you’ve been pushing.

To which I replied:

The good thing about these phorums is that they have time stamps. Sure, today the idea seems crazy. It’ll probably seem crazy for the next 5 years or more. Ten years? Anything is possible. We’ll see. Care to wager on it? Wink

Wager: Within the next 10 years, i.e. before July 26, 2017, a major news source will carry a headline indicating the US may default on a foreign debt obligation.

No one took me up on it 🙂 It’s only been 5 months, but the first cracks in the long term credit quality of US sovereign debt has surfaced

This is from the Financial Times

Moody’s warns on US sovereign rating

The US is at risk of losing its top-notch triple-A credit rating within a decade unless it takes radical action to curb soaring healthcare and social security spending, Moody’s warned on Thursday. The warning over the future of the triple-A rating – granted to US government debt since it was first assessed in 1917 – reflects growing concerns over the country’s ability to retain its financial and economic supremacy. It could also further pressure candidates from both the Republican and Democratic parties to sharpen their focus on healthcare and pensions in the run-up to November’s presidential elections. Most analysts expect future governments to deal with the costs of healthcare and social security and there is no reflection of any long-term concern about US financial health in the value of its debt.

I’ll repeat, I don’t see any real threat of a US sovereign default in the next 5 years, which is probably beyond the horizon of most investors and so might be considered irrelevant. But 10 years? 15 years? 20 years?

Written by Eric

January 10, 2008 at 10:30 pm

The new corporate trend: “onshoring”

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Ha! What did I tell you? It is wayyy past my bedtime and I should be sleeping (especially since I’m sick and feel like I’ve been run over by a truck), but just stumbled on an interesting article from one of my favorite economic development blogs: Design Nine. He points to an article in the

Recall that in the midst of all the market doom and gloom, I recently said:

I’m actually ironically optimistic about the outlook for suburban and rural economic development. A weaker dollar will make outsourcing less attractive. That will bring manufacturing jobs back home. I can imagine a boon in suburban and rural development. Just imagine if communities developed decent broadband via fiber-to-the-home/business. Suddenly, there will be attractive jobs and living standards in affordable places.

I admit that the quote is a bit misleading because Andrew Cohill has influenced the way I think about things, but still timely I think. Here is an excerpt from the article:

Small-town America: The new Bangalore?


Onshoring, in fact, is becoming trendy.

Some U.S. companies recently have pulled back from India to set up shop in rural areas where access to high-speed broadband connections isn’t the problem it was just a few years ago and where lower real-estate prices and wages are attractive.

Note that the key to onshoring is an investment in telecommunications infrastructure. In particular, fiber-to-the-home. It is quite sad to see so many municipalities rest their hopes on wireless broadband. That will only end in tears as the reality of wireless broadband becomes apparent. Any community that is not investing now in fiber will lose out on an important opportunity that is now beginning to present itself: onshoring. As Andrew will tell you more eloquently than I could, an intelligent investment in a communities future MUST involve a combination of both fiber and wireless and I would put wireless as a distant second. I can explain in gory detail why wireless will fail if you like (I did my PhD in the subject), but for now need to hit the sack.

Go onshoring! Go USA!

Written by Eric

December 4, 2007 at 12:50 am

Another proponent of economic Darwinism

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Just a quick note from MarketWatch before I hit the sack…

17 reasons America needs a recession

Here are some of my thoughts on the subject.

Good night and have a Happy Thanksgiving!

Written by Eric

November 21, 2007 at 10:28 pm

Bye bye dollar

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Needless to say, after my comment on August 28

PS: I’ve been ignorantly harsh on both Greenspan and Bernanke, but I have to say that I am quite impressed with Bernanke’s recent performance maneuvering through the current credit crisis. I expect him to hold the target rate at 5.25% on September 18. If he does, I’ll gladly apologize for anything less-than-flattering I’ve ever said about him. If he lowers rates, I’ll lose respect and throw him back in the Greenspan “save my Wall Street buddies” bucket.

I wasn’t particularly excited about the surprise 50 bps cut in both target and discount rates for the general long-term prospects of the US economy, although on a selfish level it was certainly good for my career stability. As far as I’m concerned, it is open season for Bernanke bashing. Greenspan bashing has been accelerating as well. Besides, if things really get bad with the USD, we’ll just move to Hong Kong or something 🙂

One of the things that I learned from Al Wojnilower was that the US economy could certainly keep chugging along for as long as the USD was the world currency. As he liked to repeat often, having the USD as the dominant world currency is like having an “American Express card with no limit”. One of the things that keeps the USD as the world’s currency is its position in sovereign reserves as well as the fact that oil is priced in USD. As far as I can see, both of these factors are beginning a worrisome decline.

With sovereign reserves continuing to diversify away from USD and Saudi Arabia refusing to cut rates in lock step with the US marks a real turn in the outlook for the USD dollar, and consequently the ability of the US economy to continue chugging along.

Written by Eric

September 22, 2007 at 7:28 am