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The Political Temptation Posed by “Price Gouging”

August 26, 2021 1 comment

The arc of explanations about the rise in inflation and the end of the disinflationary era was foreordained:

  • There’s no inflation.
  • What you’re calling inflation is just a series of one-offs.
  • This is just a ‘transitory’ phenomenon, a one-off at the broad economy level, and will soon fade.
  • “It’s actually okay.” (NY Times: Inflation Could Stay High Next Year, and That’s OK)
  • It’s greedy manufacturers and vendors that are price-gouging. Where is my pitchfork?

In the current arc, we are already easing past level 3, as “transitory” is starting to be stretched a bit to “well, not past 2022” (Former Fed Chair Ben Bernanke opined yesterday at an online event that inflation would “moderate” in 2022). And we’ve seen signs of #4, and even some #5. The blame game is heating up, and with an Administration under pressure for its handling of…well, everything…I suspect we will move sooner rather than later into the full-blown level 5, complete with price controls in some industries and possibly economy-wide. Yes, there’s a very clear lesson from history that price controls don’t work to restrain inflation, but (a) today’s politicians don’t seem to really know much history, and (b) price controls need not be about restraining inflation – for some, it’s worth the political points.

Since it’s a term we will hear more of, I thought I’d try and put a little more structure around the accusation of “price gouging.” It is an easy term to throw around, but what does it mean?

Developed economies are still mostly free markets, in that buyers and sellers are given wide latitude to negotiate on price and quantity. In certain markets, where there are limitations on competition (electric utilities being a classic example) or vast differences in negotiating power or information (health insurance?) there are limits on the terms of trade but for the most part, if you want to buy an apple from the apple vendor you can strike whatever deal suits you both. In a free market, either the buyer or the seller can choose not to transact at the proffered price; ergo, economists assume that if a transaction occurs then both buyer and seller made themselves better off or at least not worse off. Unlike many economist assumptions, this one doesn’t seem like a bad one, at least in most cases.

If the price is “too high” for the buyer, then the buyer can complain but the buyer can always choose to not transact. So there’s only two senses in which “price gouging” might mean something:

  1. The price is egregiously high because the seller knows you really have no alternative, as the buyer, other than to buy. If there is a mandate to buy insurance or lose your liberty, but no cap on the price of insurance, then the insurance provider can charge any price it wants. This is infrequent. Arguably, in the aftermath of hurricanes it might apply to building materials, but even in that case I would argue #2 below is a more-accurate sense of the word.
  2. The price is, in some sense, “unfair.”

What is “unfair?” We do, as social animals, have some innate sense of fairness. A classic result from “the ultimatum game,” where one person is endowed with money that he/she chooses unilaterally how to split with a second person who can in turn accept the split or reject it (in which case both parties get nothing) is that under experimental conditions splits that are worse than 70:30 tend to be rejected by the responding party – in other words, the respondent would rather get zero than 30%, if it feels “unfair.” It is in that context that “price-gouging” accusations could be related to “anchored” inflation expectations. If a vendor is charging a very high price, but the buyer expects price changes to be large, volatile, and generally not in the buyer’s favor, then an accusation of “price gouging” is less likely than if the buyer expects price changes to be low and random. So, it might be that accusations of price gouging simply means that the buyers have not adjusted to a new inflation/pricing paradigm, and perceive the price increases as unfair even if they are objectively fair.

If that’s the case, then the buyer is going to lose in cases where the higher prices are a result of changes in the supply/demand balance. Higher prices are how limited supply gets rationed among the buyers – it is a feature, not a bug, of the capitalist system. In the case where a surge in demand (caused by, say, massive government transfers to consumers) causes stock-outs and rising prices, then accusations of price gouging are just sour grapes. Rising prices in this case are simply normal inflation happening in an environment that has not adapted to normal inflation again. (Listen to the Inflation Guy Podcast, episode 2, where I point out that “supply chain problems” is exactly what inflation caused by too much money looks like.)

Nevertheless, where the “price gouging” accusation is code for “this feels unfair,” it is a terrific opportunity for a political lever. Politicians will feel that they can make people happy by instituting price controls, and blaming the wealthy industrialist, even though economics and history tell us that this isn’t the right answer. But it is a siren song, and I think that we are very likely to start hearing this more and more.

Once price controls are instituted, what follows is that the stock market craters (since the difference between input costs and consumer prices is some part profit), a black market develops in the restricted goods and services, and many products get impossible to acquire or rationed by a lengthening waitlist rather than by price.

Can you really control prices in the Internet age? It hardly matters. Politicians don’t really care about controlling prices after all; they merely want to appear as if they’re on the side of the voters. Bashing suppliers is one easy way to do that. I don’t think it will be long now. Keep the torches and pitchforks at the ready.

Categories: Behavioral, Government, Politics, Protectionism and Tariffs

Inflation Guy Inaugural Podcast Published

August 20, 2021 4 comments

I wrote recently about the new (free!) Inflation Guy app, which you can get in your app store.

Now, there’s also a podcast for the Inflation Guy. It is called “Cents and Sensibility: The Inflation Guy Podcast,” and you can get it on PodBean here.

I’ve got a long list of topics, but I am always adding more. Follow, and let me know if you have a request/idea for a topic!

Categories: Announcements

Average Inflation or Price-Level Targeting: Where Are We Now?

August 19, 2021 3 comments

One of the reasons the Federal Reserve has been slower than usual to respond to the upswing in inflation, in addition to claiming that it believes any acceleration to be ‘transitory,’ is that the FOMC cleverly changed its modus operandi a couple of years ago to focus on “average inflation targeting,” or AIT. This adjustment in policy had been debated for many years, as the Committee grew concerned that the Fed could lose credibility (ha ha) in the downward direction if it did not commit to its 2% target symmetrically. They were afraid that, if investors believed they would respond aggressively to inflation but not to disinflation, they would start to incorporate this asymmetry into their investment decisions and push the economy uncomfortably close to price stability.

Parenthetical editorial comment – the idea that the Fed needed to fight against the notion that it might be too hawkish is a head-scratcher. It is unclear how the Federal Reserve could be less dovish than it has been in practice for the last dozen years.

In any event, AIT is similar to price-level targeting, although it is more flexible in terms of the period over which the average is intended to be taken. The Fed meant to signal that it would allow a period of above-target inflation to persist, until at least the period of below-target inflation had been compensated. But again, AIT is vague about what all of this means. However, it happens to have been timely as the Fed now can evince patience with higher inflation, since there had been an extended period during which prices were “too stable.”

How are they doing?

In my recent article “CPI Forwards Show Inflation Concerns Aren’t Ebbing,” I discussed how inflation forwards could be estimated, and give a steady reading on particular points in the future. Here is what that would look like today. If we measure 2.25% target CPI growth (which is roughly 2% on PCE, given the historical spread), then from the announcement of AIT the chart below shows the actual inflation index, and what is implied about the future.

This chart would suggest that the Fed chose an inauspicious time to begin focusing on AIT, since already the undershoot from 2019 has been fully retraced and then some. Moreover, the market seems to believe that the Fed is going to have to focus on a new level, as prices will never get back down to a level implied by 2.25% from the inception of AIT.

As I said, though, the great thing about AIT (from the standpoint of a political economist) is its vagueness. If we instead take as the starting point of the average the period just after the global financial crisis, when rents were recovering at last, then you get a much more agreeable picture. Looked at this way, the market is generously giving credit to the Fed for making a perfect landing, very gradually, over the next 5-10 years.

That seems a bit too generous by half in my opinion, but the takeaway is this: even choosing an extremely long averaging period, the Fed has already used up as much slack as it had saved up. If the next year’s worth of inflation outturns deliver what I think they will deliver, then either the inflation curve is going to become increasingly inverted or the Fed will have to recognize that investors are not buying the AIT framework.

Interested in content about identifying, measuring, and overcoming inflation? Download the free Inflation Guy app today!

Categories: Federal Reserve, Uncategorized Tags: , , ,

Summary of My Post-CPI Tweets (August 2021)

August 11, 2021 1 comment

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy. Or, sign up for email updates to my occasional articles here. Investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! And, of course, download the Inflation Guy app from your app store!

  • Now for the walk up: We’ve now had four “high” surprises in a row from the CPI report. In each case, the market for the setting (in the interbank CPI market) has been closer than the economists’ estimate, but still too low.
  • The last four prints on CORE CPI are +0.34%, +0.92%, +0.74%, and +0.88%. The economist consensus for today is 0.4%, with the market closer to a rounded-up 0.5%.
  • (N.b. Core CPI doesn’t trade, but the headline CPI index traded at 273.1 yesterday and that implies 0.54% m/m on headline and something a little less on core)
  • If the economists are right, y/y headline will drop down to 5.3% (just barely) and core to 4.3% from 4.5%. That will be the first decline in quite a while. Unfortunately, the comparisons to last year get easier from here. For the next 7 mos, core is comping 0.14% on average.
  • So even if today we see an ebb in y/y due to base effects, I believe we still have significantly higher highs in core inflation ahead.
  • Now, on the details: we may ACTUALLY see a DECLINE in Used Cars CPI, as the Black Book Used Vehicle Retention Index, the best leading indicator of Used Car CPI, dropped 2.5% last month.
  • But before you get too excited, note that the change in the BB index m/m only has the same SIGN as the change in the used car/truck index about 50% of the time over the last decade. Lagged 1 month, it’s about 60%.
  • So better chance for a decline in used cars next month. But it’s a risk of a drag, and it hasn’t been a risk for a while. One way or the other, the BIG contributions from Used Cars are past.
  • On the other hand, there’s still other “reopening categories” such as airfares, lodging away from home, and car/truck rental that are likely to still be jumpy. And New Cars as well, though this is less obviously a ‘reopening category’ and more about supply chain.
  • Who cares about those, honestly. If that’s where the strength comes from, economists just wave their hands dismissively and say “transitory.” Where I’m focused is shelter (of course), and on BREADTH.
  • Shelter will eventually rise a lot. For a while, the eviction moratorium was holding the average-paid-rent below asking rent increases. And, with another (questionable) extension in the moratorium, that effect is still there.
  • But we have started to see some increases in Primary rents and OER anyway. The difference is just too wide. So, while the meat of that acceleration is ahead of us by some ways, I’m expecting to see it start to happen.
  • And breadth – that’s the real story to watch. Our diffusion index is the highest in years, because it’s not JUST the reopening categories (whatever you read). The scariest number would be another 0.5% on core but without contribution from reopening categories.
  • Now what’s the market impact? Interesting question. There now looks like there is a majority of Fed heads who are willing to at least talk about tapering, and a high core number will reinforce that. But the important voices on the Committee remain firmly dovish.
  • Personally I think that, faced with the decision of somewhat higher inflation vs sharply lower markets, the Fed will err on the side of somewhat higher inflation and keep hoping their models are right.
  • So buy dips in breakevens (the high tails are not priced in, anyway), but not sure I’d be as eager to sell strength in nominals. Stocks probably go up either way, because that’s what stocks do these days (until they don’t).
  • There’s a lot of chatter from companies about being forced to push through price increases and seeing consumers actually not push back as much as they thought, so this is feeling less transitory every day. Don’t think we are going back to 0.1%-0.2% per month soon.
  • That’s all for now. My gut tells me the consensus has finally gotten to something close to a fair bet, but I won’t be shocked at all if we get another 0.7% on core. I also won’t be surprised by a small miss lower caused by some one-off change. So fair, but large error bars.
  • Well, on headline CPI it was finally a tie between economists (slightly too low) and the market (equally too high). But pretty close. Core was 0.33% m/m, slightly soft of estimates.
  • 0.33% m/m, of course, is still 4% annualized on core. But let’s see the breakdown.
  • Glancing I can see the curious bit will be the softness in Primary Rents. 0.156% m/m vs 0.23% last month. That seems odd, but importantly it also is unsustainable. Primary rents are going to go MUCH higher.
  • In reopening categories, Airfares FELL -0.14% m/m (+2.7% last mo). Lodging Away from Home +6% (+6.95% last). Used Cars +0.22% m/m – no decline, but feels like it after +10.5% last month! New Cars +1.72% m/m.
  • Now here’s a big surprise in a very little category. So not much impact, but car and truck rental -4.6% m/m. Last month +5.2%. Rented a car recently? That’s an odd one. But only 0.13% of CPI so rounds to 0.01% effect.
  • The broad core categories: Core Goods +8.5% y/y (8.7% last month); Core Services +2.9% (3.1% last month).
  • Core inflation ex-shelter decelerated to only 5.3% y/y from 5.8%. That’s a little tongue-in-cheek. But to be fair, used cars is still a large part of this.
  • Only large declines (<-10% annualized) in core were Car & Truck Rental and Motor Vehicle Insurance. Large increases in Lodging Away from Home (101%), Personal Care Services (29%), New Vehicles (23%), Car parts/equipment (13%) and Car maintenance/repair (11%). All m.m ann’lized.
  • Early guess at Median is that it will be 0.30%, which would be the highest in several years if I am right. And that speaks to breadth.
  • Here is y/y Rent of Primary Residence. Again, this has a long way to go, to well above the prior levels in fact, unless the boom in housing prices never get reflected in rents.
  • And here is Owners’ Equivalent Rent. Which is moving higher a little more earnestly, but still reasonably inert.
  • Haven’t mentioned apparel. On a nonseasonally-adjusted basis it fell 1% m/m, but seasonally adjusted +0.04%.
  • And I haven’t mentioned Medical Care. Overall +0.26% m/m. Breakdown: Drugs +0.17% (-0.39% last month), Doctors’ Services +0.40% (+0.26%), Hospital Services +0.55% (+0.22%). Some signs there.
  • CPI – Doctors’ Services (y/y). Interesting ratchet pattern.
  • …if you ever think you understand the CPI, just look at Health Insurance. In the CPI, Health Insurance is a residual since consumers don’t pay most health insurance directly. Went from +21% to -9% y/y over last year.
  • So, the four-pieces breakdown. Then we’ll look at diffusion. Here is Food & Energy. No surprise. Not core, but felt in the pocketbook acutely especially by lower-wage employees.
  • Core Goods – slightly off the boil, thanks to Used Cars. This will come back down as the y/y Used Car spike gradually leaves the data. I’m not worried about this staying at 8%. But 4% or 5% given global shipping problems – wouldn’t surprise me.
  • Core services, ex rent-of-shelter. Air fare softness, motor vehicle insurance softness, car and truck rental softness – none of those likely to remain very soft in the near term I don’t think. And medical care heating up a little.
  • And rent of shelter. To be sure, a lot of this is Lodging-Away-from-Home. But then, so was most of the decline. This piece is going MUCH higher over the next year. Our model for OER has it over 5% next year.
  • Now, the big story is the diffusion. Inflation is broadening. Our inflation diffusion index is the highest in nine years. So it isn’t just the reopening categories, folks. Your eyes ain’t lying.
  • Here is the distribution of category price changes. Six months ago, this was skewed to the left. Now, it’s skewed to the right. Long tails to the high side is a signature of an inflationary process.
  • So, let’s sum up. The reopening categories are lessening in importance as we knew they would. Is inflation transitory then? It depends on the answer two two questions:
  • is shelter inflation going to rise? And/or is that transitory? Shelter is slow, and right now it is depressed by the eviction moratorium. It has a LONG way to go, unless home prices and wages plunge. I don’t see those things happening. Ergo, we’re going to see more here.
  • Is inflation due to supply chain constraints in a narrow group of categories? Answer here is no. Price acceleration is broadening. Apparent shortages, resulting in higher price, is how supply/demand imbalances are reconciled in a market economy – even if it’s demand-side.
  • The comps for core inflation get easier going forward. 0.35% next month, but then 0.19%, 0.07%, 0.17%, 0.05%, 0.03%, and 0.10%. Core inflation is going to reach new highs into early 2022. And Median inflation is going to gradually accelerate too as inflation broadens.
  • Last month, the CPI was high but it really WAS mostly about Used Cars. This month is lower, but it’s more worrisome because of the broadening of inflation pressures. I think there’s no turning back now. Inflation expectations are going to be broken.
  • Will the Fed care? I give a ‘taper’ sometime this year maybe a 50-50 chance, although I don’t think it will last very long since the moment that stocks and bonds soften, QE will be back. Every taper so far has led eventually to larger QE!
  • I give almost no chance of an actual hike in the overnight rate, for a very long time. I don’t think Powell or Brainard are going to turn into hawks – they may express alarm at inflation but they would be more alarmed by an equity bear market. Hope I’m wrong.
  • That’s all for today. Remember to download the Inflation Guy app. Tune into @TDANetwork at 1:45ET today. And register for the Simplify webinar tomorrow at https://us02web.zoom.us/webinar/register/5216230941517/WN_O20LE_xlRUOAe7ysdVBDnA  Harley Bassman and Mike Green are the hosts! Busy busy Inflation Guy. Thanks for tuning in!

Well, I had said “the scariest number would be another 0.5% on core but without contribution from reopening categories.” We didn’t exactly get that; it was a little softer on core and some of the reopening categories still contributed. But not all of them. The number of inflating categories is getting broader, and shelter is starting to rise – although still very slowly, thanks to the continued eviction moratorium. All that means is that the rise in rents will be smeared over a longer period, and won’t really get started for a few months although I think there are starting to be clues in the data that shelter costs are percolating. With soft comps, this means that late Q3 and Q4 are very likely to see a sharp acceleration in core inflation. If we only average 0.3% m/m on core inflation, then by March (February’s print) core inflation will be at 5.4%, compared to 4.3% now.

Will that matter to the Fed? Until the people come with torches, probably not. However, these days – I wouldn’t count out the possibility of torch-bearing mobs.

Categories: CPI, Tweet Summary, Uncategorized Tags: , , ,

CPI Forwards Show Inflation Concerns Aren’t Ebbing

August 9, 2021 1 comment

One of the most important things I learned as a markets person was the relationship between “spot” prices and “forward” prices. A spot price is the price today, if you buy a particular investment or commodity. A forward price is the price that you agree today to pay in the future on some date for delivery of that investment/item.

To a non-markets person, this seems odd. If I want to buy a carton of milk, but the grocery store is out of milk so I tell the grocer “hold one of those cartons for me when they come in,” it wouldn’t occur to me that I should pay a different price than is on the shelf. Or, maybe, I might expect to pay whatever the price is, when the milk comes in. But I wouldn’t think that today I should arrange for a different price for that milk just because I get it in the future.

But of course, the idea of the present value of money is super important in investing. A dollar received in the future is worth less than a dollar received today. (That is, unless interest rates are negative. In that case, a dollar in the future is weirdly worth more than a dollar today, and we are in that bizarre situation I described once, in a really neat post, as ‘Wimpy’s World.’) But it isn’t just money that has a different value for future delivery than it does today. There are at least two ways that I can own a pound of gold six months from now. One is to buy a pound of gold, and pay for storage and for insurance for six months. The other is to arrange with someone today to deliver me a pound of gold in six months. In that case, I don’t have to pay for storage and insurance, so I’ll be willing to pay more for gold in the future. In commodities markets, we say that this curve is in “contango,” where futures prices are above spot prices.

The important thing to realize, though, is that all of these things converge. The spot price of gold will eventually converge to the 6-month forward price of gold…in, as it happens, about six months. If there is no change in the price of insurance and storage, every day the spread of the futures price over the spot price will decline by one day’s worth of those expenses. (n.b. – there are other parts of the carry, too; I’m abstracting here for illustration). If nothing else in the market changes, then the spot price will gradually rise towards that forward price. Here is the important bit that markets people learn: in some sense, that is not a true profit:

Buy today: $1700 plus $10 storage plus $10 insurance = $1720 cost of gold 6 months’ forward

Buy for forward delivery: $1720.

In both cases, if I sell the gold six months and one day from now at $1720, I have made zero money, even though in the first case I paid $1700 for it. But it looks like gold rallied.

I’m not really here to talk about gold. I’m here to talk about economists.

Economists don’t really internalize this well. Case in point is the question about whether inflation expectations are ‘anchored.’ An economist – in particular, a Fed economist – looks at the following chart of 2-year inflation swaps since February and says “Expectations for inflation two years in the future rose between February and May, and then have been flat-to-down since then.”

But that’s not really what happened.

Someone who bought inflation swaps in early May got something that a buyer of inflation swaps today doesn’t get. The May 15th version of inflation swaps, because of the way they work with a 3-month lookback, got half of the 0.6% March CPI print, plus the 0.8% April print, the 0.6% May print, and the 0.9% June print. The person who buys inflation swaps today doesn’t get March and April, and only half of the May uptick (plus June). Ergo, if nothing else changes we would expect the price for a 2-year inflation swap today to be lower than the price in mid-May.

As the high prints from the last few months pass into the rear view mirror (although there will be some high ones to come, I don’t really expect +0.9% m/m any time soon), the inflation swaps and breakevens markets should look softer. It’s just carry. But how much softer?

One way to find out what is really happening to inflation expectations is to look at the forwards. Let’s pretend for a minute that the CME had actually launched CPI futures a few years ago, and we had a CPI futures contract that traded in December 2023 (settling to the November CPI print that comes out that month). Over the last few months, what would have happened to the price of that futures contract? The chart below shows that it would have enjoyed a very steady rise over the last six months. The CPI futures contract settles (or anyway, it would have) to a particular price level. We would almost always expect the futures prices to be above the current NSA CPI number, which was 271.696 in June. But these prices – which I’ve calculated from an inflation swaps curve I build every day – are showing that investors have responded to these higher CPI prints by steadily raising their expectation of future prices.

If investors thought these last few months were going to be reversed in the coming months, then the forwards wouldn’t have responded in this way. Investors would be betting that the high prints would be followed by low prints that reverse the changes. However, that’s not what is happening. Investors are taking these high prints and putting them in the bank. While they might think the rise in the inflation rate is transitory, they don’t think the rise in the price level is transitory.

This is a key distinction. The inflation we are seeing, even if it later slackens, represents a permanent loss of purchasing power. How much of a permanent loss have we seen in the last couple of years? Here are my calculations of the theoretical futures curve for CPI, as of August 1st, 2019 compared to last Friday. The last column shows how much higher investors think prices will be on those dates today, compared to what they thought two years ago.

Notice that this is from well before the crisis, and so takes into account the plunge in prices from early 2020 and the recent increases. After all of the zigzags, investors expect prices to be about 5% higher in 2023 than they would have thought previously, and about 8% higher in 10 years.

And I think they’re too sanguine.

Categories: Investing, Theory Tags: , ,

Inflation Guy Mobile App Launched!

August 3, 2021 2 comments

I am happy (and a little scared) to launch my mobile App “Inflation Guy” now available in Apple (https://t.co/28zNrvAhEg ) & Android (https://lnkd.in/eg_CK2T ) stores. Or, just search for the “Inflation Guy” app.

The app will have various inflation-related content – curated, commented, and often created by me. I’ve added a daily chart package. There will be How-Tos. My media appearances will show up there. These blog posts. We are working on other tools and reports (simulated CPI futures?). And I’m going to have a companion podcast that will be linked there as well.

The app allows you to filter content based on your interest. I look forward to your feedback once you’ve downloaded the app!

My thanks to the team at NoCodeApp Center (https://nocodeapp.center) for helping me put together and launch this app.

Get what will soon be the Grand Central Station for #inflation! Join the Inflation Guy as together we expose the hidden tax, oppose the insidious assault on our wealth, and defend our money!

Categories: Uncategorized