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Shortages are Unmeasured Inflation

October 24, 2021 5 comments

Recently, I’ve been saying occasionally that “shortages are unmeasured inflation.” In some conversations I have had, it became apparent to me that people were taking this statement as being a throwaway line: “inflation is bad, shortages are bad, therefore they’re kinda the same.” But what I mean is actually more profound than that, and so I figured I would explain and illustrate, and hopefully thereby to convince.

Let’s use some charts.

What has happened since the large increase in federal spending and transfer payments were implemented in several waves since the shutdown began is that demand in many product markets has shifted outward. This implies that output “Q” moves from c to d while the price level “P” moves from a to b. [1]

So a strong increase in demand causes an increase in the quantity exchanged at the new equilibrium, and an increase in the price of the good or service at that equilibrium. This is the nice, smooth, continuous markets, instantaneous-adjustment picture from Econ 101. It’s also not the way the real world works, especially with large shifts in demand.

If price only adjusts partially, maybe if “anchored inflation expectations” or a fear of being accused of gouging restrained vendors from raising prices enough to ration the available supply, then a shortage results. This is the same thing which occurs classically if a price cap is instituted from the outside. Now price moves up from a only to b’, but the quantity demanded at that price is at d’. Thus, the bracket on the chart below shows the size of the shortage at that price, where consumers want d’ but suppliers can’t/won’t provide that much.

Note that this shortage is a direct substitute for the increase in price that would otherwise happen if prices could instantly and fully adjust. Moreover, the picture is somewhat worse in the short-term because the supply curve – in the short-term – is much more inelastic at some point (because, for example, no matter how high the price gets we can’t deliver more used cars in the short run). So, in the picture below the short-run supply curve in blue implies that the large increase in demand pushes prices to b’ with output only at d’, until supply eventually adjusts to the long-run supply curve S(lr), when we end up in the new market-clearing equilibrium.

In this case, the difference between b and b’ is “transitory” inflation, caused by temporary supply constraints. But note that in this picture, there is no perceived shortage. The market clears at b’ and d’. In other words, the conditions leading to the “transitory” increase inflation are not the same ones leading to the shortages.

We can combine these; if in the last picture above vendors also constrain prices to b, then there is a shortage as the quantity demanded stays up at d rather than at the market-clearing level d’. But, again, in that instance the shortage reflects the fact that prices should have adjusted to b’ but did not. Also in that case, it would be inaccurate to claim that the inflation was transitory, since prices should remain at b even when the supply eventually adjusts to the long-run equilibrium. It would be the shortage that was transitory.

In theory, if we knew the shapes of the curves of supply and demand for each product market, we could estimate how much higher prices would be at equilibrium and therefore how much additional inflation the shortage implies. We could directly translate the shortages to an “equilibrium” price level and therefore inflation. It strikes me as plausible that we could develop a rough estimate of such a number, but I leave that to the PhD candidates looking for dissertation topics. In the meantime, just remember that with inflation over 5% presently and shortly headed above 6%…the inflation rate is understated, and we know that because there are lots of shortages.


[1] If the deficits, funded by Fed purchases of Treasuries, had just offset the loss in incomes due to the shutdown – perfectly, across all individual markets – then there would have been no demand shift and no net change in output or prices. And if the deficits had not been accompanied by an increase in the Fed balance sheet, then it would have been individuals buying the bonds and so the only effect would have been because the marginal propensity to consume of the people receiving transfer payments is higher than the marginal propensity to consumer of the people buying the bond issuance. But in this column I’m trying not to muddy the discussion with the argument of whether we need both fiscal and monetary stimulus to cause inflation. I’m just focused on the narrow question of what it means when I say “shortages are unmeasured inflation.”

Summary of My Post-CPI Tweets (September 2021)

October 13, 2021 2 comments

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! Get the Inflation Guy app in your app store! Check out the Inflation Guy podcast!

  • Here we are, #CPI Day again – where did that month go!? – And everyone is gathered around for the number. So many interested people! So many experts on inflation suddenly!
  • Last night, @TuckerCarlson led his show with a monologue re inflation. And he got it basically right, which is unusual for nonfinancial media. But the point is, “transitory” inflation is now important enough to get the lead on one of the biggest cable opinion shows in the world.
  • Which of course is why there are so many experts suddenly. Demand creates its own supply. But I am not complaining. There’s only one Inflation Guy and he has his own podcast https://inflationguy.podbean.com and app (in your app/play store)! [Editor’s Note: See the last bullet]
  • More importantly some regional Fed folks are starting to sound queasy. Atlanta Fed’s Bostic and St. Louis Fed President Bullard. The NY Times! The Wall Street Journal! The Poughkeepsie News-Gazette! Made up that last one but it’s everywhere.
  • Not the Chairman though, and not the Treasury Secretary, both of whom want the same thing: more money. Who was it? In the Volunteers with Tom Hanks I think: Mo money means mo power.
  • Meanwhile 1y and 3y expectations in the Consumer Expectations Survey are at all time highs since the inception of the survey in 2013. Which of course is why Carlson is leading with it. Consumers are noticing.
  • Are they only noticing because of used cars? Seems unlikely. They’re noticing broader pressures, which we are starting to see and still will be watching for in this report.
  • Speaking of used cars…while the rate of change might come down on some of these spikes, there’s no sign the LEVEL is retracing. See latest Black Book survey. “Holding steady” around 30% y/y. But that’s down from 50% in May.
  • Consumers are also noticing shortages, which is unmeasured inflation. If you put a price cap below equilibrium, you get shortages. And if you get shortages, you can presume the equilibrium price is higher. Repeat: Shortages are Unmeasured Inflation
  • Now, there’s good news. Delays at China ports are down. Although some of this is seasonal and some is due to the fact that…all the ships are sitting in OUR ports. But there is SOME good news anyway. Had to search for it.
  • Question going forward is how much of the pressure on suppliers gets passed through. It will be more (a) the longer it lasts, and (b) the more suppliers see others passing along costs. And profit season is about to start, where we will hear some of those answers.
  • In this CPI report today: the Street is expecting a very tame +0.2% on core, after a soft +0.1% last month. That seems very, very optimistic to me. If we get +0.27%, the y/y core rate will uptick to 4.1%.
  • And AFTER this, the comps are terribly easy so core inflation will be moving higher almost certainly for the next 5 months. The total for those 5 months in 2020 was +0.43% on core. The TOTAL.
  • So, core will be moving back towards 5%, even if the monthly figures settle in only at 0.2% per month. I’m not very optimistic that’s going to happen. But the Street is!!
  • We will be watching the usual ‘reopening’ items of course, but also watching RENTS and the breadth of this figure. And let’s not ignore food although not in the core – it’s one thing that consumers notice more than other things when it’s persistent.
  • I expect Rents to continue to move higher. So looking for that. And watching Median CPI, which set a new multi-year high month/month last month. It’s at 2.42% y/y and will be higher this month.
  • I’d also look at some of the “re-closing” categories that dragged down core CPI last month to reverse. Again, not a lot of sign that most prices are declining, even if rates of change are slowing.
  • Good luck out there. 5 minutes to the figure.

  • The economists nailed it! Well, mostly. Core was +0.24%, so at the upper end of the forecast range before rounding up. Y/Y went to 4.04%, also just barely not rounded up. But been a while since we were worried about rounding. Let’s look at the breakdown though.
  • Airfares plunged again, another -6.4% m/m. That’s going to change soon if vaccine mandates provoke more labor shortages there. But it does appear, from my own anecdotal observation, that airfares have been actually declining.
  • Lodging Away from Home -0.56% m/m. Used cars -0.7% m/m. Car and Truck rental -2.9% m/m. So, most of the “reopening” categories are still dragging this month, what I’d thought was a one-off. I didn’t think they’d top-ticked the prices before.
  • But New cars and trucks were +1.30% m/m after 1.22% the month before. As I’ve said before, the New/Used gap that closed when Used car prices spiked can open again in two ways. Used car prices can decline (no sign of that) or New car prices can rise.
  • Now, that was your good news for the day.
  • Primary Rents were +0.45% m/m, boosting y/y to 2.43%. OER was +0.43% m/m, boosting y/y to 2.90%. Whoopsie. Totally expected. And yet, kept seeing how the eviction moratorium wasn’t really holding down rents. Hmmm.
  • Medical Care, though, remains a soft spot for reasons that I just can’t fathom. Flat m/m. Pharmaceuticals rebounded to be +0.28% this month, but Doctors’ Services fell -0.30% and Hospital Services followed a strong month with a tepid +0.11%.
  • Apparel also plunged this month, -1.12% m/m. Small category, big move. Still 3.4% y/y, which is big for clothing, but it’s weird. With ports backed up, I’ve been seeing stock-outs in a lot of sizes of the stuff I buy. Shortages are unmeasured inflation. But still.
  • Quick look at 10y breakevens has them +3bps since before the number. The rents spike has people spooked. And it should. That’s the steadiest component. All of these large moves in little categories tend to mean-revert.
  • Core goods decelerates to +7.3% y/y (yayy!). But core services accelerates to 2.9% y/y (boooo!).
  • Core CPI ex-shelter dropped to 4.66% from 4.79%. So that’s the effect of all of these small categories. Meanwhile, rents boomed. And core-ex-rent at 4.66% isn’t exactly soothing.
  • Chart of core ex-shelter, and shelter. In the middle, you get core at 4%. If you want core to get back to 2%, you need core-ex to really plunge because shelter isn’t about to reverse lower.
  • Speaking of shelter, I hate to say I told you so but…and we have a long way to go.
  • Now let’s look at tuitions. Since we are in the Sept/Oct period, we’re going to find the new level of tuitions, which will be smoothed out over the next year with seasonals. This month, the NSA jumped 0.56%, and the y/y rose to 1.73% from 1.20%.
  • Tuitions aren’t going to jump a ton this year, but in 2022 I expect them to take a bump – partly to reclaim colleges’ purchasing power and partly because the product will be better next year.
  • Sorry, error. That was for the Education and Communication broad category. College Tuition and fees rose 0.96% m/m (NSA), and to 1.72% y/y from 0.83% y/y. Sorry.
  • Other goods. Appliances +1.55% m/m. Furniture and Bedding +2.35% m/m. Motor vehicle parts and equipment +0.85% m/m. Medical equipment and supplies +0.96% m/m. So doctors? Not so much. EKG machine? Syringe? Give me your credit card.
  • Breakevens dropping back. That’s profit-taking on the pop. They’re going to keep going up I think.
  • Biggest core m/m declines annualized: Public Transportation (-46%), Car/Truck Rental (-30%), Womens/Girls Apparel (-28%), Jewelry & Watches (-18%), Misc Personal Goods (-13%).
  • Biggest core annualized m/m increases: Motor Vehicle Insurance (+28%), New Vehicles (+17%), Household Furnishings/Ops (+13%), Motor Vehicle Parts/Equip (+11%), Infants’/Toddlers’ Apparel (+11%).
  • I said pay attention to food, which is what people notice. Overall Food & Beverages was +0.87% m/m. Some big movers: Meats Poultry Fish Eggs (+29% annualized), Other food @ home (15%), Cereals/baking products (13%).
  • Oh my. Median. My early estimate, which I hope is wrong, is +0.45% m/m. If I’m right that would be the highest in 30 years. On MEDIAN. Not meaningfully higher than that m/m since 1982.
  • If that’s right, the y/y would be 2.78%. Still short of the 2019 highs, but not for long.
  • That median calculation tells me I need to look at the diffusion and distribution charts. Which will take a couple of minutes to calculate. Please hold.
  • While we are waiting for the diffusion stuff, here are the four-pieces charts.
  • Piece 1: Food & Energy. The most volatile, but recently it’s just been up. And this is the part that people notice. Normally ignored because it mean-reverts. But it’s hard to get near-term bearish on energy or food, especially as the latter involves lots of pkging and transport.
  • Core goods. Coming off the boil because of Used Cars. Staying as high as it is because of New Cars and other durables. Sort of concerning it isn’t dropping faster.
  • Core services less rent of shelter. The one encouraging piece although it relies heavily on medical. Service providers not yet passing through wage increases so much. This is where the spiral would really happen, if it did.
  • Piece 4, and the news of the day. Rent of Shelter is now shooting higher, after being held down by the eviction moratorium and lack of mobility. This will set multi-decade highs over the next year, and as the slowest piece makes “transitory” much harder to believe.
  • The Enduring Investments Inflation Diffusion Index. Not that you need this chart to convince you, but price pressures are the broadest in about 15 years. And getting broader, fast.
  • So, here is the distribution of y/y price changes by base component weights. Note two things: (1) there is a long right tail, which is symptomatic of inflationary periods. Core above median. (2) The whole middle has shifted higher. This is of course largely rents.
  • So…we are getting higher inflation from the slow-moving pieces, and higher inflation from the fast-moving pieces. What’s not to like.
  • And finally, here is a chart of the weight of all components that have y/y inflation above the Fed’s target (which equates to about 2.25% on CPI, roughly). Highest in a long time. Only 1 in 5 purchase dollars is going to something inflating less than the Fed’s target.
  • So in sum…the overall 0.2% on core, which was nearly 0.3%, was the best news of the day. There is nothing in the details, distributions, or trends to make you think this is about to end.
  • Because of comps, we can be confident that y/y core and median inflation are going to accelerate for at least the next 5 months. And there’s nothing to convince me that the monthlies are going to stay nice and tame.
  • Transitory is dead. There is too much liquidity. The Fed now needs to choose whether to drain liquidity (not just taper), and live with much lower asset prices, or keep pumping asset prices “for the rich,” while we all ultimately lose in real purchasing power.
  • Powell is over a barrel, but to be fair he was also the cooper.
  • FWIW, I think the taper will happen. It will stop when one of two things happens: (1) Brainard replaces Powell or (2) Stock prices decline 15%. The Fed is fighting a war and they don’t even know it yet. They are working to keep the bread and circuses flowing.
  • That’s all for today. I will have the summary post up on http://mikeashton.wordpress.com  in an hour or less. Visit our website https://enduringinvestments.com ! Get the Inflation Guy app. Check out the podcast “Cents and Sensibility.” And stay safe out there.
  • Biden to meet with ports, labor on supply chain bottlenecks
  • I mean, this will definitely help, right? “Mister President, since you asked, we’ll clean it up.”

Biden to meet with ports, labor on supply chain bottlenecks

  • Just heard that the Inflation Guy app has been “temporarily” pulled from the Google Play store. Uh-huh. Totally normal. Waiting for the notice from Twitter that I’ve been kicked off for “spreading disinformation.”

One of the ways you can tell this is getting bad is that the people who told us this was all transitory, had nothing to do with money, and would be over soon are doing one or more things from this list:

  1. Pretending they never said it.
  2. Pretending they didn’t mean what they obviously meant.
  3. Getting angry because they were wrong and you were right.
  4. Accuse you of also being wrong because you didn’t specifically say Used Cars was going up.
  5. Trying to talk over, or squelch, the people who are bearing the bad news.

Last month, we had an 0.1% on core. But when you looked at the details, it wasn’t really soothing because it was being held down by the “COVID categories” which were falling again. You didn’t really have to squint, but you had to look below the headline. This month, we almost printed an 0.3% on core, and that was only because of those same categories (plus apparel), for the most part. You didn’t need to look hard to see the problem. Primary rents had their biggest m/m jump since 1999. OER, the biggest jump since the heart of the housing bubble in 2006. Those are big pieces, and we have a great deal of confidence that they are going to continue to rock-n-roll. After all, we have long said that rents were being restrained mainly by the eviction moratorium and would begin to normalize after the moratorium was lifted. Quod erat demonstrandum.

The trajectory of inflation is becoming clearer. The debate is no longer whether inflation is going up but how high it will get and when the peak will happen. That’s the right debate. The ancillary debate is whether the next ebb will be at 2% or something higher, like 3%. Some outliers still see the next ebb as serious deflation, but those are the same people who thought we wouldn’t see inflation when the Fed started printing money that the Treasury spent. [Note to the purists: yes, the Fed doesn’t “print” money, but it’s silly to argue that buying bonds for reserves isn’t equivalent ‘because it’s an asset swap.’ That’s just sophistry. It’s also an asset swap when I buy a refrigerator for cash, but circumstances have clearly changed for both buyer and seller when I do so. Anyway, go sell your crazy somewhere else. We’re all stocked up here.]

There is at least a sliver of good in this mess, and that’s that while investors in the main totally blew the chance to buy cheap inflation protection before this all happened (because they believed inflation was not a risk), and totally forgot that inflation affects not only asset prices but stock and bond correlations, they are re-learning these lessons from the 1970s and 1980s. And so investing hygiene will be better going forward. We have more tools to hedge inflation now than we did in the 1970s, and failing to use those tools in a healthy investment portfolio will no longer be acceptable.

And I know I don’t need to say it, but my company Enduring Investments is here to help those investors. Just like all of those other experts, except we’ve been here for longer.

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