Archive
Inflation Guy’s CPI Summary (August 2025)
Before I begin talking about today’s CPI, a quick word about the 24th anniversary of the terrorist attacks of 9/11. As someone who worked 1 block from the Towers, I can tell you it’s a day I will never forget and filled with images I can never erase. But I also remember that in the weeks that followed, the country was unified in a way I’d never seen. Rudy Giuliani was “America’s Mayor” for his courage and steady hand during the disaster and in the period that followed. When I traveled to the Midwest, menus were filled with ‘Freedom Fries’ and strangers asked with concern about my family and friends when they heard I was from New York. It seems crazy to me that only 24 years removed from that, the country is divided in a way I’ve never seen. Everyone said “we will never forget.” And then they forgot.
But I do not forget. I give prayers and thanks for the brave first responders I saw that day and for the families of those who didn’t return. And you should too.
All of which makes the monthly CPI report seem very small. In truth, it is small all of a sudden. From being one of the most-important releases for a couple of years because of the Fed’s assumed reaction function, it has abruptly been pushed to the back. This is partly because of the weak Employment data and the massive downward revisions to the prior data but that point is reinforced by the Fed’s recent adjustment to the inflation targeting framework, in which they removed any imperative to make up for periods of high inflation by engineering lower inflation so that the reaction function is basically one way. (See my writeup on this at https://inflationguy.blog/2025/09/02/the-fate-of-fait-was-fated/.) I guess there’s an ironic parallelism here. After the inflationary 1970s and the pain of bringing inflation back down, the Fed said “we will never forget.” And then they forgot.
But I do not forget. And neither should you. An investor’s nominal returns are irrelevant (except to the IRS). What matters is real returns, and a period of higher and less-stable inflation has historically resulted in lower asset prices since the most important indicator of future returns over normal investing horizons is starting price. If markets need to adjust to higher inflation to give higher nominal returns, the easiest way to do that is to lower the starting price. So whether the Fed cares, we should.
And with that – we came into today with real yields having fallen some 20bps this month, but with inflation expectations having not declined much at all. Obviously, that’s the market’s reaction to the presumed tilt of the Fed.
The CPI report was slightly above expectations, which were already somewhat higher than in prior months. So when people tell you this was a ‘small miss higher,’ that’s mainly because economists adjusted their expectations, not because the number was similar to prior months. Month/month headline inflation (seasonally adjusted) was +0.382% (expectations were +0.33%), with core at +0.346% (expectations were +0.31%). Markets have not reacted poorly to this figure, but I wonder if core had been slightly higher and rounded to +0.4% if we’d have seen more introspection.
But as I said, this is a ‘small miss’ but that does not mean it was a small number. Indeed, with the exception of the jump in January associated with tariff noise, this is the highest core figure in 17 months.
There were a number of upside categories, but one of them was not Medical Care. Some people had been looking for a move higher here, and Doctor’s Services rose a bit, but Medicinal Drugs fell -0.372% m/m and is now down year/year. That surprises me, but there are a lot of pressures on the drug industry right now and it is going to take a while to see how it shakes out.
Core goods prices continued to accelerate. On a y/y basis, core goods are +1.54%. With the exception of the COVID spike, this is the highest level of core goods inflation since 2012. Some of that is definitely due to tariffs, and that will trickle in for a while. But the long-wave concern is that deglobalization/re-onshoring of production means that it will be very hard to get core goods inflation back to the persistent mild deflation we had enjoyed for a very long time. And without that, it is very hard to get core inflation to 2%, especially if core services (+3.59% y/y) stops improving as the chart sort of hints it might.
One surprise you will hear a lot about is Owners Equivalent Rent, which was +0.38% m/m. Primary Rents were +0.30% m/m. Both of those are higher than the recent figures, but this looks like some residual seasonal-adjustment issues to me. The y/y for both continues to decline, albeit at a slowing rate, which means that the number we dropped off from last year was higher than the upside surprise of today.
Rents are on schedule.
We also saw another jump from airfares, +5.87% m/m, and Lodging Away from Home (+2.92% m/m) finally rebounded after months of weakness. Used cars were +1.04% m/m, and new cars +0.28%. When you look at all of the pieces, it adds up to Median CPI being almost the same as last month: my early guess is +0.276% m/m.
Turn that picture any way you want to. I don’t see a downtrend.
When we break down inflation into the four main pieces, none of them is in deflation and none seems to be an overt drag or pulling everything else up. Food and Energy is +2.16% y/y. Core goods is +1.54% y/y. Core services less rents (aka Supercore, chart below) is +3.56% y/y. And Rent of Shelter is +3.61%. How do you want to get inflation to 2% from those pieces?
Long-time readers will know this does not surprise me. Median CPI will be around 3.6% y/y again. That’s where we are. We overshot my ‘high 3s, low 4s’ target to the downside a bit, but we’re back up in the mid-to-high 3s. I’ll take that as a win.
I want to share the money supply chart. On an annualized basis, we’re near 6% y/y over the last six months. That is back to pre-COVID levels, and is too fast in this environment. You can’t get 2% inflation with deglobalization and sour demographics if you’re running the monetary playbook from when you had globalization and positive or neutral demographics.
And finally, we now know USDi’s price through the end of October.
So what does all of this mean for policy? Well, see what I said above about inflation targeting and the change of the Fed’s operating framework. The most important things to the FOMC right now are, in order:
- Employment
- Politics, and jockeying for position to be named next Fed Chair
- Internal modeling about tariffs, inflation expectations, rents, etc.
- Actual inflation numbers, like CPI
35th or so in importance is “the quantity of money,” if it’s on the list at all. You can probably glean from my list that I think the Fed is likely to ease. Let me make clear that I do not think that a wise Fed chair would even consider easing with median inflation steadying around 3.6%, and a 50bps cut would be laughable. However, this is not a wise Fed chairman, and this one is going to ease. In my gut, I think the Fed will cut 25bps but with several dissents for 50bps. I would not be shocked with a 50bps ease even though it is completely boneheaded to do it with inflation still running hot with no clear path for it to decline to what used to be the target.
But that’s the point I suppose. Is there even a target, if the Fed doesn’t mind missing it?
One final announcement. If you’re an investor in cryptocurrencies (in particular, stable or flatcoins) and have a Telegram account, consider joining the read-only USDi_Coin room https://t.me/USDi_Coin where the USDi Coin price is updated every four hours or so…and where many of these charts are also posted shortly after CPI just as I used to do on Twitter.
The Fate of FAIT was Fated
Growth in the US is ebbing, and it is likely only the AI boom that is keeping us from recording a small recession. Unemployment is still rising, although slowly, and credit delinquencies are rising. Because the services sector and the goods sector are still asynchronous – a holdover from the COVID period – we haven’t seen an aggregate contraction, but it will happen eventually. That doesn’t concern me. Recessions happen. It is only worrisome because equity markets are so ‘fully valued’ that an adjustment to a recession could be rough. On the other hand, all signs point to the Federal Reserve starting to ease, and this may support stocks. I would go so far as to say that investors are counting on that.
That is a rather ordinary problem. The bigger problem has not yet been realized by equity markets, but as we look at long maturities on the yield curve we see that yields are near the highs of the year even with the Fed expected to ease. That is not normal. When the Fed eases the curve tends to steepen, because however long the period of lower short rates, it will be a larger proportion of a shorter-maturity instrument. But long rates still decline in that case, normally.
You can insert your favorite story here, about how foreign investors hate Trump, or people are worried about inflation, or the credit profile of the United States. My preferred explanation (see “The Twin Deficits – One Out of Two IS Bad”) is that if you reduce the trade deficit sharply but do not reduce the budget deficit equally sharply, then the balance must be made up by domestic savers and that implies a higher rate of interest.
There’s also some reason to be wary of the turn higher in inflation, even though that was entirely foreseen (see “Ep. 145: Beware the Coming Inflation Bounce”) and a good part due to base effects. There are, though, some signs of underlying secular rather than cyclical pressures on prices. For example thanks partly to AI electricity prices started accelerating higher in 2021 but unlike other parts of the CPI have continued to rise. The CPI for Electricity stands 35% above the level of year-end 2020, and well beyond the long-term trend. Beef prices are 41% higher and still rising.
Of course, there are always prices that are rising but there are two reasons I am more concerned about this now. The first is that the money supply has returned to a positive and rising growth rate and is at a level inconsistent with long-term price stability even before the Fed renews its easing campaign.
Five percent was once a nice level for M2 growth, when demographics and globalization were following winds. Now they are headwinds and we need to be lower. Still, I wouldn’t get panicky about 5%. Get to 8% and I’ll be more concerned. But the reason that might happen concerns changes happening at the central bank.
What gets the headlines is the continual pressure that the Trump Administration is putting on Fed Chairman Powell and others on the Federal Reserve Board, several of whom are jockeying to be dovish enough to be selected as the next Fed Chair. But the much more important development was the 5-year review of the Fed’s operating framework, which Powell discussed at his Jackson Hole speech. The significance of this was seeming lost on most investors, although 10-year breakevens have gradually risen and are up at 2.42%, and other than in the post-COVID surge they’ve not been much higher than that since 2012 or so.
These are 10-year breakevens, so this isn’t a tariff effect. What’s going on here? Not much, yet, but…there is the change in the Fed’s framework, which I think is important.
Five years ago, the Fed abandoned a specific inflation target in favor of “Flexible Average Inflation Targeting”, or FAIT, which basically said “we are targeting 2% inflation, but only over time. So when inflation is too low for a while, then it’s okay to let it run hot for a while later.” At the time, this was a clear sign that monetarists – who don’t necessarily believe there is a tradeoff between inflation and growth like the Keynesians do – were losing the battle. More flexibility to respond to inflation ‘tactically’ is not something that we needed, and it wasn’t clear how that would be a helpful change anyway.
But the current 5-year framework adjustment is worse. It basically abandoned the good part of FAIT, which was any kind of soft commitment to be hawkish in the future if necessary. In Powell’s words – and I’m not making this up – “…we returned to a framework of flexible inflation targeting and eliminated the ‘makeup’ strategy.”
Yep, that’s what he said.
There is a lot more in Powell’s explanation, but most of it all leans in the same direction. For all my historical criticism of former Chairman Greenspan, he deserves credit for this: he used to say that achieving low and stable inflation was key to achieving maximum stable employment over time. Thus, inflation was primary, not secondary, in achieving the dual mandate. Now, the Fed ostensibly wants to target a low level of inflation…because that’s what central banks are supposed to do…but recognizes that sometimes they’ll want to emphasize lower rates to help Employment – and the important part is that as I just noted, they won’t ‘make up’ for running too much liquidity now by running less liquidity later. Does anyone want to take the other side of the bet that the Fed will have an easier time lowering rates and keeping them low, than raising them and keeping them high? Accordingly, the long-term inflation outlook just got worse. I don’t think we are returning to the 1970s, but we aren’t returning to 2% any time soon – and the Fed is okay with that!
FAIT was never a very good idea, and I didn’t think it would survive the first time inflation ran too high and dictated an extended period of very tight money. It didn’t. I didn’t think they’d actively make it worse, and maybe the joke’s on me. They always make it worse.
How to Calculate USDi’s Current Value
I haven’t been writing a lot during August, nor have I done many podcast episodes. I feel like I make this apology almost every year, but it seems every year August just gets slower, and slower, and slower – and any content I push out gets less engagement during August than during any other full month (although the end of December, naturally, gets very thin as well. It’s really remarkable how August has changed during my career. In the 1990s, there were maybe a couple of weeks that were a little thin in the markets, but that has metastasized so that now it’s all of August and a week or two into July. I am speaking of the US markets – Europe has always been slow for the second half of the summer, at least in my experience, and I don’t know if there has been much change in that over the last few decades.
In any event, I’m more than happy as a writer to take a little time off and recharge. As an entrepreneur? Not so much.
This is, though, a good time for a ‘utility’ post. As readers know, a few months ago we launched USDi, the first CPI-linked cryptocurrency that’s fully backed by traditional finance assets. Because those assets for the most part reside in a private fund (which, because it’s a private fund issued under Reg D, I can’t talk much about on a public post so forgive my vagueness here about what the fund does and how), there is regularly confusion when potential buyers of USDi think that they are buying a share of the fund. They are not, for two reasons. The first is that a coin that represents a tokenized share of a traditional-finance fund would clearly be a security under US law, which creates lots of other complexities that we don’t want: for example just as I can’t tell you much about the fund, if the token was a security then I couldn’t tell you much about that, either! Which would make distribution difficult, to say the least.
The second reason that we didn’t want the coin to represent a tokenized share of the fund is that then the coin would not exactly track CPI. It is important that the coin be a zero-risk instrument, and I illustrate why that’s important in the post “USELESS Coin vs Very Useful Coin”. Accordingly, USDi’s value is entirely formulaic, and known in advance by at least a few weeks. It’s my purpose today to explain how the value of USDi is derived from CPI prints.
USDi, like TIPS and US CPI swaps, is linked to the Non-seasonally Adjusted Consumer Price Index for All Urban Consumers…the NSA CPI for short. The CPI that is released every month is related to this number – specifically, the ‘headline CPI’ is the month-on-month percentage change in the Seasonally-adjusted number. Here is where you find that number (rounded, of course) in the monthly BLS release found at https://www.bls.gov/news.release/cpi.nr0.htm:
The problem with using a seasonally-adjusted number is, you guessed it, that the seasonal adjustment factors can change. Consequently, all inflation derivatives rely on NSA numbers, which are almost never revised. In the same report linked above, the BLS notes the NSA number:
The highlighted number, 323.048 in this case, is the number that TIPS traders and inflation swaps traders care about. And, if you buy USDi, you will care about this number as well. This is the price index value defined relative to the base of 100.000 representing the average of the 1982-1984 price level. The index value of 323.048 tells you that the (quality-adjusted) price level has risen 223.048% since the early 1980s, slightly more than a tripling!
(As an aside, the BLS has an enormous number of NSA series for different subcomponents available. You can see and chart a lot of them here: https://data.bls.gov/dataQuery/find?fq=survey:%5Bcu%5D&s=popularity:D )
Now, the BLS reports this number just once a month, and in arrears. It was mid-August when they reported the July CPI referenced above. So we have two things we need to account for when we turn this into an index that USDi (or TIPS or inflation swaps) can track: 1. We have a monthly number, and we need a daily number – or in USDi’s case, one number every block, and 2. We have numbers for every month ending in July, but today isn’t July, so we need something for today. Let’s call the index value that we are going to construct, to use for TIPS/swaps/USDi, the “Reference CPI.”[1]
The second problem is handled in the simplest way possible: we just lag the data.[2]
So when we got the July data this month, we have the Ref CPI for October 1 (the 323.048 number I mentioned above). We already have the Ref CPI for September 1 (that was the June CPI, reported in July, 322.561). So now, we can straight-line interpolate the Ref CPI for any day in between those two dates, based on the number of calendar days in that month. So, the Ref CPI for September 2nd is:
1/30 * 323.048 + 29/30 * 322.561 = 322.57723
Voila, that’s just what the Treasury calculates for September 2nd, which isn’t surprising because that’s how math works.
Now, the only subtlety to USDi is that while TIPS and CPI swaps have one settlement per day USDi in principle is tradeable 24/7. That means that if we changed the Ref CPI for USDi just once per day, at 1 second before midnight every day you could buy USDi and then sell it at 1 second after midnight and get the entire day’s interest. That doesn’t seem fair. The blockchain is much closer to continuous settlement, so we have to interpolate not by day, but by block. On Ethereum (where USDi exists, initially), a block is roughly 10-15 seconds long, so USDi accrues interest basically every 10 seconds. The actual code for USDi looks at the block number and does the exact same calculation that we do above except that it is interpolating between the first block in September and the first block in October. You can get very close to the right answer by simply using spreadsheet NOW() functions, which in Google Sheets has 1-second precision. I do the approximate calculation for USDi on a Google Sheet here: https://docs.google.com/spreadsheets/d/1UnPzAu-U2zy5TEIcxgLBqkVP7QNtBJhwrwLnHt9EitM/edit?gid=0#gid=0
Let’s see, why did I want to calculate the Reference CPI? Oh, I remember: I want to find the price of USDi for a given time, in the past or present or any time up until (for now) the end of September. We have done all of the work except for the last step, which is to divide the current price level index – the Reference CPI – by the base price level index. For USDi, we defined the denominator as the December 2024 CPI. This is why we say that USDi is a dollar that preserves the purchasing power of a December 2024 dollar.
The December 2024 CPI was 315.605. Since the December 2024 CPI was also the Reference CPI for March 1st (see the handy drawing above), that means the value of USDi on March 1st was (drum roll) 315.605/315.605 = 1.000000. The value of USDi on October 1st will be 323.048/315.605 = $1.023583.
So the USDi coin is not a fund, nor a share of a fund. It is a time machine.
[1] The Reference CPI for TIPS and swaps is identical. The Treasury calculates them too, and reports them at https://treasurydirect.gov/auctions/announcements-data-results/tips-cpi-data/ (look for the PDF and XML files for the “Reference CPI Numbers and Daily Index Ratios Table.”)
[2] In principle, we could take the recent data trend and project to the current date, which would make it contemporaneous but lose accuracy…since when the inflation data is actually released, we will find out that method isn’t perfect. It would also be confusing, since on any given day in the past there would now be the actual CPI data and the previously-used projected-trend data. Since the importance of the exact timing of the price level diminishes with distance, while the two-index confusion would persist, the simple-lag method makes sense to me.
Inflation Guy’s CPI Summary (July 2025)
The inflation story and the employment story are about the only things rippling the still summer waters these days, it seems. The weak employment data in the most-recent report got equity investors very excited since every analyst worth his or her salt believes that lower rates are good for the companies he/she covers, but those companies will surely be able to avoid losing business in an economic slowdown. And, to be fair, because the goods and services sectors in the US (and global) economy are out-of-sync, any recession is likely to be fairly shallow (and being out-of-sync is probably why the recession has been so delayed – different sectors are having recessions at different times. I discussed this in last week’s podcast, Ep. 147: Out of Sync).
But the fly in the ointment would be if inflation heads higher, wouldn’t it?
Well, maybe not so much. In normal times, probably. But in today’s world there is a nice, built-in excuse for any inflation uptick: it’s the tariff effect! It is amazing how focused on tariffs everybody has been, when they forecast/analyze the CPI report. The core goods sector of the economy is about one-fifth of total consumption. Tariffs will (and finally are) driving this higher, but that story will eventually pass. Core goods will not be what keeps inflation high or sends it higher in 2026. But you know why everyone wants to focus on it? Because if you can blame the inflation uptick on tariffs, then you can argue that rate cuts still make sense. More on that later, but when you look at the monthly changes in real yields and inflation expectations you can see what is happening: yields are down, inflation expectations basically unchanged, over the last month. The best of all worlds!
Which brings us to today’s report. The consensus expectations were for +0.23% on headline CPI (seasonally-adjusted), +0.29% on core, pushing the y/y figures higher for both of them as we drop off soft data from last summer. The actual prints were +0.197% on headline (yay!) and +0.322% on core (boo!). That was the highest m/m core inflation figure since January, and the first time since then that core has been higher than consensus expectations. It also was the highest m/m core number, other than January’s tariff-related spike, since March 2024.
The category breakdown was interesting for a change because the top culprits were Medical Care, Recreation, and Other.
To be fair, housing would have contributed more except for another drop in Lodging Away from Home. Seasonally-adjusted prices for lodging away from home have now fallen 7.3% since January. I have been working on the assumption that this is a deportations story, or possibly a tourism story (I don’t really think ‘foreigners aren’t visiting the US because they hate Trump’ is really happening but in some quarters that’s the story they’re selling). But if you look at this chart and notice the times that hotel prices declined meaningfully, there’s an argument that it’s a recession story. Or that it could be, if it continues to slide.
Primary rents accelerated slightly m/m, +0.26% vs 0.23% last month, but Owners’ Equivalent Rent decelerated to +0.28% vs 0.30%. Both are playing to form, but it’s worth keeping an eye on Primary Rents here. Deportations as an inflation story would show up in Lodging Away from Home but it also could show up eventually in rents – but a recession wouldn’t be expected have any meaningful impact on rents. So how those two series behave might give us a clue. Or maybe not; perhaps I’m trying to read too much into this.
Core goods accelerated again. The bounce was totally expected, but now that we are over +1% (+1.17% y/y) we are clearly seeing some of the impact of tariffs. Core services is more interesting, though. Even with rents decelerating and Lodging Away from Home dropping again, Core services ticked higher.
Indeed, lumping core services and core goods together, but taking out shelter, and we can see that the underlying core dynamic looks like it had been bottoming anyway and might be heading higher.
A large jump in airfares (+4.04% m/m) is partly to blame this month…but in March airfares were -5.3% m/m and the worst since 2021 while today’s number was the highest since 2022. Since COVID, airfares have just been really unstable, or the seasonals have been unstable, or both. I am not worrying too much about this jump.
Airline fares are 0.9% of CPI, but this volatility has added to the overall volatility of the CPI. And before you say ‘this is a consequence of resource constraints at the BLS!’ you should realize that airfares are not collected by people with clipboards but by web scrapers. However this is yet another reminder that Median CPI is a better way to look the overall trend, so as not to be distracted by little categories. My early guess at Median this month is +0.276%, a bit better than last month. But there is nothing here that looks to me like a moderating trend to lower inflation.
In fact, median y/y ought to tick higher again this month to about 3.65%. It is stabilizing in the high-3s. The next few monthly figures to drop off will be 0.3s, so I don’t think we will see median y/y head back to the 4% level. But having said that, there is one development that bears watching.
Core services less rent-of-shelter, aka “Supercore”, rose +0.48% m/m. If higher tariffs and deportations lead to more domestic employment and higher wages – which they should, but it isn’t yet really in the data as employment looked weak and the Wage Growth Tracker ticked down to +4.1% y/y this month – then this part is what will keep inflation uncomfortably high even if rents continue to decline (I don’t see them declining lots further than this) and goods inflation eventually declines after the tariff effect passes through. That isn’t today’s story. But it might be a 2026 story. Stay tuned. At the tails of the distribution this month we had greater than -10% annualized monthly inflation from three non-core categories while greater than +10% from eight non-core categories – including motor vehicle parts and equipment and miscellaneous personal goods, which are tariff stories, but also tenants and household insurance, miscellaneous personal services, public transportation, and motor vehicle maintenance and repair. Those are all service stories. As is this one, although it’s also a goods story indirectly (I explain further in the Q3 Quarterly Inflation Outlook, due out tomorrow – subscribe at https://inflationguy.blog/shop).
Overall, the underlying trend is the same: we’re settling in the high-3s for median inflation. Last month, I said that unless the economy starts to soften more seriously there just isn’t a good argument right now for rate cuts and the optics of rising year/year inflation would make it more challenging for the FOMC to consider an ease. That is still true. If Fed credibility matters to inflation, then inflation should start heading up because we are clearly getting more doves. If tariffs matter, inflation should be heading up because the tariffs are now showing and will be an effect for a while. If money growth matters, inflation should be heading up because M2 growth is back to +4.5% and accelerating.
But the core question is whether the Fed cares about inflation right now. Listening to their public statements, it doesn’t appear they do. One might argue that they are just supremely confident that if the Unemployment Rate heads higher, inflation will head lower so they have some room to move. To be honest, “supremely confident” and “Fed official” are not phrases that should appear in the same paragraph except sardonically. Nevertheless, the Fed is likely to ease soon, and likely multiple times before the end of the year.
And they’re worried that President Trump is going to hurt Fed credibility! That’s a little like the streetwalker who is afraid that this skirt is going to make her look cheap. Honey, that ship has sailed.
One final announcement. If you’re an investor in cryptocurrencies (in particular, stable coins) and have a Telegram account, consider joining the read-only USDi_Coin room https://t.me/USDi_Coin where the USDi Coin price is updated every four hours or so…and where many of these charts are also posted shortly after CPI just as I used to do on Twitter.
An Update/Reminder on Rent Inflation
A subscriber to our Quarterly Inflation Outlook (you can subscribe here) wrote to me recently and asked about a research piece put out by a major sell-side investment house that discussed how private rental indices (such as Zillow) and the Fed’s NTRR (“New Tenant Rent Index”, as defined in a paper by the Cleveland Fed’s Randall Verbrugge a couple of years ago called “Disentangling Rent Index Differences: Data, Methods, and Scope”) were indicating that a decline in rent inflation was on the way. I felt like it was time for an update on this topic, since it has been a little while since the exact same arguments made the rounds a few years ago.
I even had a podcast (Ep. 74: Inflation Folk Remedies) in July 2023 in which I discussed (among other things) the NTRR issue. So the deceleration of Zillow and the other private rent indices, the NTRR which was forecasting sharply negative rent growth (before revisions!), the supply of new rental units – all of those are arguments from 2023!
Here are rents. The black line is the actual CPI for Primary Rents, y/y. In July of 2023, it was at 8%. You may notice that it never went negative in 2023 or 2024, and isn’t showing any signs of going negative in 2025.
Before I go any further, here is sufficient reason to ignore the NTRR, in addition to the other arguments I’ll make in a bit. Here is the chart of the NTRR from the 2023 paper.
And here is the updated NTRR from Bloomberg today. You will note that the 0% print in 2023Q1 from the 2023 paper has been revised up to around 4.5%. That’s even higher than the upper edge of the error range in the prior chart.
So forgive me if I don’t panic at the -2.2% current reading of the NTRR. Here’s the problem: the conviction among economists in 2023 (not just the Fed economists, but it was a general consensus at the time that rents were about to collapse) that the “stock” of rent inflation would eventually respond to the “flow” of new rents is just not how rents work. The new rents are not indicative of new conditions while the stock isn’t…those are two totally different populations.
There are people who turn over rents and move with some frequency, or who are moving now for one reason or another, and there is a stock of open units that landlords want to fill. But just because a landlord offers a low rent to fill his one open unit has nothing to do with his desire to cut rents on all of the units that aren’t turning over.
What is amazing is that the only reason this ever looked like it worked was because when both rates are very low, the noise outweighs the signal. So there’s no data for economists to really test the hypothesis on a period that matters because it’s similar to the current period of generally rising prices. But if economists just spoke to landlords, they would understand. That’s what I did, and the reason that in 2023 I switched my model from a top-down to a bottom-up (which is the dotted line in the first chart above…and that was not revised significantly). If costs are growing for landlords, they aren’t going to be cutting rents for their tenants even if they want to cut them for new tenants to fill a unit.
It should not be a surprise that the ‘faster’ NTRR has large error bars and large revisions. Essentially, the idea behind those indices is that they take the same rent data the BLS generates and squeeze out several different indices, some of which are “faster.” But basic information theory says you can’t get 3 bits of data from a pile that holds 1 bit, for free. What happens is those new indices are faster…but they have huge error bars that are huger the shorter the forecast length. Duh. Which means you can’t reject any null hypothesis about the near-term path. In the original paper they mention this and they show the data on the variance but they didn’t really explain it well. The short way to describe the problem is that you can’t get three pounds of crap out of a one pound bag. Period.
Now…having said all that I do entertain the possibility that rents could slow meaningfully further than here, even more than the mild softening that my model has. But my reasons for that are different:
- Rents in NYC will likely decline sharply if Mamdani wins, partly because jobs will absolutely flee the city but mainly because of his not-very-veiled-threat to seize property if they don’t. The smart landlords will dump their property at any price and get out, but some will try to ride out his term as Mayor. That’s unlikely to work but they’ll try. And NYC is a big part of the rent indices (by the way, one hedge for this is to sell the Shiller NYC property index, which futures trade (thinly, but they trade) on the CME. Combined with naturally slowing rent growth from some of the really hot but now getting overbuilt areas – like Miami – and you could get the overall indices to look better than the median would.
- (Offsetting this but probably nearer-term, LA rents will be buoyant for a while and maybe more sharply once the wildfires are further in the rear-view mirror so the claims of “profiteering” can be ignored. They bounced right after the fires destroyed a huge number of units but predictably people screamed at landlords so that stopped. But supply and demand, you know. There are fewer rental units in Los Angeles, and rents are going to go up faster as a result).
- If mass deportations really do turn into mass deportations, then what we are already seeing with Lodging Away from Home could become broader pressure on rents. The hotels were where the newest and biggest wave of illegal migrants were housed in the big cities. Elsewhere, they live in apartments and sometimes own homes when they have been here for a while. I can’t imagine the government will be able to deport more than say 1mm over the next year or two. That would be 2000-4000 per work day, and while the illegal immigrants generally walked in they generally have to be flown out. However, 1mm is still a big number and if enough other illegals ‘self-deported’ so that you’re talking about a million households then you’d have to consider a good chance of significant housing disinflation as the stock of rental units – currently just barely out of shortage – becomes a glut from the demand side.
But note that neither 1 nor 2 is currently something that you’d be able to detect with NTRR or Zillow or other rental indices. Maybe at the margin we could see deportations affecting rents in some of the ‘sanctuary cities’ where a lot of the deportations are concentrated, but I doubt it. Too soon.
In any event, my forecast for rents is not super-aggressive and I recognize there are mostly downside risks associated with those enumerated reasons. But right now? In the data? There is nothing that looks like it spells housing deflation.
USELESS Coin vs Very Useful Coin
It is rare, in the investment world, for an investment to honestly and fully disclaim its basic nature in a way that finishes the story and requires no further analysis from us before making an investment decision. I have found such an investment. It is a cryptocurrency/meme coin called, appropriately, USELESS. https://coinmarketcap.com/currencies/theuselesscoin/ If you were to buy all of the USELESS in existence, it would cost you (as of this writing) about $272 million dollars. This seems to me to be a lot of money to pay for something useless, but what do I know?
Now, it should be noted that there are lots of useless coins. DOGE coin. Fartcoin. I could go on and on. But the difference here is that as far as I can tell, USELESS is being completely honest. It is not usable as a payment rail. It is not redeemable for anything, at any time, and therefore it is guaranteed to one day be worth zero. It doesn’t even come printed on a nice certificate so that the scripophiles can frame it and put it on the wall.
To be fair, as I said it isn’t the only such memecoin that is useless. It is merely the only one that turns that uselessness into a dare. It is a game, of seeing who eventually gets the ‘pride of place’ as top-ticking it, paying the highest price for something that is useless and that never pretended otherwise. (People who bought Enron stock were buying something that turned out to be worth zero, but they didn’t know it at the time. USELESS buyers are fully aware and cannot possibly claim otherwise.)
And actually, ironically, that unlocks the reason this coin exists. It reminds me of a fantasy baseball auction. For those of you who don’t play fantasy sports, there are generally two varieties: the ‘draft’ kind, where people take turns drafting players, and the ‘auction’ kind, where someone offers a player and a price they will pay for that player, from a limited budget allotment. The other participants in the draft all take turns bidding until someone wins the player, and then the process is repeated until every fantasy team is full. Done correctly, a bidder doesn’t merely bid for the players he or she wants but also bids up the price of a player he or she does not want, in order to force someone else to pay more than that player is worth. This part of the auction is a game, trying hard to make someone else pay top dollar – which requires you to figure out what everyone else’s top price is – while not getting stuck with the now-overvalued hot potato.
I think that’s what USELESS is. It’s a game of trying to push the price higher and higher, until someone is stuck with the honor of having paid the highest price for an utterly worthless unit. It’s a game; it’s only a game; and it is just as much of an “investment” as is the forty-two dollars you paid to select Juan Soto for your fantasy team.
Now, as you all know by now I have been at least partially converted and no longer think that all crypto is useless. The absolute opposite of USELESS is the enormous utility of our inflation-linked stablecoin, USDi. And yes, I’ve written about it before. And yes, I will write about it again. Because it’s as useful as it gets. There is no such thing as inflation-linked cash in traditional finance space. I am not aware of any bank that offers an inflation-linked savings account. And this is not a little thing. This is a big, big thing.
The chart below shows a hypothetical efficient frontier made up of a lot of different asset classes; this frontier might look a little different from what you’re familiar with because the x-axis and y-axis are in real terms whereas most of us learned finance in nominal terms where you had a Treasury bill as the risk-free asset. But we don’t care about nominal returns (if we did, we’d own stocks in the most hyper-inflating country we can find) – we care about real returns. In the nominal world, Tbills or money market funds exist with sub-zero real returns most of the time. More importantly, they have significant risk in after-inflation terms. As a result, in real space we are confined to the blue curve as our efficient frontier (the curve shows the lowest-risk portfolio that achieves a given expected real return. Remember these numbers are all hypothetical but the point I am making doesn’t depend on the numbers).
But USDi is, as I said, super useful. It is the origin security, the zero-real-risk, zero-real-return point. And that means that it improves every portfolio in real terms, with the possible exception of very-high-risk portfolios.
Now, most of these securities don’t yet exist in the defi world. There really aren’t any tokenized commodities yet, except in the narrow edge case of gold and one or two other single spot commodities – and no tokenized commodity indices yet, and commodity indices have additional sources of return beyond the spot commodity return. No tokenized TIPS, and few tokenized equities. Someday, the defi world will have these things. But what it does have right now, which is really useful and a good enough reason to visit the crypto world, is the low-risk security: USDi. How useful is that?
[N.b.: USDi was originally launched in a manner only available to accredited investors. However, because of growing regulatory clarity about its status as a stablecoin or currency rather than as a security, we have re-launched USDi so that the mint/burn functions are available to all. The coin’s address on mainnet is 0xAf1157149ff040DAd186a0142a796d901bEF1cf1. We will be adding functionality to allow minting or burning via user tools on our website, but in the meantime users can make a public call to the blockchain to mint or burn versus USDC. Reach out via the https://USDiCoin.com website if you want more information.]
Inflation Guy’s CPI Summary (June 2025)
If you squint, can you see an effect of the deportations of illegal aliens in today’s CPI report?
I don’t want to encourage anyone to obsess over every jot and tittle of the report. That’s almost always a fraught exercise. But there were at least a couple of things in the data this month which could indicate both inflationary and disinflationary effects of the deportation campaign. A serious part of my brain is saying ‘come on, there just haven’t been many deportations in the context of the population of illegals, how can we see an effect?’ And that instinct is probably right.
Before we get into today’s release let’s remember that there is one important context to keep in mind and that is that unless there are major surprises to the downside, core and headline inflation are going to be accelerating for most of the rest of the year on a year-over-year basis. I discussed this in a short podcast last week, Ep. 145: Beware the Coming Inflation Bounce. So we need to keep in mind as we think about markets and policy that the optics are going to look worse for a while here.
That is, unless we get numbers like we did in the May CPI, which was a major miss due mostly to very soft figures on rent inflation. Last month, Primary rents were +0.213% m/m and Owner’s Equivalent Rent (OER) was +0.275%. Rents are decelerating but not that fast, but if they did then a 2% target on inflation becomes at least possible. It’s not yet possible.
The consensus for today’s number was +0.26% on headline and +0.25% on core. Right in the middle of 0.2% or 0.3% rounded prints. What happened is that we got one that ticked up and one that ticked down. Actual CPI was +0.287% on headline, and +0.228% on core inflation. That caused the year/year headline number to print +2.7%, up from 2.4% last month (and higher than 2.6% expected), and y/y core to be 2.9% (vs 2.8% last month, and as-expected). The usual suspects trumpeted ‘another miss softer on core CPI! Rate cut on tap for September!’ But what is the real story?
The real story is not nearly that encouraging. As we will see, there are quite a few signs that the core miss was an aberration. Not a bad one, but deceiving.
Here is my guess at Median CPI.
The median category is likely the West Urban OER subcategory, which means that the actual median will depend on where that seasonal adjustment comes down. But two of the four OER subcategories are higher than that, so I doubt my guess is wildly off (when it isn’t one of those subcomponents, I nail the median but because they split up OER, sub-seasonals matter). So median should be around 0.30%, or 3.6% annualized. Median CPI has rounded to 3.5% y/y since February and it’ll be there again. That looks like progress has stopped. The chart below doesn’t include today’s figure but to illustrate that we’re seeing a flattening out of progress.
Now, this is what we would expect if tariffs were starting to affect prices generally, is that median would accelerate a little bit but core not necessarily. However, tariffs aren’t going to affect prices generally. They’re going to affect core goods primarily. So what is going on here?
One clue is that there was only one category this month that had an annualized monthly change of less than -10%. Normally there are a handful of categories on the tail (for example, there were 8 categories – in the way we slice them up for calculating Median CPI – where the annualized monthly rise was greater than +10%). This one category was Lodging Away from Home. Month/month was -2.9%, and year-over-year changes in hotel prices are at -2.5%: near the lowest levels since the sharp declines during COVID.
That may be where we squint and see a positive (lower inflation) effect of the deportations. We should expect that mass deportations should cause a relief on upward pressure on certain goods and services that happened when 8mm+ new residents arrived over 4 years. Folks love to focus on the wage effects as being inflationary (more on that in a moment) but they forget that you’re removing a bunch of consumers and while not 100% of illegal aliens work, 100% of them consume. And one of the things they consume is shelter. To be sure, we haven’t had anything remotely like ‘mass’ deportations yet. But releasing some of the hotels that were being paid for by cities to house migrants is one place that it’s totally understandable we should see a positive effect. The effect on home prices will come later.
While some pressure may continue to come off of shelter inflation, there’s this disturbing trend in Tenants and Household Insurance – and that’s before State Farm announced a 27.2% increase for Illinois. Yuck!
To be balanced on the deportation issue, let me point out something that comes up in the ‘four pieces charts’. Piece 1 is Food and Energy; Piece 2 is Core Goods; Piece 3 is Core Services less Rent of Shelter aka Supercore; Piece 4 is Rent of Shelter.
First, notice that core goods continues to trend positive – finally. Y/Y core goods went to +0.7% from +0.3%, despite continued softness in autos. The auto softness will not last forever; some of it is likely due to front-running tariffs. But more interestingly, note the small but measurable hook higher in Supercore. That’s where wages show up most strongly, so if deportations are causing better wages, we would expect that. So is this a deportations effect at the margin? I doubt it. As I said before, deportations are no where near “mass” yet so I’d be surprised to see an effect there. But watch this space.
So how excited are we about the core surprise lower?
The answer is not at all. Core goods is trending positive and while I don’t expect a massive tariff effect I am pretty sure it won’t be negative. Core services is going to have some upward pressure if deportations turn out to make a difference at all. Eventually, the effect on shelter and on other goods and services demand will be disinflationary but timing-wise that’s going to be after the tariff effect. And in the meantime, monetary aggregates are accelerating again in the US and Europe.
Is the story, then, that core inflation is going to continue to surprise to the downside? Well, when you look at the broader picture, at not only which prices are rising and falling but how broadly it’s happening, the news is not all unicorns and rainbows. Here is a chart of the weight of the CPI basket that is inflating at faster than 4% y/y.
That has improved, but I can’t help but notice that it is not even vaguely in the vicinity of pre-COVID. How can we get overall inflation to 2% if nearly half of the basket is inflating faster than 4%? Well, you’d need core goods to be really soft, and that part is done.
We can see that also in the Enduring Investments Inflation Diffusion Index (EIIDI), which has been sub-zero for a while but this month, jumped to positive.
These tell the same story – this month we could get all excited about the core miss…except that outside of Lodging Away from Home, the story isn’t so happy.
From a policy standpoint, there is just no reason to drop rates below neutral and we’re pretty close to neutral right now. Here’s something to think about (but the Fed won’t think about this because they don’t pay attention to money). Abstract from tariffs for a moment – tariffs are never a reason to maintain higher rates, because they are a one-off. But let’s suppose you believed that mass deportations would push up inflation and wages. The argument for a central banker would be that fewer workers in the economy implies a smaller economy, and a smaller economy needs less money. Therefore, while tight Fed policy can’t affect tariffs, they could affect prices that are rising because of deportations.
Again, let me clarify that I don’t think deportations are doing anything yet, and I think they’re as likely to push prices down in shelter and some core goods as they are to push wages and prices higher in services. I’m just saying that if you think deportations are inflationary, there is a monetary policy response that makes sense and it isn’t easy money.
So unless the economy starts to soften more seriously, there just isn’t a good argument right now for rate cuts. And now that the y/y numbers are heading higher because of base effects at least, the optics are going to be worse for the Fed to consider an ease. There is always an ‘unless’, and here the ‘unless’ is ‘unless Powell resigns and is replaced with an uber-dove.’ I can’t imagine that Powell wants to be the first Fed chairman ever to resign in disgrace, and no one can force him out, but stranger things have happened. However, I can’t handicap politics. I’m only handicapping inflation.
And, by the way, if you think that inflation itself is a handicap, consider the USDi coin! Here is a chart of the value of the coin by day. The red dot is where we are.
One final announcement. If you’re an investor in cryptocurrencies (in particular, stable coins) and have a Telegram account, consider joining the read-only USDi_Coin room https://t.me/USDi_Coin where the USDi Coin price is updated every four hours or so…and where these charts are also posted shortly after CPI just as I used to do on Twitter.
When and How Much Tariff Effect?
As we look forward to the CPI report next week, the monthly-repeating theme is ‘when will the tariff effect show up?’ The answer, so far, is ‘not yet,’ but economists who had forecasted the end of life as we know it when the Trump tariffs went into effect have been befuddled.
I’ve already admitted in this column that I was educated in the tradition of ‘tariffs bad,’ but that over the years Trump’s insistence otherwise has made me carefully re-think of which ways tariffs are truly bad, and which ways they’re not so bad. Naturally, if tariffs were uniformly bad – which seems to be the orthodoxy – then it would be really hard to explain why almost every country levees tariffs. Maybe forty years ago we could blame the benightedness of those poor policymakers in other countries, who clearly just didn’t understand how bad tariffs are. But now? Heck, all someone in one of those countries needs to do is ask ChatGPT ‘are tariffs bad,’ and they’ll learn!
… Conclusion: Tariffs can be useful tools in specific, limited circumstances — like protecting vital industries or responding to unfair trade practices. But long-term, high or broad tariffs often do more harm than good, especially in highly interconnected global economies. (ChatGPT, July 9, 2025 query ‘Are tariffs bad’)
But it seems every country has these specific limited circumstances! It’s evidently only bad when the US does tariffs. And that is what made me ask whether maybe there is some nuance. My 2019 article “Tariffs Don’t Hurt Domestic Growth” was really good, I thought.
Even as there has been some small movement in the economintelligencia, though, about whether tariffs are all bad there has been very little movement in the notion that they are clearly inflationary. No doubt, implementing a tariff will raise prices at least a little, but how much is the important question. And regardless of that answer, tariffs are a one-time adjustment to the price level even if that effect is smoothed over a period of time. (This is why it’s weird to hear Powell say that the Fed can’t ease because they’re waiting to see the effect of the tariffs on inflation. That’s economic nonsense. The Fed can’t possibly believe that keeping rates high is the proper response to a one-time shock.)
On this question, I thought I’d share something I wrote in our Quarterly Inflation Outlook from Q1 (in mid-February), in which I roughly estimated the effects of a 20% blanket tariff. I know the answer isn’t “right,” because that’s the wrong question – there isn’t a 20% blanket tariff. But I undertook the estimate to get an idea of the relative scale of effects. (I included in the piece some parts from that 2019 article mentioned above, because I’m not above stealing from myself!) I will add some concluding thoughts after this ‘reprint’ from our QIO – which, by the way, you can subscribe to here.
Tariffs as a Tool to Promote Domestic Growth and Revenue
In the President’s view, the fact that the U.S. has a very low tariff structure compared to the tariffs (and arguably VAT taxes) that other countries place on U.S. goods is prima facie evidence that the U.S. is being taken advantage of and treated unfairly on world markets. The U.S. has, for the better part of a century, been the main global champion of free trade and this tendency accelerated markedly in the early 1990s (as the familiar chart below, sourced from Deutsche Bank, illustrates well).
The effect of free trade, per Ricardo, is to enlarge the global economic pie. However, in choosing free trade to enlarge the pie, each participating country voluntarily surrenders its ability to claim a larger slice of the pie, or a slice with particular toppings (in this analogy, choosing a particular slice means selecting the particular industries that you want your country to specialize in). Clearly, this is good in the long run – the size of your slice, and what you produce, is determined by your relative advantage in producing it and so the entire system produces the maximum possible output and the system collectively is better off. To the extent that a person is a citizen of the world, rather than a citizen of a particular country – and the Ricardian assumption is that increasing the pie is the collective goal – then free trade with every country producing only what they have a comparative advantage in is the optimal solution.
However, that does not mean that this is an outcome that each participant will like. Indeed, even in the comparative free trade of the late 1990s and 2000s, companies carefully protected their champion companies and industries. Even though the U.S. went through a period of being incredibly bad at automobile manufacturing, there are still several very large U.S. automakers. On the other hand, the U.S. no longer produces any apparel to speak of. In fact, the only way that free trade works for all in a non-theoretical world is if (a) all of the participants are roughly equal in total capability, and permanently at peace so that there is no risk that war could create a shortage in a strategic resource, or (b) the dominant participant is willing to concede its dominant position in order to enrich the whole system, rather than using that dominant position to secure its preferred slices for itself and/or to establish the conditions that ensure permanent peace by being the dominant military power and enforcing peace around the world. We would argue that (b) is what happened, as the U.S. was willing to let its own manufacturing be ‘hollowed out’ in order to make the world a happier place on average.
The President (and many of those who voted for him) feel that (b) is inherently unfair, or has reached extremes that are unfair to U.S. citizens. Essentially, the President is rejecting the theoretical Ricardian optimum and pursuing instead a larger slice for his constituents. This is where reciprocal tariffs (where the U.S. matches the tariff placed on its exports by a trading partner, with a tariff placed on the imports of that product from that trading partner) or blanket tariffs (where the U.S. imposes a tariff on all imports of a product irrespective of source – e.g. aluminum – or on all imports from a given trading partner) come in.
Blanket tariffs are good for domestic growth,[1] but definitely increase prices for consumers. How good they are for growth, and how much prices rise, depends on how easily domestic un-tariffed supply can substitute for the imported supply and also on whether your country is a net importer or exporter, and how large the export-import sector is in terms of GDP. Because this is an inflation outlook, let’s make a very rough estimate of the impact on the overall domestic price level of a blanket 20% tariff (such as the one Treasury Secretary Bessent has proposed). We suppose the average elasticity of import demand in the U.S. to be 3.33[2] and the elasticity of export supply to be 1.0[3]. In that case, the incidence of a tariff falls about 23% on consumers: [1.0 / (3.33+1.0) ]. So, for a 20% tariff, prices for the imported goods would be expected to rise about 4.6% (20% tariff x 23% incidence). However, imports only account for about 15% of US GDP, which means the effect on the overall price level would be 15% x 4.6% = 0.69%.
So, for a 20% blanket tariff on imports, Americans should expect to see a one-time increase in the overall price level of something on the order of 0.7%, smeared over the period of implementation. This is not insignificant, but it is also not calamitous. It does affect our estimates for 2025 and 2026 inflation, shown in the “Forecasts” section (somewhat less than 0.7%, because we do not expect a blanket tariff but rather reciprocal and targeted tariffs). Also note that the retaliatory tariffs on US exports have no direct effect on domestic prices, so that whether or not trading partners retaliate is irrelevant to an analysis of first round effects, anyway.
Thus my wild guess back in February was that a 20% blanket tariff would result in a bit less than 0.7%, smeared out over 2025 and 2026. That doesn’t answer the ‘timing’ question, but the delays in implementation (so as to not affect Christmas 2025 prices of the GI Joe with the Kung-Fu Grip) and the importer/retailer initial reaction to try and absorb as much as possible for optics – presumably, easing price increases into the system later – mean that it shouldn’t be shocking that we haven’t seen a big effect yet. My point in the above calculation, though, is that we really shouldn’t expect to see a big effect, regardless.
For what it’s worth, the Budget Lab at Yale estimates that currently “the 2025 tariffs to date are the equivalent of a 15.2 percentage point increase in the US average effective tariff rate,” so if we take my 0.7% guess for 20% then we would be looking closer to 0.5% in total. And in fact, lower even than that since the 15.2% average will have less impact than a 15.2% blanket tariff, assuming that the tariffs will be highest where domestic substitution is easier.[4]
Wrapping this up, let me make one final observation. Current year/year headline CPI inflation is 2.35%. The inflation swaps market, specifically the market for ‘resets’ where you can trade essentially the forward price level, currently suggests that traders expect y/y inflation to rise to 3.29% over the next six months: almost 1 full percentage point from here. But that actually flatters what the market is pricing, because the shape of the energy curves suggests that rise is being dragged about 20bps lower by the implied moderation in energy prices (give me a break, inflation traders: I’m doing this in my head).
So, the market is pricing core inflation peaking about 6 months from now, about 1.2% higher than it currently is. Not all of that is the effect of tariffs; some is due to base effects as the very low May, June, and July 2024 numbers roll off of the y/y figure. But if we get that result, you can be sure that economists will put most of the blame on Mr. Trump, while Mr. Trump will put most of the blame on Mr. Powell. Either way, I think the interest rate cuts that the President would prefer are unlikely unless growth takes a significant stumble.
[1] …but bad for global growth! There is no question that unilaterally applying tariffs to imports is bad for all suppliers/countries providing those imports. If Ricardo is right, the overall pie shrinks but the domestic slice gets larger…at least for the dominant players who already have a large slice. If everyone raises tariffs in a trade war outcome, the less-productive countries suffer the most loss of growth and the most-productive countries likely still benefit. But prices rise for all.
[2] Kee, Nicita, and Olarreaga, “Estimating Import Demand and Export Supply Elasticities”, 2004, Figure 5, available at http://repec.org/esNASM04/up.16133.1075482028.pdf Your answers may vary!
[3] Estimates are wildly all over the map, depending on the exporting country and the product. In general the smaller the country, the more price-inelastic it is. We chose unit elasticity here (a 1% increase in price cause a 1% increase in the quantity supplied) just to be able to get a rough guess.
[4] To be fair, the Budget Lab at Yale also estimates the effect on PCE inflation of a whopping 1.74%. They must be really surprised at the impact so far.
The Twin Deficits – One Out of Two IS Bad
From time to time on this blog, I circle back to the question of the balance of deficits. In my mind, as our economy goes through whatever the “Trump Transition” is, the biggest risk to the bond markets is not from some fear about whether the Treasury will default or whether the US dollar will cease to be the world’s currency of choice for reserves (neither of which I think is going to happen any time soon) but that large secular changes in the balances of savings and dollar demand could lead to outsized moves in interest rates.
First, let me remind you that the deficits are all intertwined. When the US Federal Government runs a deficit and borrows money, they have to get it from people/entities that have saved that money. One place that the government bond salesmen know they can turn to is non-US investors, who are in possession of those dollars because the US runs a large trade deficit with most other countries. When we run a trade deficit, it means we are importing more stuff than we are exporting or, equivalently, we are exporting more dollars than we are importing. Those dollars are pretty useless except to buy things that are dollar-denominated. By construction, we know that the new owners of dollars aren’t buying goods, because if they did there wouldn’t be a deficit; the main other thing they buy are securities or real property.
So if you don’t want other countries buying US stocks, buildings, and farmland, run a big trade surplus and they won’t have the dollars to do it.
It’s a good thing they have all of those dollars, because the Federal government needs them! The federal deficit needs to be funded by those foreign dollars, or by domestic savings (banks, individuals, companies, e.g.), or by the central bank buying up those bonds. And that’s pretty much it. Over time, the trade balance plus the budget balance plus the central bank balance plus private savings equals zero, more or less. During COVID, the massive expansion of the federal deficit was only possible because the Fed bought about the same number of bonds as the government sold. Had they not, interest rates would have risen precipitously because private savers would have had to be induced to put those dollars into bonds.
(Or, the government would give incentives for banks to hold more govvies, say by exempting them from the SLR. Not that such a thing would ever happen!)
Let’s pivot this then back to the Trump Transition. The stated goal of the Administration was to lower the trade deficit a lot, lower the budget deficit a lot, and lower interest rates. That all makes sense and is internally consistent. It could happen that way, if all of it happens that way.
What if, though, the President’s team makes more progress on one front than on the other? Early returns on the tariff front seem to imply that the US will face a smaller trade deficit going forward. Now, the latest spike higher (smaller deficit) here is at least partly and maybe mostly due to a ‘payback’ of the pre-tariff front-running that led to massive deficits in the prior three months. But it should not surprise us that increasing tariffs should cause the trade deficit to decline. That is, after all, sort of the point.
If we concede that the trade deficit is actually heading back towards some better semblance of balance, then that’s plank 1 of the Trump agenda. That will supply fewer dollars to cover the federal budget deficit, though. As long as the federal budget gets into something closer to balance…
That was the promise of DOGE, and of the revenues from tariffs. The latter will indeed be yuge, and will help balancing the budget. Or it would, if we weren’t about to run an even bigger deficit with the Big Beautiful Bill soon passing into law. The trailing-twelve-month budget deficit is just less than $2 trillion, which was a number we never even sniffed prior to COVID. So that’s the demand for savings: the feds look like they’re going to keep on spending more than they take in.
Unlike during COVID, too, the Fed is now letting its balance sheet shrink. No help there.
Now, there is also a movement in Congress to pass legislation preventing the Fed from paying interest on the reserves that banks hold at the Fed. For decades, the way the Fed managed the money supply was to adjust the quantity of reserves, which rationed credit and caused the price of credit (interest rates) to move as well. But it was the rationing of credit, not changing the price, that affected the money supply. Beginning with the Global Financial Crisis, the Fed flooded extra reserves into the system, forcibly deleveraging banks (look at that chart above again) – but, since that would also crush bank earnings, they started paying interest on reserves (IOR). Since, if banks were not being paid to hold reserves, they would hold as little as they could, the Fed had to pay interest or the excess of reserves in the overnight market would cause interest rates to always be zero. So the Fed started to manage the price of credit, rather than its quantity. The central bank fully intends to always hold way more in securities and therefore force way more reserves into the banks, going forward – but has gradually been reducing its portfolio securities. As I said, no help there.
If Congress succeeds in preventing the payment of IOR – and the politics on this looks good since the Fed now runs operating deficits, so that it is basically paying banks interest with taxpayer dollars (see chart below…Fed remits to the Treasury have dried up completely), then as I said above banks will try to hold fewer reserves and overnight interest rates will drop as banks compete to lend their excess reserves at anything above zero, unless (a) the fed increases the reserves banks are required to hold (really unlikely) or (b) the fed makes reserves scarce so some banks will have to buy them and some will sell them (the old way) (also really unlikely). In neither case does the Fed expand the balance sheet as a first intention, so unless we get another crisis the expansion of the Fed balance sheet is unlikely in my view.
So that leaves private savings. If the trade deficit declines and the budget balance doesn’t move significantly towards balance, then interest rates will have to rise, potentially a lot. I think the President’s stated plan makes very good economic sense. I just wonder if it’s going to be derailed by the desire to keep the Federal spend going.
The Road to Crypto Conversion
While this isn’t exactly the conversion of Saul on the road to Damascus, I came to a realization recently that subtly changes the way I look at the potential for large cryptocurrencies, such as Bitcoin.
Historically, my attitude has been dismissive about the value of bitcoin itself. While I recognize the amazing reach of blockchain technology and the genius of using asymmetric key cryptography to secure the public record of private transactions, I’ve always thought that bitcoin didn’t really achieve the promised goal, which was to be a better money than fiat dollars. After all, bitcoin is not backed by anything more than the dollar is – nothing. Its value is based on scarcity, and scarcity by itself is not a source of value (if it was, my toenail clippings would be immensely valuable). So in my 2016 book What’s Wrong with Money? I wrote in a chapter on bitcoin:
“But is bitcoin money? Calling it a virtual currency, or a digital currency, or a crypto-currency doesn’t make it money. At some level, it is of course money in the same sense as cigarettes are to prison inmates. It serves as a medium of exchange, a store of value, and a unit of account – but only within the special community that already accepts bitcoin as credible…It is not yet broadly a credible currency. It doesn’t have universal value because not everyone believes that everyone else will accept bitcoin.”
Even in that chapter I recognized that bitcoin may someday be money-like. And I underwent a partial conversion and even worked for a while on a paper with my co-authors Kari Walstad and Scott Wald to define a measure (“Crypto Trust Index”) that would objectively measure how much like money the cryptocurrency world was becoming. [That paper ended up being overtaken by real-world developments, as stablecoins fully backed by fiat balances are obviously crypto money by identity, rendering the question moot.]
But in my mind bitcoin, eth, etc aren’t money but speculative vehicles – they are distinctly separate from USDC, USDi, and other fully-backed coins. It may be that they belong in a portfolio with stables and/or securities, but since bitcoin has no intrinsic value I have always held the view that I don’t want to own it as it can go to zero in a nonce.[1]
Recently, as I said, I’ve had a mild conversion as a result of two realizations.
The first realization is that even in the traditional securities world, we sometimes invest in things which have no intrinsic value in many states of the world. For example, we buy out-of-the-money options, or equity in a firm that is highly leveraged so that if the business goes under, the equity-holders get nothing. I am not sure this is a good excuse to buy bitcoin, though, since even if a far out-of-the-money option is unlikely to ever have intrinsic value there are at least future states of the world in which it could have intrinsic value. Similarly, that penny stock might end up being worth something if business booms. So we could think about bitcoin as being an option that may go to zero or may go up a lot. The problem with this, and the reason this reasoning alone is not compelling to me, is twofold. First, those far out-of-the-money options and long shots tend to have low prices, not high prices, and bitcoin certainly does not seem to have a low price. Second, there is no state of the world in which bitcoin will ever have an intrinsic value. Therefore, it doesn’t make a lot of sense to think of it as a real option, but at best as a speculation with an option-like payout (low in many states of the world, but massive in a few states). Put another way, while the value of that penny stock or out-of-the-money option can go to zero for some clearly-defined reasons, bitcoin can go to zero for any reason or no reason and it wouldn’t be wrong.
The second realization, though, relates to scarcity. Yes, scarcity alone cannot be the basis for value (see: my toenails). For scarcity to matter, there needs to be exogenous demand. And that demand need not be rational. If someone wants to hold bitcoin, not caring that it has no intrinsic value (or erroneously believing that it has some), then scarcity matters. The realization is that scarcity goes from not mattering at all, to mattering a great deal, as soon as there is any demand. To be sure, if that demand goes away, then scarcity again ceases to matter.
(By the way, it is entirely possible and even likely that someone else has pointed this out.)
So the case for speculating in bitcoin (no, I won’t call it investing) is that since the total supply is independent of price, the supply curve is vertical and moving to the right at an ever-slower rate. As this happens, it takes less and less increase in demand to push price higher.
It also takes less and less decrease in demand to push price lower. Since there is no slope to the supply curve, it means that oscillations in demand are responsible for all of the oscillations in bitcoin’s price. And we can say more about the volatility dynamics. Early in bitcoin’s development – when demand was very low, supply was relatively high compared to demand, and the price was as a result very low – we were operating at the far left end of the demand curve where demand was relatively more elastic and therefore there was a lot of volatility. As bitcoin matures, and demand catches up to the existing supply, we should expect price volatility to decline. And this is, in fact, what has happened (chart below, source: Bloomberg, shows rolling 100-week historical volatility (about two years, but I like round numbers today), now at the low-low level of 43% (about 3x equity market volatility).
The fun part comes later, when the supply curve shifts get slower and slower as the bitcoin halving converges to zero and the bitcoin supply gets closer and closer to its absolute maximum. At that point (and here is where the uberbulls get really excited), if there is a steady secular increase in demand, price just goes up without bound.
Don’t get too excited, uberbulls, because we aren’t there yet. When we are starting to get close to that point I would expect that we will also see volatility start to go up again. If historical volatility continues to decline, it means (a) we aren’t close enough to that point that the vertical singularity is nigh, and/or (b) people are losing interest in or diversifying away from bitcoin so that the steady increase in demand is not manifesting and interest is fluctuating less and less. So, I am waiting for that volatility to begin to expand at higher prices.
In any case, I am much more likely to invest in tokenized real world assets than I am Bitcoin or Ethereum. I am not a speculator at heart. Heck, I’m a bond guy which means I worry more about return of my principal than return on my principal. But if you are already long bitcoin, I will no longer sneer at you, because I recognize at last that one way or the other I will may be driving your car someday – either because it was repossessed and I bought it at auction, or because I am your chauffer.
Did You Know? Want to buy USDi, the inflation-linked stable coin, but don’t own any crypto you can exchange for it? You can actually use the coin as an on-ramp. Accredited investors need merely complete onboarding with USDi Partners and then can invest fiat dollars and receive USDi coins.
[1] Pun intended.
