Related Articles Sign up for Jim Jubak's new newsletter See how Jim's stock recommendations are faring Jubak's Journal Recent articles: • 5 growth stocks for a weak-kneed rally, 5/20/2005 • 5 stocks aided by rising prices, 5/18/2005 • Get ready for a nice growth surprise, 5/17/2005 More... | Jubak's Journal The Fed is all wrong about inflation We all feel the effects of rising prices, but the Fed doesn't see them. It looks at short cycles, but it's the long inflation waves that change history. By Jim Jubak For the last year, I've been convinced that inflation is back and getting worse. I can feel it in my everyday life. My favorite pizza guy raised his price for a slice by 20% last month. My kids' tuitions climbed 8% this year. Heating oil and electricity are more expensive. Breakfast cereal. Books. You name it, it costs more. Yet for the last year, Alan Greenspan and the other members of the Federal Reserve's interest-setting body, the Federal Open Market Committee, have been telling me not just that there isn't any inflation, but that there really isn't any danger of inflation. Well, I've finally figured out why they're wrong. It's not because government statisticians have cooked the books to keep inflation numbers low (although they have), or that the Fed governors are part of a conspiracy to cut the inflation-indexed payments going to retirees (although they may be), or that these folks are so out of touch with the real economy that they can't see what the rest of us feel in our everyday lives (although that's quite probably true). No, the real problem is that the Fed is worried about the wrong kind of inflation.
You see, the kind of inflation that the Fed cares about -- and tries to fight -- is the short-term, cyclical kind. Prices jumped by 13% in 1979, for example, after a 9% increase in 1978, as members of the Organization of Petroleum Exporting Countries (OPEC) ratcheted up the price of oil. So the Fed, under then-chairman Paul Volcker, drove U.S. interest rates up to 14.7% on 3-month Treasury bills in 1981, throwing the country into a recession that did indeed put an end to double-digit inflation. By 1982, inflation was down to 3.87%. The long view of inflation But the kind of inflation that you and I feel right now isn't cyclical but what is called secular. My belief is that prices tend to move up in long, long waves that last anywhere from 80 to 180 years and contain many short-term cycles -- like the one that peaked in 1979. It's the duration of these waves of rising prices, rather than the magnitude of year-to-year increases in inflation, that's important. Past price waves have been characterized by annual increases of as little as 0.6%. But applied over long periods, even that rate is enough to set economic expectations, to produce a strong sense that something has gone wrong, to create intolerable stress in the economy and to lead finally to a political and economic crisis. Related news and commentary on MSN Money
If the history of prices is an accurate guide, we're now about 100 years into a wave that hasn't yet peaked. David Hackett Fischer, Pulitzer Prize-winning history professor at Brandeis University, lays out the case for long periods of steadily increasing prices interrupted by briefer periods of price equilibrium in his 1996 book, "The Great Wave." What's fascinating to me about Fischer's price waves, which are very different and much more convincing in my opinion than the long-cycle theories of folks like Pretcher or Kondratieff, is how much they explain about our current economy. Price waves boiled down In contrast, productivity improvements in the machines that make goods are relatively easy. The Middle Ages, for instance, had their own "Industrial Revolution" when water power was applied to jobs like washing and preparing cloth that had previously been done by hand. Makes you think twice about our current insistence on taking energy and food costs out of our most-watched measures of inflation. Price waves begin as demand inflation increases the prices for food, fuel, land, and shelter. In all price waves until the 20th century, population growth led to that increase in demand. In the 20th century, rising consumer incomes and expectations produce the same effect. Wage-earners, on the other hand, lose ground steadily to prices. And to taxes. Governments, facing their own debt crises as prices rise, attempt to raise taxes. But those taxes aren't distributed equally among the population, since the wealthy use their political clout to get themselves exempted from the tax increases. Where Fischer left off Fischer's book ends with a discussion of the price wave that began in 1896 and continues today. But the book was published in 1996, so it doesn't discuss the rise of China and India, the U.S. debt bubble or Washington's fiscal crisis. Let me try to add those events to Fischer's framework. First, adding the 2 billion consumers of China and India to the global economy is our century's equivalent of the population increases that Fischer posits as the cause of earlier price waves. This is a massive increase in global demand, and we're seeing the expected increases in the prices of food, fuel and other basic commodities. And we're seeing the stable of declining prices of manufactured goods that are typical of the first half of price waves. Second, Fischer is a subtle-enough historian to realize that the changing nature of governments and societies changes the possible response to a price wave. He notes, for example, that social relief programs that date back to the 18th century have been critical in reducing the degree of suffering among the poor during more recent price waves. I'd add that the expansion of political power from a narrow elite as in pre-revolutionary France to the voting population of today's America has changed the way that the society responds to the initial stages of a price wave. Real wages still fall in today's United States because of rising prices, but thanks to credit cards and home-equity lines of credit, you don't have to be the Duc de Deux Ponts to find a way to keep up with inflation. (In 1786, the Duc said about the peasants, "It is in our interest to feed them, but it would be dangerous to fatten them.") Third, we don't know where we are in this price wave. If it started in 1896 and lasted 80 years -- the minimum for the waves Fischer studied -- it would be over by now. If it lasts 180 years -- the maximum for previous waves -- it will end in 2076. I think this price wave still has years to run, and when it ends and how it ends depends not on some mechanical theory of history but on the decisions we make now. As Fischer points out, the collapse of the French monarchy, the bloodbath of the French revolution, and the world war unleashed by Napoleon were by no means preordained. Fischer writes: "By 1787, Europe's most powerful government (France) was on the edge of bankruptcy. … Ministers tried desperately to balance their books. Economies were enacted. The king himself, Louis XVI, set an example by reducing his household expenses from 22 million livres to 17 million, largely by consolidating the royal stables. … The financial ministers of Louis XVI pleaded desperately for more revenue, and were refused. The possessing classes refused to accept new taxes. Many demanded more privileges and exemptions. This combination of public need and private greed was fatal." So how will this wave end? It's our choice. New developments on past columns 5 growth stocks for a weak-kneed rally As I wrote in my May 20 column, I've got my doubts about the staying power of the current rally. But investors did get a major positive sign last week when the New York Stock Exchange reported that short interest climbed 1.54%. That's the fifth increase in a row. Short interest is a measure of how many shares of a stock (or in this case, of all stocks) traded on the NYSE have been sold short. The number is important in trying to gauge the potential strength of any rally, because investors who are short a stock are betting on it to fall in price. When the stock instead starts to move upwards, short sellers often decide to buy shares to cover their short sales in order to limit their losses. That buying by short sellers provides important fuel for a rally. And when the short interest is high, as it is currently on the NYSE, there's more fuel to keep a rally going. Philip Erlanger, who charts short intensity (short interest corrected for trading volume) for his newsletter, Erlanger Squeeze Play, sees major jumps in short intensity in energy minerals, consumer services, health technology, finance, health services, consumer durables, consumer nondurables, producer manufacturing and process industries. The Nasdaq, which reports short interest independently from the NYSE, is set to issue its numbers today, May 24. Editor's Note: A new Jubak’s Journal is posted every Tuesday and Friday. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak did not own or control shares of any equities mentioned in this column. He doesn't own short positions in any stock mentioned in this column. | ||||||||||||||||||||||||||
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