March 02, 2004

The Inflation Zone

Your editor has just rolled into Paris after a thirteen hour flight from sunny-and-warm Mexico to sunny and not-as-warm France. I'm putting together an ambitious weekly edition for tomorrow. Today, I'll answer a few questions. But first, a missive from the good Lord (Rees-Mogg), sent late last week. I'll be seeing him next week in London, incidentally, where I'm going to be based for a bit. Today, LRM says the American political season is a prescription for higher inflation. Judging by yesterday's ISM numbers he may be right. Up until recently, higher prices in raw materials have not shown up in higher prices for finished goods. But as the prices manufacturers pay go up, so too might pricing power. ISM reports that February was the 24th consecutive month the Prices index has registered higher prices. The release stated, "February's index is at 81.5 percent, 6 percentage points higher than January's reading of 75.5 percent. The last time the index registered higher than February's index was in February 1995, when it registered 81.7 percent. In February, 65 percent of supply executives reported paying higher prices and 2 percent reported paying lower prices, while 33 percent reported that prices were unchanged from the preceding month." There were eighteen industries that reported paying higher prices in February. They included: Tobacco; Leather; Fabricated Metals; Textiles; Wood & Wood Products; Primary Metals; Industrial & Commercial Equipment & Computers; Rubber & Plastic Products; Food; Chemicals; Transportation & Equipment; Furniture; Apparel; Miscellaneous*; Electronic Components & Equipment; Instruments & Photographic Equipment; Paper; and Printing & Publishing. The market, of course, focused on the jobs data, which grew for the fourth consecutive month. And it IS a good sign. But higher inflation in consumer prices (finished goods) will put a dent into already thinly stretched consumer incomes. Employment and income growth need to grow much faster than incomes to take pressure of consumer balance sheets. Rising prices won't help. Strategic Insider – 25 February 2004 – William Rees-Mogg Alan Greenspan uses the language of the Fed., that is the language of bankers and economists, to warn the American public of the rocks ahead. I wonder whether the public has heard the message. He has recently been giving evidence to Congress on the state of the U.S. economy. He referred to a study by the Congressional Budget Office, a non-partisan body, so he was quoting a Congressional study to Congress. He observed that “the budget scenarios considered by the CBO in its December assessment of the long term budget outlook offer a vivid and sobering illustration of the challenges we face.” The Financial Times observed that the Chairman of the Fed “yesterday ratcheted up his warning about using budget deficits in the U.S.” What the Budget scenarios show is that the U.S. budget deficit, currently running at half a trillion dollars a year, is out of control, and that the looming deficit on social security pensions could add another half trillion dollars in the next generation. Things are very bad, and they are destined, on unchanged policies, to get worse. This will require higher taxes or lower spending or both. Higher taxes will reduce the expected rate of growth of the U.S. economy, and thereby add their own weight to the scale of future Budget deficits. The consequences are already apparent in the foreign deficit and in foreign borrowing, which are both running at the same level of half a trillion dollars, and are both out of control. The dollar has fallen to $1.25 to the euro, and is massively supported by Japan and China. Nobody in the early stages of the Presidential campaign is even beginning to offer useful policies to put this right. No politician can even begin to discuss higher taxes, for fear of losing votes. The Democrats are competing with protectionist sound bites, though Senator Kerry, who sometimes sounds almost as protectionist as Senator Edwards, has given some insight into what is probably his real opinion. “I don’t want to be protectionist because I think that’s the wrong thing to do for America.” President Bush believes that he can balance the budget by making his tax cuts permanent and raising public expenditure. George Bush will find he is mistaken. I never feel much sympathy for Gerhard Schröder, the German Chancellor. He has visited Washington with a request to the President to do something about the weakness of the dollar. He does not say what ought to be done. Even if the President did want a stronger dollar, he does not control U.S. interest rates – they are the Fed’s decision. He would not want to have them rise in a President election year. Nothing much could be done before November, even if anyone knew what to do. I doubt if this will play well with the electorate in the presidential campaign. A Budget deficit, a trade deficit, growing foreign debt and a falling dollar are bad for confidence, whether one is talking about the stock market – despite rising earnings – or the election itself. What is the name of the rocks ahead? They are called the “inflation zone” on the charts.


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