Wednesday, October 26, 2005

Rising Consumer Prices

Whatever the topic is, you know that when everybody is saying the same thing, nobody is thinking very much. It is refreshing to read in the New York Times a dissent by James Grant on both the overwhelming celebration of the Greenspan legacy and the new chairman of the FRB, Ben S. Bernanke:

"Now Mr. Bernanke stands to inherit what Mr. Greenspan and he, among others at the Fed, wrought. Certainly they have whipped deflation. But by pressing down interest rates to the floor, they have pushed housing prices to the sky. And they are the uneasy witnesses to an unscripted climb in the Consumer Price Index, which, in September, registered a 4.7 percent increase over last year.

Don't worry, many counsel. The seemingly alarming inflation data are the statistical tracks of a boom in energy prices caused by the Iraq war and the Gulf Coast hurricanes. It will pass.

But what if it doesn't? What if a new cycle of rising prices has already begun - as I happen to believe it has?"
James Grant is on to something that was brought home to me at the coffee shop today. The price of a small increased to $1.74, up twenty cents. Gas and heating prices have also been increasing. Deflation sounds good for consumers about now...perhaps it would drive down home prices, too...Stay tuned.


PiedPiper said...

You can take our guns, but goddamnit, don't increase the price of Ilya's coffee!

Unfortunately, I don't know enough about this stuff to say anything more than that.

xtrachromosomeconservative said...

Ultimately the issue of gas and heating is what is driving inflation as opposed to monetary policy. The question of energy prices is largely unrelated to how cheap or expensive money is but centers around questions of supply and demand. We have not seen supply increase in a manner commensurate to demand mostly as a result of the ascendant economic machines of India and China.

To the extent that Greenspan made money cheap after the burst of the bubble and Sep. 11 attacks this was fairly sensible as it prevented the recession from being much more drastic. Whether we have an honest to goodness asset bubble in the housing markets is frankly debatable. There are some markets where basic fundamentals such as demand don't seem to be apparent (think Naples, Florida) and housing prices are largely being driven by speculation. A larger driver of the housing price increases is one the low interest rates (though they are not at their historical floor, Greenspan has consistently pushed rates up over the last several years) but also creative financing techniques. I think where you are most likely to see a significant downturn in the housing market is with the condo market where people our age (in the early to mid 20s for readers out there) are taking out interest only loans whereby the only possibility of their building up equity is tied to the continual appreciation of housing on the current trajectory, which is unlikely. Five years down the road when they have to pay a balloon payments, unless there incomes have soared in the interim, they will be in for a world of hurt, and we will probably see a number of people in our age cohort defaulting on their mortgages.

But the other thing is as we increasingly regulate land use policies and zone in a fashion that makes land scarce we drive up the price of real estate.

The other trap people tend to fall into is comparing the housing market to securities and by extension the bursting of the tech bubble. Securities are: 1. liquid, 2. intangible. A house, no matter how ugly or crappy, is somebody's castle. People don't just flip houses, some do, but a very small percentage compared with securities. If the housing prices start to level off, which they will, or even undergo a downturn, there won't be a run. You sell your house you are out of house and home, a little different than selling off that tech stock on the Nasdaq.

The other thing with regards to deflation, Ilya, is you should be wary of advocating deflation. Deflation is phenomenal for those that have money because you make the money supply scarcer thus increasing the value of their wealth. In the process of making it scarcer you build up impediments to accessing capital making it expensive to the point of essentialy shutting out large swaths of the population in building up personal equity whether be that equity in their home or business.

archduke f. f. said...

Xtra- Salient commentary, as per usual.

Ilya- Another factor in the rising coffee prices, something that is probably compounded by the rising prices of oil as Xtra has noted, is the fact that MN just pushed the minimum wage up to 6.50 an hour. I noticed that immediately after the bill passed the legislature, many restaurants in Duluth pushed the price of a large Coke up by twenty or thirty cents. I'm sure this is probably just a small factor, but it is a factor nonetheless

Ilya said...

Thanks for all the info. I'll think it over and get back sooner or later. I still want to redeem deflation, it's not an inherently evil word as some might think, nor is inflation an inherently good thing. I guess one has to ask, inflation or deflation of what, how much and for how long, etc.?

Hey, I took a class on economics for the citizen...I should find my notes.

Aljavar said...

I was going to go through a few econ related info-garbs in regards to the post. Then, I read Xtra's post. He nailed most of it. Nice current events essay Xtra! A+!

I will say this. Historically, the real estate bubble bursts five years after the economy turns sour. That puts us at the econ timetable position of "we're about do for it". And it should crash hard. The amount of the general economies bubble burst is responded to in [nearly] direct proportion by the fed's drop in interest rates. Lower rates intice people to spend, and earn, and spend, and earn, and spend (economic activity), and hence, really low interest rates really intice people.

When politicians say "I'm going to turn the economy around". That's all they're really going to do is pick of the phone and call the fed and recommend to them that they do what they always do when economic activity drops. Yeah, there's other factors besides only the fed, but the others are more politically argueable than interest rates drops.

All in all, you're darned if you do [drop rates] and you're darned if you don't. There's no free lunch on this one either. Personally, I'd rather have a temporary rise in prices rather than layoffs and such.

Lastly, the only reason everyone agrees that Greenspan has done well is that it's a hard job to totally mess up. The game plan is over fifty years old now and it's pretty bread and butter, vanilla stuff.