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CPI vs. Reality

US gasoline is touching $4 per gallon. Yet inflation is missing from the Consumer Price Index...

that – in an age where governments of every political stripe distort economic data to promote their own self-interests – inflation statistics are wildly at odds with the reality faced by consumers and businesses, writes Gary Dorsch of Global Money Trends.

   Regarded with utter disbelief, the latest US government report on inflation, for instance, made a glaring "seasonal adjustment" for energy prices that cast great doubt as to the accuracy of its findings.

US Labor Dept. apparatchiks said consumer prices rose a smaller than expected 0.2% in April, tamed by energy prices which were unchanged for the month. Utilizing an obscure "seasonal adjustment", the Labor Dept. then figured that gasoline prices actually fell 2% in April, which doesn't reflect the reality of what consumers were paying at the pump.

Furthermore, the International Monetary Fund's (IMF) global food price index rose 43% over the last 12-months, yet the US consumer price index for food only stood 5.1% higher last month from April '07.

CPI vs. Inflation Reality

Wall Street cheered the tame inflation rate this week, reckoning it gives the Federal Reserve more time to peg the Fed funds rate at 2%, jigging-up the stock market with massive money injections.

But the folks who aren't fooled by the government's propaganda on inflation are the American people, whose Dollars buy less with each passing month. The inflation tax is the great thief of middle class wealth.

   For the 12 months through April, prices for US imports were 15.4% higher. Yet Wall Street economists massaged the data, and explained that wholesalers and retailers are absorbing the higher costs out of reluctance to increasing prices and driving away customers.

   Should we trust the inflation statistics conjured-up by government apparatchiks, or rather, place greater faith in the depreciating Dollars and Cents that flow through the commodity markets each business-day?

   According to the chart above, unleaded gasoline futures traded on the Nymex ended +12.2% higher in April, up at $2.93 per gallon.

   The US Energy Information Administration (EIA), however, said average retail gas prices actually shot up 9.5% in April from March. Less than two weeks later, gasoline futures advanced another 10% to a record $3.22 per gallon, and retail prices at the pumps are closing in on $4 per gallon nationwide.

   On May 14th, upon hearing the Labor Dept.'s report of a scant 0.2% inflation rate during April, former Fed chief Paul Volcker cast doubts about the way the government is measuring inflation.

   "It doesn't feel quite right. I think the bias clearly is more towards higher inflation, offset by the weakness of the domestic economy," Volcker said.

   "Seasonal adjustments" are one of the most useful tools that Labor Dept. apparatchiks have developed to fudge US consumer price inflation statistics.

   The Bernanke Fed has a simpler model. It simply strips out food and energy costs from its inflation calculus. Either way, the Labor Dept. said retail food prices in April were +5.1% higher from a year ago. Yet the Dow Jones Agricultural Commodity Index, which measures a basket of corn, coffee, cotton, soybeans, soybean oil, sugar, and wheat, was up 40% in April from a year earlier.

   How come? Major central banks have greatly increased the levels of cash available to banks and brokers to stave off a credit crisis, and much of the excess money has found its way into agricultural and energy futures.

   Also driving up food prices is bio-fuel production, which jumped 43% in the year through March. The American Farm Bureau Federation calculates that bio-fuel use accounts for up to 30% of the food price surge. About a third of the US corn crop, or four million bushels, is expected to go to making ethanol this year.

   The White House's chief economist, Ed Lazear, said rising energy costs account for as much as 20% of rising food prices, while the sliding Dollar accounts for about 13% of this increase.

   Other factors supporting higher food prices are bad weather in traditionally big production areas, plus changing tastes in Asia – where consumers are shifting toward greater consumption of proteins from meat and poultry. That requires more grains for animal feed.

Not included in US inflation statistics is the Baltic Exchange's Sea Freight Index, which monitors the costs of shipping dry goods across 40 major trade routes for minerals, grains, cement and sugar.

   Earlier this week, this key gauge of global economic activity jumped 4% to a record 11,067.

   Across in Asia, demand for grains and natural resources has not yet been dented by the global banking crisis or the economic recession in the United States. Freight shipping costs on key export routes are 75% higher than a year ago, and 1,100% higher than seven years ago.

Bernanke Fed vs. Volcker's View of Inflation

   The Fed's latest rate-cutting spree, taking the Fed funds rate to 2% from 5.25% last Sept., has opened up the monetary floodgates. Besides re-jigging the stock market as planned, however, it's also fueled a global commodity boom unlike anything witnessed since the 1970s.

   The weak US Dollar is contributing to yet another speculative binge, this time in commodities, led by crude oil's surge to $127 a barrel in mid-May.

   The US money supply, meantime, is growing by 16.5% from a year ago (on the M3 measure), close to its fastest rate of expansion in history and far above the growth rate of the US economy.

   That monetary inflation is generating powerful inflationary pressures on consumer pay-packets, with increases in the cost of living far outstripping wage increases. But as recently as Feb. 25th, a top Fed official – Frederic Mishkin – defended the central bank's prevailing focus on "core inflation", stripping out food and energy costs in order to keep the printing presses rolling at full speed.

   "Stabilizing core inflation leads to better economic outcomes than stabilizing headline inflation. If central banks raise rates aggressively to counter inflation caused by a sudden rise in oil prices, unemployment will be markedly higher," Mishkin warned.

   "The shock of energy price increases will likely wear off and have only a temporary impact on inflation. When inflation expectations are well anchored, the central bank does not necessarily need to raise interest rates aggressively to keep inflation under control following an aggregate supply shock."

   Come May 14th, former Fed chairman Paul Volcker – the man who raised US interest rates to almost 20% to combat the late '70s/early '80s inflation – strongly disagreed.

   Volcker warns that the US economy could face a 1970s-style period of skyrocketing inflation if consumers and investors lose confidence in the buying-power of the US dollar. "If there is a real loss of confidence in the Dollar, then I think we are in trouble. That is something that has to be watched. That has to be very much in the forefront of our thinking.

   "Without that, we are back to the inflation of the 1970s or worse."

   The Fed has already pumped half-a-trillion dollars into the financial system in the form of "open market" operations to lend cash, plus its special emergency lending measures to un-freeze the subprime mortgage-bond market. Much of the excess cash in the financial system has not yet shown up in the economy, because the banks are afraid to lend the money. But once the credit crunch eases, the excess liquidity could not only expand bigger bubbles in the commodity markets, but also fuel hyper-inflation in the US economy if it's not drained out quickly.

   "If inflation gets too high, the economy will suffer dramatically," warned Kansas City Fed chief Thomas Hoenig on May 6th, in unusually candid remarks.

   "Rising price pressures are not temporary, as some assert, but are more serious. These increases are beginning to generate an inflation psychology to an extent that I have not seen since the 1970s and early 1980s. Energy, food and other commodities have simply soared. If an inflationary psychology becomes embedded, it will require significant monetary policy tightening to reduce it."

   Yet soaring commodity inflation is greatly at odds with historically low US Treasury bond yields, and it's difficult to understand why investors are still holding 10-year US Treasury notes at all. This could in fact be the next major bubble to burst.

   Aren't strong price pressures in the commodities markets getting noticed in the bond market? Oil is shooting north of $125 a barrel, retail gasoline costs $4 a gallon, and basic food staples such as corn, soybeans, wheat and rice are doubling in price?

   Incredibly, however, China and Japan still chose to boost their holdings of US Treasury securities by $18 billion in March, and the Arab oil kingdoms added $25 billion – mostly through their brokers in London. Institutional investors worldwide meantime have plowed $40 billion into commodity index funds so far this year, lifting their bets to $200 billion.

   Retail investors added $16 billion into commodity exchange-traded funds (ETFs) in the first four months of this year, and ahead of last year's pace of $15 billion. The Dow Jones Commodity Index is up 24.5%, and the Reuter's CRB Index, with a greater energy weighting, is up 39% from a year ago, far outpacing the returns in US Treasuries, in an environment of escalating inflation.

   The Fed's last two rate cuts – equaling 100 basis points all told – have back-fired. Setting rates at just 2.0%, the Fed is lifting the commodities markets, especially crude oil, while undermining the 10-year Treasury note market, which saw prices fall to a three-month low this week, lifting the yield as high as 3.98%.

   What if bond-buyers go on strike altogether? On April 15th, NBER chief economist, Martin Feldstein, a top advisor to the Bernanke Fed, said surging commodity price inflation should stop the US central bank from cutting its overnight lending rate below 2 percent.

   "It would make sense for the Fed to stop cutting its target rate at between 2% and 2.25%, because to go lower could exacerbate the problem of inflation emanating from high commodity prices," Feldstein said on CNBC television. There is now widespread speculation that the Fed's rate cutting spree has ended at 2%, but – most likely – the central bank will drag its heels on combating inflation, and move in slow-motion baby-steps, when raising interest rates.

   Seeking a quick fix to halt the slide in US T-Notes, the US Treasury is banking on the doctored-up consumer price index to contain the rise in 10-year yields at 4.0%. That would make borrowing costs for the US government more viable. Yet efforts to achieve this by keeping short-term interest rates below the inflation rate simply provide fertile ground for commodity traders and operators in the stock market.

For more analysis of top stock markets around the world, plus commodities such as crude oil, copper, gold, silver, and grains as well as currencies, Libor interest rates and global bond markets, order a subscription to Global Money Trends here...

GARY DORSCH is editor of the Global Money Trends newsletter. He worked as chief financial futures analyst for three clearing firms on the trading floor of the Chicago Mercantile Exchange before moving to the US and foreign equities trading desk of Charles Schwab and Co.

There he traded across 45 different exchanges, including Australia, Canada, Japan, Hong Kong, the Eurozone, London, Toronto, South Africa, Mexico and New Zealand. With extensive experience of forex, US high grade and corporate junk bonds, foreign government bonds, gold stocks, ADRs, a wide range of US equities and options as well as Canadian oil trusts, he wrote from 2000 to Sept. '05 a weekly newsletter, Foreign Currency Trends, for Charles Schwab's Global Investment department.

See the full archive of Gary Dorsch.


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