The more I read from Daniel Gross, the less I think he understands the real marketplace.

He goes back, looks at overall CPI, and comes up with, gasp, three percent inflation over the last four years. Yes, lower inflation is better. But three percent, when considered on any sort of historical scale, is hardly disastrous.

Taken alone, you might expect that three percent inflation would prompt the fed to tick interest rates upwards. Maybe. But interest rates affect other things besides inflation. Important things, like economic growth. And to be frank, I'd rather have healthy, sustained growth with low to moderate inflation rather than recession with textbook-perfect inflationary equilibrium.

I work in an business that provides services and equipment to other businesses. Local industry is heavy in manufactured housing and RV's, and while I've seen things much worse, everybody around here has been sensing the downturn in the last four or six months. The housing bubble never got too frothy here and the crash was only a muffled thump, but homebuilders are having a hard time anyway. I can only imagine the mess in places where prices ran up badly.
I'm not sure I buy into the idea there was a full-fledged liquidity crisis a few weeks ago, but there have been a goodly number of banking messes. And, yes, that had some corresponding effects in the stock racket.

Gross pooh-poohs the "core" rate of inflation, and I agree that the overall rate more accurately indicates the functional effects in the marketplace, but there is good reason why core inflation is a better indicator of the true way inflation is playing out. Energy costs factor into everything we do, especially manufacturing and transportation. If energy prices go up, making/growing/building the things we purchase and moving them to markets costs more, and so we pay more for those items... in other words, inflation. It's a non-linear effect on overall CPI, quite literally double-dipping for a single sector of the economy.

(Personally, I think food prices should be counted in the core inflation number. But that's a separate argument.)

If you want to see how much the woman-in-the-street is bleeding, then sure; look at the overall CPI. To see how the economy is actually functioning, and understand the state of the processes which the Fed can actually affect with interest rate adjustments, then it's core inflation all the way.

After all, what the Fed does will in no way directly affect what's happening in energy and commodity markets. Oil prices are doing what they're doing because of overall scarcity, weather disturbances, and the (not wholly sane) pricing in of potential geopolitical disasters. Fossil fuels are ultimately a limited resource. Not one that will be exhausted within our lifetimes, but it seems increasingly unlikely that production capacity will ever again spike upwards. Eventually prices will reach a new equilibrium when "alternative" methods of production scale up to meet demands, but I don't expect to see that for a couple of decades.

And this is true of many commodities... one of which Gross uses badly to try to prop up his straw man. Yes, when there's inflation people run to gold. But gold is also more in demand then ever as a product. Not just for jewelry, but also for manufacturing, especially of electronics. Furthermore, the (relatively) recent introduction of gold ETF's has given retail-level traders easy access to the gold market and those traders have jumped at the opportunity... which makes gold even more scarce for manufacturers which use it, which drives the price up more, which brings in more bandwagon traders... (And it's even worse for platinum, or at least it was the last time I looked.) Comparing the price of gold to where it was in the last real inflationary crisis and drawing the simple conclusion that the market thinks we have an equivalent crisis isn't just avoiding nuance, it's avoiding any semblance of critical thought at all.

Bernie did his job correctly. He looked at everything that was going on, balanced the pros and cons, and then did something which was in the best interests of the economy. Maybe if Gross would get out of his ivory tower he would understand that.

I was going to ask you why food and energy are left out of the core inflation index and then you answered me. In a way energy is fuel for the economy and food is fuel for humans so maybe that's the thinking. I get the fact that you'd be measuring energy twice because it knocks on into more or less everything anyway. That only thing about leaving food out of the mix is that poor people spend a disproportionate amount of their income on food as compared to everybody else so they get hit the hardest by these ignored hikes. But why should the Fed factor into its decision-making how hard it is for our most badly off to put food on the table and dictate policy accordingly?

I agree with your points. And anyway, I think economists and finance-pundits are obsessed with inflation. The economy is everything we do with money and inflation is a small small part of the picture.

The one nit I would pick is that you say 'overall scarcity' when I think you should maybe say 'perceived overall scarcity'. I agree with you take on the whole fossil-fuel thing, if prices do go even higher then alternatives will look cheaper in comparison. My bet is on solar cells and hydrogen. People make it out as all doom and gloom, if the price of fossil fuels goes down then happy days, if it goes much higher then we'll have a brand new economy and again happy days - the worst is if oil stays at around $80 a barrel which just benefits OPEC and the major oil conglomerates and nobody else besides.

3% my ass. Its not 3% - the actual monetary inflation is more like 8-10% per annum. The books have been cooked and I can't believe that so many people can't see beyond their noses. Greenspan should be in prison along with Bernacke and Bush and Cheney. We have been robbed blind. In two years a US dollar won't have any value other than that of a rather mediocre bathroom tissue substitute.

I think the only way you could justify leaving energy out of the calculation is to include a suitable proportion of gasoline, electricity, heating oil, and heating/cooling natural gas, all of which are end products used by the consumer, in the core inflation basket. I am not sure which might be there but I have my suspicions that they aren't. If that is done, then the energy costs of producing consumer goods (embedded in the retail prices) and the energy costs of consumer direct use of energy would both be accounted for.

Somehow (due to my capricious thought patterns, no doubt) that reminds me of the book and movie "How Green Was My Valley".

"After all, what the Fed does will in no way directly affect what's happening in energy and commodity markets."

You have GOT to be kidding me. You DO know that the FED's only purpose is to control the supply of money, right? You DO know that money created has to go somewhere, right? How, then, would the FED creating tremendous sums of cash NOT create inflation in the commodity markets?

Some people just do not understand this simple concept - Newly created money eventually finds it's way EVERYWHERE - Commodities, housing, stock markets, EVERYWHERE.

MrSmarteyPants:

"After all, what the Fed does will in no way directly affect what's happening in energy and commodity markets."

You have GOT to be kidding me. You DO know that the FED's only purpose is to control the supply of money, right? You DO know that money created has to go somewhere, right? How, then, would the FED creating tremendous sums of cash NOT create inflation in the commodity markets?

Some people just do not understand this simple concept - Newly created money eventually finds it's way EVERYWHERE - Commodities, housing, stock markets, EVERYWHERE.

To answer your question, the Fed increasing the supply of money would indeed inflate the commodities markets - but with highly volatile items like energy and food, the Fed's ability to influence price is dwarfed by market volatility.

Hence why it makes sense to largely remove such items from the Fed's decision making process.

Appreciate your efforts here chaps, but I should clarify a few things for you. First, the reason food and energy are excluded from the basket to form core CPI is that they are both extremely inelastic goods whose prices are therefore volatile and not necessarily indicative of the underlying signal of inflation. In effect, the Fed is (ostensibly) trying to maximize the signal to noise information they can glean from the data, and hence excluding the low ratio outside 'core' CPI. This reasoning is done in when that is not the case- i.e. when there is a strong signal in the off core items, which there has been this whole decade. That means that the Fed, and anyone else who falls prey to this idiocy, is missing the picture (and worse if they use core personal consumption expenditure, Greenspan's favorite index, which does not even attempt to measure the price level but rather influences on inflation expectations). If you don't believe all that then you should sell short Exxon, because crude has a long way to fall to get back to $25 a barrel. Copper, zinc, lead, aluminum, corn, wheat, soybeans, coffee, etc. etc. also are good candidates if you have a commodities account.

Inflation has been held down due to low interest rates, resource slack in developing countries and mammoth export subsidies of consumer goods in Asia. Everywhere where these forces haven't existed- e.g. labor intensive and offshoring proof healthcare and education- have experienced sharp price increases. The conditions that have kept a lid on things however are unsustainable, as noted by Greenspan in his self-serving memoir, and the acquiescence of the Federal Reserve in the wholesale inflating of liquidity (the term 'money' is passe) will eventually result in either a massive depression style deflation or a Latin America style inflation- IMO.

Majorajam:

We may not be on the same page on explanation; but, I do hope you hang around. You have afar better take on this than I do.