Inflation Fears Ease — So Watch Out!

As I’ve pointed out before, the extreme leverage increases in our economy created a false inflation, and the de-leveraging is an inherently deflationary process.

There are signs that this false inflation is easing, and possibly even heading into a deflationary curve.

Consumer prices were flat in September as retreating costs for gasoline, clothes and new cars helped to offset rising prices for food, medical care and other things.

The new reading on the Consumer Price Index, the government’s most closely watched inflation barometer, came after prices actually dipped by 0.1 percent in August, the Labor Department reported Thursday.

In the inflation report, when energy and food products are stripped out, “core” prices inched up by just 0.1 percent in September, an improvement from a 0.2 percent advance in August.

The latest showing on inflation was better than economists expected. They were forecasting a 0.1 percent increase in overall prices and a 0.2 percent rise minus energy and food.

I’ve been watching locally as gas prices here in Orange County have dropped, from the $4.50/gallon range at the high points down into the $3.35/gallon range this morning. As they tend to lag the price of oil, they could drop even further. The [impending or currently existing] recession is eating into demand for most consumer goods, which puts downward pressure on prices for those as well.

Food is holding steady, but if we can get some pressure in Washington to end our silly corn ethanol program (only possible if Congressional Democrats try to punish their Midwestern Republican opponents), it could reduce prices there as well.

So why do I say watch out?

With the economy in for a period of weakness that could extend well into next year, inflation should also moderate, Bernanke and other Fed officials predict. Tamer inflation would give the Fed more leeway to slice rates again or at least keep them at low levels for some time.

“The rapidly disappearing inflation threat is providing the Federal Reserve full latitude to move to an easing bias on rates to combat the recession as well as the ongoing financial crisis,” said Brian Bethune, economist at Global Insight.

Many economists believe there’s a strong chance the Fed will lower rates at its next regularly scheduled meeting later this month. In an unprecedented assault on the financial crisis, the Fed and other major central banks together reduced rates last week. The Fed’s main rate dropped to 1.50 percent, from 2 percent.

He says this coming off a 2-week bender where the Fed, the Treasury, and our elected officials have pledged to throw liquidity at the problem to “unfreeze” this market. Now, there’s a chance that our super-intelligent always-prudent benevolent masters in Washington may lay down exactly the right amount of liquidity to forestall deflation, get markets moving, and not create inflation of their own… Yeah, that’s about as likely to happen as France adopting a 55-hour work week.

Much more likely is the scenario where our government throws dollar after dollar, rate cut after rate cut, and stimulus package after stimulus package at the problem until they see movement. After all, now that they know inflation fears are “disappearing”, they know that they have “full latitude” to act. Once they begin to see movement, they’ll finally realize that all those free dollars had a lag period and that they’ve overreached. We’ll have “booming growth” on paper as the value of our money erodes.

Sadly, only the few of us who know that these cycles are induced by a loose monetary system— those of us who saw this problem coming 2+ years ago— will accurately diagnose that the apparent growth is a chimera. And as usual, nobody will listen until it’s too late. They’ll blame the guy in office, and get ready to elect their next savior politician to take care of them. “Pay no attention to the man behind the curtain! All hail the Wizard!”

  • Quincy

    The only time a politician knows when to quit is when they’re throwing dirt on his coffin. Too bad, because if they quit now we’d end up in a pretty good spot.