Zero inflation in February

The Labor Department reported zero inflation for the month of February as rising prices for medical care and education were offset by sharply lower costs for energy and apparel. This comes after a 0.2 percent increase in January and marks the eleventh straight month that the price index did not drop after a series of steep declines beginning in late-2008.
On a year-over-year basis, the overall consumer price index was up 2.2 percent following an annual gain of 2.7 percent the month before, however, we may not have seen the last of rising annual inflation as recently higher gasoline prices are not reflected in the most recent data.

By category, it was a familiar story as health care and education costs continued their relentless advance while prices for many other goods again fell. The closely watched shelter component (within the housing category) was flat in February after a decline of 0.5 percent last month and is now down 0.4 percent on a year-over-year basis.
Energy prices were down 0.5 percent in February after an increase of 2.8 percent the month prior and are now 14.4 percent higher than a year ago. Last month, gasoline prices fell 1.4 percent but they are still almost 37 percent higher than last year at this time.

Recall that gasoline prices did not move much above the $2 a gallon mark last year until May, so there will be a few more months of big energy price increases in the period ahead.

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Japan doubles down

At the rate they are going, someday we'll be calling it "The Lost Century" in Japan as they now embark on their third "lost decade" with little sign of changing course. The scourge of deflation is once again being countered by a doubling of the Bank of Japan's "quantitative easing" program, otherwise known as "money printing", as reported this morning.

Governor Masaaki Shirakawa and his board increased the three-month loan facility to 20 trillion yen ($222 billion), the bank said in a statement after its meeting in Tokyo. They also held the overnight lending rate at 0.1 percent.

Shirakawa said there is no “miracle” cure to stem declines in prices that are deepening even as the economy sustains a revival from its worst postwar recession. Prime Minister Yukio Hatoyama’s administration, restrained from adding to fiscal stimulus by a record debt load, has been pushing the bank to do more to bolster growth.

The move “could implant a strong impression among the government that the stronger it presses, the more it can get from the BOJ,” said Mitsuru Saito, chief economist at Tokai Tokyo Securities Co. The expansion “is highly unlikely to shore up the macro-economy, while having only a limited impact on liquidity,” he said.

Nobel Prize winning economists Joe Stiglitz and Paul Krugman (among many others) are again talking about a "liquidity trap" and how this may not end well for more than just Japan.

As is the case for the Great Depression, any "liquidity trap" discussion always seems to begin with, "Here we are in an awful mess, how do we get out of it using the tools of mainstream economic theory?", whereas, maybe, just once, they should start with, "Mainstream economic theory has failed us again, maybe we should just do nothing for a while and see what happens or, better yet, improve economic theory so we don't make such messes."

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Steve Keen does not ♥ Ben Bernanke

In one of the most compelling pieces of writing in recent weeks on the subject of the upcoming Senate re-confirmation vote for Fed Chief Ben Bernanke, Australia's Steve Keen explains why modern economic theory must be taken out back to the woodshed.

The US Senate should not reappoint Ben Bernanke. As Obama’s reaction to the loss of Ted Kennedy’s seat showed, real change in policy only occurs after political scalps have been taken. An economic scalp of this scale might finally shake America from the unsustainable path that reckless and feckless Federal Reserve behavior set it on over 20 years ago.
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Bernanke is popularly portrayed as an expert on the Great Depression—the person whose intimate knowledge of what went wrong in the 1930s saved us from a similar fate in 2009.

In fact, his ignorance of the factors that really caused the Great Depression is a major reason why the Global Financial Crisis occurred in the first place.
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If this were just about the interpretation of history, then it would be no big deal. But because they ignored the obvious role of debt in causing the Great Depression, neoclassical economists have stood by while debt has risen to far higher levels than even during the Roaring Twenties.

It continues to amaze me that so many smart people can go on thinking that the Great Depression materialized out of nowhere in 1929. Keen's piece is worth reading in its entirety, particularly the part about how the "expert" on the Great Depression (Bernanke) willfully ignores the role that debt played.

With each new defense of central bank policies over the last 20 years, neoclassical economists are sounding more and more like the early-17th century Catholic Church.

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Prices rise, "deflation" nearly averted

The Labor Department reported that consumer prices rose more than expected last month, largely due to higher prices for automobiles and rising energy costs, and the year-over-year inflation rate moved back toward zero after spending nearly all of 2009 in negative territory as shown below.The government's measure of inflation rose 0.3 percent in October after an increase of 0.2 percent in September, the ninth monthly increase in prices so far this year after three months of plunging prices late last year, again, largely due to energy.

After sinking as low as -1.9 percent (on a seasonally adjusted basis) at mid-year, the annual inflation rate has now recovered to just -0.2 percent and is likely to move into positive territory next month, remaining there well into next year as energy price comparisons from year ago levels will produce some rather large percentage gains, that is, unless the price at the pump tumbles from its current level.

The 1.5 percent gain in energy costs last month, paced by an increase of 1.6 percent in gasoline prices, put the year-over-year change in the closely watched energy index at -14.0 percent in October, up sharply from many months of readings at -20 percent or more, and this is likely to produce a positive number when the November data is reported next month.
Aside from energy, there is little excitement in the inflation data these days as consumer prices still appear to be under control, the downside now well protected by the government's proxy for the cost of home ownership - the nefarious owners' equivalent rent - which stubbornly refuses to go down despite home prices that have been falling for years.

Owners' equivalent rent now shows an annual increase of 1.2 percent, a result that is clearly at odds with other homeownership costs.

Rental costs are also reported to be up 1.2 percent from last year but, given all the anecdotal accounts of landlords bending over backwards to attract tenants and reports of falling rental costs in most of the country, this seems to be at odds with the reality on the ground as well.

Of course, that seems to be standard operating procedure for the government inflation data.

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Marc Faber on the U.S. dollar and stimulus

Gloom, boom, and doomster Marc Faber made the rounds yesterday talking about the future of the U.S. dollar and the news wasn't good - something about its value going to zero, over time, in this talk with Ricky Cash at Bloomberg

He's still clearly in the "hyperinflation" camp, but not just yet because of the near-term oversold condition for the U.S. currency.

On Bernanke: "He's a money printer. He does that well."

At Reuters the topic of discussion is the U.S. economic stimulus program where the prognosis is not good either - something about government spending being inherently inefficient at getting an economy going again and ultimately leading to much higher levels of debt and then much higher interest rates.

You have to wonder whether there's anyone in the Obama administration who pays any attention to this sort of commentary.

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No COLA for you!

You'd think that if the Consumer Price Index were really doing what it was supposed to do (i.e., accurately reflecting changes to the cost of living in the U.S.), there wouldn't be a need for the government to provide aid to senior citizens when the inflation index says none is required. Yet, that's exactly what's happening as indicated in this report on the big lump of coal being placed in millions of stockings this winter by the Social Security Administration.

There will be no cost of living increase for more than 50 million Social Security recipients next year, the first year without a raise since automatic adjustments were adopted in 1975, the government announced Thursday.

Blame falling consumer prices. By law, cost of living adjustments are pegged to inflation, which is negative this year because of lower energy costs. Social Security payments do not go down, even when prices drop.

The Obama administration, meanwhile, is pursuing a different way to boost recipients' income. On Wednesday, President Barack Obama called for a second round of $250 stimulus payments for seniors, veterans, retired railroad workers and people with disabilities.

This $250 payment would effectively be a one-time cost of living adjustment of two percent following an increase of almost 6 percent earlier this year, a boost that was driven by soaring energy prices in 2008.

If the government were to be more honest about this, they'd construct an inflation index for senior citizens as one British newspaper has done in recent years. There, the age 65+ inflation rate comes in at 2x or 3x the "overall" inflation rate since seniors spend a disproportionate amount of their money on medical costs, energy, and food, making far fewer purchases of items that have been going down in price such as electronics and apparel.

Claims such as this one somehow fail to ring true:

"Social Security is doing its job helping Americans maintain their standard of living," said Social Security Commissioner Michael J. Astrue.

But, he added, "In light of the human need, we need to support President Obama's call for us to make another $250 recovery payment for 57 million Americans."

Again, there's something clearly wrong with the logic there.

Of course that doesn't mean that it won't get repeated enough times that people actually start to think that their personal experience in the world is somehow the exception to the rule.

Social Security recipients shouldn't get a raise next year because their purchasing power has already increased with falling consumer prices, said the Center on Budget and Policy Priorities, a liberal-leaning think tank.

"Since the purpose of COLAs is to preserve beneficiaries' purchasing power, the decline in overall prices means that beneficiaries do not need a COLA in January 2010," Kathy Ruffing, a senior policy analyst at the center, wrote in a report this week.

Over the past 12 months, gasoline prices have fallen 29.7 percent and overall energy costs have decreased 21.6 percent, the Labor Department said Thursday.

Things could get very interesting this winter if energy prices remain elevated, something that appears increasingly likely with each passing week.

In mid-December of 2008, gasoline cost only $1.61 a gallon and current prices of about $2.50 a gallon represent an increase of more than 50 percent. That's going to be a tough argument to counter if seniors begin complaining loudly about getting stiffed later this year.

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Concern over the contraction in credit

Ambrose Evans-Pritchard writes in the Telegraph of the mounting concern (at least, in some quarters) about the rapid contraction in money supply and credit. Along with his Cheshire grin, Pritchard offers up something that we haven't heard for months now - a few comparisons to the Great Depression.

Both bank credit and the M3 money supply in the United States have been contracting at rates comparable to the onset of the Great Depression since early summer, raising fears of a double-dip recession in 2010 and a slide into debt-deflation.

Professor Tim Congdon from International Monetary Research said US bank loans have fallen at an annual pace of almost 14pc in the three months to August (from $7,147bn to $6,886bn).

"There has been nothing like this in the USA since the 1930s," he said. "The rapid destruction of money balances is madness."

The M3 "broad" money supply, watched as an early warning signal for the economy a year or so later, has been falling at a 5pc annual rate.

Similar concerns have been raised by David Rosenberg, chief strategist at Gluskin Sheff, who said that over the four weeks up to August 24, bank credit shrank at an "epic" 9pc annual pace, the M2 money supply shrank at 12.2pc and M1 shrank at 6.5pc.

"For the first time in the post-WW2 [Second World War] era, we have deflation in credit, wages and rents and, from our lens, this is a toxic brew," he said.

Not having looked at M3 for some time now, the broadest measure of money supply but one that is no longer reported by the U.S. government, the graphic you see below was something of a surprise when recently spotted over at NowAndFutures.

This is not what most cynics thought the Federal Reserve would be trying to hide when they discontinued this data series a few yeas ago.
The inflation/deflation debate is clearly not yet over, though, given the looks of asset markets and commodity prices all around the world, it looks like the former has the upper hand - at least for the time being.

Back to Ambrose...

It is unclear why the US Federal Reserve has allowed this to occur.

Chairman Ben Bernanke is an expert on the "credit channel" causes of depressions and has given eloquent speeches about the risks of deflation in the past.

He is not a monetary economist, however, and there are indications that the Fed has had to pare back its policy of quantitative easing (buying bonds) in order to reassure China and other foreign creditors that the US is not trying to devalue its debts by stealth monetisation.
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US banks are cutting lending by around 1pc a month. A similar process is occurring in the eurozone, where private sector credit has been contracting and M3 has been flat for almost a year.

Mr Congdon said IMF chief Dominique Strauss-Kahn is wrong to argue that the history of financial crises shows that "speedy recovery" depends on "cleansing banks' balance sheets of toxic assets". "The message of all financial crises is that policy-makers' priority must be to stop the quantity of money falling and, ideally, to get it rising again," he said.

He predicted that the Federal Reserve and other central banks will be forced to engage in outright monetisation of government debt by next year, whatever they say now.

That would appear to be a good bet at the moment, however, it is a matter of degree.

In the U.S., the Fed's purchase of up to $300 billion in U.S. Treasuries along with a trillion dollars or so in GSE MBSs and other agency debt hasn't brought the world to an end, however, the Chinese aren't all that happy about it.

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Bewilderingly complex Elliott Wave Theory

Peter Brimelow at MarketWatch comments on the latest prognostications from the group of perma-deflationists over at Elliott Wave International.

The good news: One successful survivor of the Crash of 2008 thinks the bear-market rally has further to go. The bad news: It's still a bear market, and it will end in devastating deflation.
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Elliott Wave Theory can be bewilderingly complex. One reason it tends to leave investors incensed is that they believe EWFF's overlapping waves constitute a sort of bait-and-switch, always leaving the forecaster with an out.

Right now, for example, EWFF is showing what it calls the "intermediate" trend as down. But the somewhat longer "primary" trend, which began in March, is intact and is projected to reach 9,000-10,000 on the Dow.

EWFF writes: "The probabilities favor a second phase of advance that carries the rally off the March lows to new recovery highs later."

For the record, EWFF also shows a "grand supercycle," beginning in January 2000 and ending at 400. Yes, that was FOUR HUNDRED.

Like many others, Elliott Wave Theory has always been bewildering to me, but that may have something to do with the fact that I have a degree in engineering and worked as a hardware/software designer for more than twenty years.

Absent that background, maybe it would make a whole lot more sense...

Here's a simplified version of the five waves.
Don't ask me to explain it but, from my limited exposure to it, there always seems to be a debate between wave 3 and wave 5. There's more from Wikipedia here.

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Inflation in the negative in India

They talk very fast on Indian business news shows...

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The inflation-deflation debate continues

The musings of Van R. Hoisington and Lacy Hunt at Hoisington Investment Management have been crossing my computer screen for years now, thanks largely to John Mauldin's weekly emails. They've always made for interesting reading and, today, CNN/Money files this report on their views regarding the raging inflation-deflation debate.

During a recent speech, money manager Van Hoisington, president of Hoisington Investment Management, asked his audience of sophisticated investors to raise a hand if they thought inflation was going to be a problem sooner or later.

Everyone raised a hand -- except Hoisington.

This "inflationist view of the world," which he outlines in his firm's recent quarterly review and outlook, stems from Milton Friedman's observation that "inflation is always and everywhere a monetary phenomenon." Hoisington goes on to say that "the Fed has expanded the money supply dramatically, and since inflation is too much money chasing too few goods," people think inflation is inevitable. But he thinks they're wrong.

It's important to remember that they are a largely a fixed-income investment management company so, to some extent, they are talking their book, a book that happens to have done quite well in recent years.

Nonetheless, it is somewhat tiring to hear the same comparisons to the 1930s era when, as noted here on many occasions in the past, just about everything is different than it was 75 years ago, most importantly, the money itself.

Second in change only to the nature of the money are two other important factors - emerging economies around the world and the finite nature of natural resources, all of which set the stage for a commodity driven surge in inflation, sometime down the road.

But, there's where the disagreement between inflationists and Mr. Hoisington lie.

For starters, Hoisington believes the economy will continue to be weak for years. And with unemployment at such high levels, companies won't be raising wages, and consumers won't be increasing their spending. That means demand for commodities and other goods will be muted, so there will be no upward pressure on prices. Overall, he sees the economy being no bigger in 2012 than it is today.

Even if inflation and interest rates were to rise in this recession or the beginning of a recovery, the economy would quickly stall. "With unemployment widespread, wages would seriously lag inflation," he writes. "Thus, real household income would decline and truncate any potential gain in consumer spending."

What about all the money the government is pumping into the system? That's not by itself inflationary, he says, pointing to the work of economist Irving Fisher (who died in 1947).

Fisher believed that gross domestic product is equal to money times its turnover, or velocity, which is basically, the speed with which people spend it. In the last two quarters, money supply has grown at 14% but velocity has declined by about 17%, so nominal (non inflation-adjusted) GDP fell 4.5%.

One reason velocity is down, according to Hoisington, is that people would rather repay debt than go out and buy a lot of new stuff. He points again to Fisher, who wrote in a 1933 article "The Debt-Deflation Theory of Great Depressions" that excessive debt controls all, or nearly all, other economic variables.

Hoisington sees this today. "People are more interested in trying to get out of debt than increasing it, which means the economy cannot grow," he says. "If there's no increase in demand, there can be no increase in prices."

This is a very U.S.-centric view of the world that will soon be put to the test. Personal debt is virtually unheard of in much of the rest of the world, a point that shouldn't be ignored.

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A dollar based on "perception"

I don't know who this guy is, but he makes a number of very good points, the most important of which is that many comparisons to the conditions present during the Great Depression (e.g., deflation) are inherently flawed since the U.S. Dollar is fundamentally different today than it was back in the 1930s - backed by gold then, today backed only by perception.

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Krugman: Fear of inflation baseless

Nobel laureate and New York Times columnist Paul Krugman laments all the wasted energy spent worrying over a potential rise in consumer prices somewhere down the road.

It’s important to realize that there’s no hint of inflationary pressures in the economy right now. Consumer prices are lower now than they were a year ago, and wage increases have stalled in the face of high unemployment. Deflation, not inflation, is the clear and present danger.

So if prices aren’t rising, why the inflation worries? Some claim that the Federal Reserve is printing lots of money, which must be inflationary, while others claim that budget deficits will eventually force the U.S. government to inflate away its debt.

The first story is just wrong. The second could be right, but isn’t.

Here's where it gets kind of interesting.

It is as if, after the worst economic contraction since the Great Depression, once banks get the "all clear" from who knows where that the system has righted itself and it's back to business as usual, all those excess reserves will just vanish.

Now, it’s true that the Fed has taken unprecedented actions lately. More specifically, it has been buying lots of debt both from the government and from the private sector, and paying for these purchases by crediting banks with extra reserves. And in ordinary times, this would be highly inflationary: banks, flush with reserves, would increase loans, which would drive up demand, which would push up prices.

But these aren’t ordinary times. Banks aren’t lending out their extra reserves. They’re just sitting on them — in effect, they’re sending the money right back to the Fed. So the Fed isn’t really printing money after all.

Still, don’t such actions have to be inflationary sooner or later?

Apparently not.

And don't worry too much about the large and growing U.S. debt and the potential for foreign creditors to eventually tire of being our sugar daddy.

It's all gonna be OK. In fact, "the only thing we have to fear is inflation fear itself".

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Britain sinks into deflation abyss

The British have succumbed to the scourge of deflation and about all the rest of the world can do now is bid them a fond farewell - they've entered the abyss, as reported by the Telegraph.

Britain sinks into deepest deflation since 1948
The British economy sank deeper into deflation last month to the lowest level in more than 60 years as the effect of falling house prices and lower mortgage repayments escalated.

Inflation on the Retail Prices Index (RPI) measure, which includes housing costs, dropped sharply to -1.2pc in the year to April, from -0.4pc in March, the Office for National Statistics (ONS) said on Tuesday.

It was the lowest RPI figure since records began in 1948, and weaker than economists had expected.

The number of times that economists have been taken by surprise over the last few years has been increasing at such an astonishing rate that, sometimes, you have to stop and wonder why we even keep them around.

Maybe we'd be better off with no forecasts and no expectations for the future at all.

More importantly, you have to wonder why their counsel continues to be sought in order to remedy the ills that took them by such great surprise.

Anyway, on the subject of de-flation, the British method of measuring the changes to consumer prices appears to be even more dysfunctional than the one used in the U.S. as central bank lending rates have a direct impact on their broadest measure of inflation which happens to include interest paid via mortgage payments.

So, all other things being equal, if interest rates are slashed, inflation goes down, whereas, if the bank hikes lending rates, inflation goes up.

The main driver of the fall was lower mortgage interest payments following the Bank of England's decision to cut interest rates by half a percentage point to 0.5pc in March, the ONS said.
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Although in the short term falling prices will appeal to consumers, RPI is used to calculate wage increases so the sharp fall in April is likely to add to downward pressure on salaries already caused by higher unemployment and falling corporate profits.
"As a result, many workers are likely to get wage freezes or even pay cuts," said Howard Archer, chief UK economist at IHS Global Insight.

Deflation poses a further threat to the economy if people expect prices to fall further and put purchasing plans on hold which can, if the trend persists, lead to lower output and even more job losses.

There's the real evil of inflation - right there in that last paragraph...

If people see negative numbers showing up in the government's measure of inflation, they'll stop obsessing about the ongoing financial market meltdown and how it must ultimately lead to the end of life as we've known it and promptly cut back on their already sharply curtailed spending plans in hopes of getting a better deal sometime in the months ahead.

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It's Deflation Week!

Oh dear! I hope we can make it through the week without the entire global economy slipping over the deflation precipice into the deep, dark abyss from which there is no escape.

The Wall Street Journal reports($) that the scourge of deflation will be sweeping the globe in the days ahead - China today, then on to Europe, and finally it'll wash up on the shores of the good 'ol US of A on Friday when the Labor Department reports April consumer prices.

Falling energy and food prices have pushed down global inflation, and that will continue. Barclays Capital economists expect the U.S., U.K., euro-zone and Japan to rack up negative year-over-year CPI readings through at least September.

That will stoke worries about a global wave of deflation, an unstoppable price decline that causes consumers and investors to park cash on the sidelines, crippling economic growth.

The consequences of deflation are so severe that central banks around the world have aggressively cut interest rates to combat it. Many, including the Federal Reserve, are engaged in "quantitative easing," essentially printing money to pump into the system and keep prices from falling.

Gather the women and children and plan for the worst, hope for the best.

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Wither the I-bond?

There is something to be said for the wisdom of Will Rogers wherein the return of his money was more important than the return on his money. But, interest rates are now reaching ridiculously low levels, particularly the "inflation protected" government I-bonds, now that short-term inflation has turned decidedly negative. This WSJ report has the details.

Friday, the Treasury Department said these inflation-linked bonds that are purchased between May and October will earn 0% for their first six months, the first time rates have hit 0% since the bonds were issued in 1998. The announcement also affects current I-bond owners, whose interest rate drops to 0% the next time their rates reset.
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Rates on I bonds, whose maturities are all 30 years, have two parts: a fixed rate, now set by the Treasury at 0.10% for new issues and which lasts for the bond's life, and the inflation adjustment, which reflects the change in the Consumer Price Index over a six-month period. Since that inflation adjustment worked out to a negative 5.56% annualized rate for the September-to-March period, the fixed-rate portion of every I bond will be wiped out during its next six-month rate period.

The good news? Rates can't go below zero.

So, even if you are a retiree whose medical expenses continue to skyrocket, whose food bill continues to rise, and whose heating bills have yet to decline, at least you won't have any less money than you started with when you cash in your bonds.

ooo

This week's cartoon from The Economist:

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Have you seen M3 lately?

Not having looked at the M3 statistics in quite a while, the broadest measure of the nation's money supply that was discontinued by the government but which has been reconstructed over at NowAndFutures, it's not surprising to see that the growth rate is down sharply.
What is surprising is that, for all the talk of deflation these days, M3 has increased by about a trillion dollars since last fall when we entered the current phase of the financial crisis.

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The U.K. is now "deflation nation"

More confusing news from the financial media for a bewildered and weary public - explaining how falling prices are a bad thing...

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Deflation scourge sweeps Europe

Spain, the U.K., Luxembourg, Portugal, Ireland - who's next to succumb to the scourge of deflation? Yesterday, the New York Times reported that Spanish merchants have been slashing prices with abandon, auguring in the possibility of a dreaded "deflation death spiral".

Prices dipped everywhere, from restaurants and fashion retailers to pharmacies and supermarkets in March.
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With the combination of rising unemployment and falling prices, economists fear Spain may be in the early grip of deflation, a hallmark of both the Great Depression and Japan’s lost decade of the 1990s, and a major concern since the financial crisis went global last year.

Deflation can result in a downward spiral that can be difficult to reverse. As unemployment rises sharply and consumers cut spending, companies cut prices. But if sales do not pick up, then revenue can decline further, forcing more cuts in workers or wages.

Once again, falling prices are characterized as the potential source of much bigger problems ahead, as if the world had something even remotely close to "sound money" where currency maintained its value over long periods of time as it did in the U.S. prior to the creation of the Federal Reserve in 1913.

To review -- in the hundred years prior to the Fed, inflation rounded to zero, whereas, in the nearly hundred years since 1913, the U.S. dollar has lost 96 percent of its value.

Policies that have resulted in this loss of value, now accepted as conventional wisdom by central bankers around the world, make real deflation (the minus 10 to 15 percent per year variety, not the -0.1 percent Spanish version) a near impossibility today.

But, that doesn't stop dimwitted dismal scientists from looking there instead of at the bursting of the biggest asset bubble in the history of Mankind when identifying villains in the current economic and financial market maelstrom.

“It doesn’t mean it will spread here to the U.S., but we need to look closely at Spain and other places to understand the dynamic,” says Simon Johnson, a professor at the Sloan School of Management at the Massachusetts Institute of Technology and a former chief economist for the International Monetary Fund. “It’s like the front line of a new virus outbreak.”

If only economists would spend more time examining how they failed the world so miserably over the last few years instead of at a 19th century phenomenon, we'd all be better off.

In the U.K. too there is much gnashing of teeth where annual deflation is running at a whopping four times the rate now experienced to the south - minus 0.4 percent.

The funniest thing about English deflation is that it is, in large part, directly caused by central bank actions. The broadest measure of consumer prices includes mortgage costs, the vast majority of which are variable rate loans, and, as short-term rates have been slashed, these consumer costs have tumbled as detailed in this report in the Telegraph.

The Retail Prices Index (RPI) measure of inflation fell to -0.4pc in March, indicating that prices paid by consumers last month were lower than a year ago - a trend not seen since March 1960.

RPI inflation, which includes housing and mortgage costs, has been driven down by the the series of aggressive interest rate cuts from the Bank of England which have triggered lower variable rate mortgage repayments .
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The economy is expected to remain in deflationary territory for many months, which will mean pensioners will receive the lowest possible increase of 2.5pc next year, adding just £2.40 to the full weekly pension, an amount criticised as "derisory and pathetic" by campaigners.

If health care costs in the U.K. are anything like those in the U.S., there are probably a lot of irate senior citizens.

A related story explains why we should all be fearful about deflation beginning with the moronic example of how, after television prices have been falling for the last 20 years, additional price declines will cause consumers to think twice. Really!?

1. It causes consumers and businesses to feel concerned about spending. Why buy that £400 television this week when you are confident it will be cut in price to £350 next month? The same applies to businesses – why invest in new machinery, or software when you think it will fall in price? Deflation can, if it becomes entrenched, cause the whole economy to grind to a halt.

2. Deflation causes wage cuts. Employers can argue that they do not need to give their staff a pay rise, because their staff can buy more goods with the same salary. Many companies are freezing pay and started cutting wages in some cases.

3. In theory, falling wages should not matter if the price of goods and services fall as well. But in practice it is very damaging psychologically. People paid £30,000 one year do not like being paid £29,000 the following year even if they can buy the same amount of goods. Everyone feels less wealthy, especially home owners whose main asset is falling in price. And when they feel less wealthy, they spend less, causing a vicious downward spiral in the economy.

4. Deflation causes the value of people's debts to mount. A £100,000 mortgage might cost £4,000 to service each year, but the value of the house could fall by £4,000 or more – a dispiriting experience, but you will still need to keep on servicing the debt.

Wage cuts, tumbling asset prices, and making debt service more expensive are all legitimate arguments but falling consumer prices really don't belong in this discussion unless it's something more than volatile energy prices and, in the case of the U.K.-style deflation, lower interest rates caused by the central banks that, ironically, are desperately trying to avoid seeing consumer prices move lower.

For a more complete discussion on this subject, see Seven key points on deflation or the many other items categorized under "deflation" at this blog.

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More on the Fed's purchase of Treasuries

Caroline Baum at Bloomberg notes yet one more set of unintended possible consequence as a result of the Federal Reserve's plan to buy $300 billion in long-dated U.S. debt.

If Fed chief Ben Bernanke is successful in his commitment to preventing deflation at any cost, buying 10-year Treasuries at 2.5 percent will turn out to be a losing proposition for investors.

Why? Real 10-year yields, as reflected in inflation-indexed Treasuries (TIPS), are currently at 1.38 percent. That’s below the historical average of 1.8 percent since the creation of the Federal Reserve in 1913, according to Jim Bianco, president of Bianco Research in Chicago. (Can you guess whether real rates were higher or lower before the U.S. had a central bank?)

Take out the World War II period, when the Fed pegged long- term rates to help the Treasury’s war effort, and the average is probably closer to 2 percent to 2.5 percent, according to Bill Poole, former President of the St. Louis Fed and now a Bloomberg News contributor.

Based on my admittedly unsophisticated math -- subtracting 10-year TIPS yields from 10-year nominal Treasury yields -- expected inflation is 1.24 percent over the next 10 years. (Second quiz question: What are the chances of inflation being that tame with the Fed pulling out all the stops?)

In other words, “there’s no real return on 10-year notes at this level,” Poole says.

As noted previously here and here, these purchases are opening up a whole new can of worms when it comes to whatever meaning the bond market provides regarding inflation.

The central bank really ought to just come out and say, "So as not to affect the 'inflation expectations' implied by treasury market prices, the Fed will always by equal amounts of Treasuries and TIPS".

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Deflation is coming! Deflation is coming!

Well, "Deflation Week" has arrived and the British are the first to sound the alarm after the government reported that year-over-year inflation fell to just 0.1 percent in January, the lowest level since 1960.

In the U.S., the latest consumer price data will be reported on Friday and we may be in for a veritable "Deflation Tsunami" from the mainstream media since we were teetering on the brink of a negative consumer price index last month.

Naturally, something must be done about it.

But, what?

Run the printing presses of course!

More money must be created promptly because the money currently in circulation is actually beginning to increase in value.

It must be right?

Prices are now falling, so that must mean that money is becoming more valuable than it was before, and if there's one thing governments don't want it's money that is gaining purchasing power...

Sometimes, it just makes you cry to think of what a mess contemporary economists have made of things and it doesn't look like they're going to stop now.

This report from the Telegraph has all the details - there will surely be similar stories state-side at the end of the week:

Politicians and analysts have warned that Britain is on the verge of deflation after economic data released this morning showed that living costs are rising at their lowest rate in almost 50 years.
...
Liberal Democrat Treasury spokesman Vince Cable said inflation was now "virtually disappearing" as a threat to families, although this might not be obvious to those facing higher council tax bills.

"It is becoming clear that for the foreseeable future there is a higher risk of deflation than inflation, which is why it is inevitable and sensible that the Bank of England should be moving towards expansion of credit and the money supply directly," said Cable.
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Economists expect CPI to drop sharply in coming months amid sliding commodity prices and a slowing economy, piling pressure on the Bank of England to take further action to stimulate the economy.

The Bank has slashed interest rates to a record low of 1% and is now considering more drastic measures to get consumers and businesses spending again.

Bank governor Mervyn King said last week the monetary policy committee would discuss "quantitative easing" – boosting the flow of money in the economy – when it meets to decide on interest rates next month.

If you're going to live in the U.K., it would probably be best not to grow old there.

It seems it's the worst of all worlds for "pensioners" as meager interest on their savings is countered by inflation that still runs at about five percent - for them.

Despite falling prices in the government's inflation data, the cost of living for retirees is still rising rapidly due to higher prices for such items as food and electricity.

This is just a horrible thing to do to the "Greatest Generation" in Britain.

ooo

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