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Money Printer Go Brrr … And No Inflation?

Money Printer Go Brrr … And No Inflation?

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4 years ago

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Although a big fiscal package is in the pipeline (admittedly the Greatest Deliberative Body in the World is playing its usual log-rolling games), smashed supply, and rampant "money printing" (ha!), breakeven inflation in the United States is cratering (figure above). This is exactly what should have happened, although the big question is whether current pricing is an overshoot of fundamentals. (I leave that market call to the reader.) I outline why this puzzling inflation perspective is the correct call -- top down inflation analysis will not work, we need to go bottom up.

Market Comments

Before I get to the inflation analysis, I want to comment on the market action behind the charts above. To be perfectly clear, I am making comments based on media chatter, and extrapolating the experience of 2008. I have no background sources giving me juicy information.

The first thing to note that the indexed yield (typically called the "real yield", but I have pedantic objections to using "real yield" for the quoted yield on inflation-linked bonds) has been jumping around far more than the breakeven inflation rate. This is exactly what we should expect: the breakeven inflation rate is the true valuation metric, and the real yield is the residual. (This is discussed in Section 4.2 of my book, Breakeven Inflation Analysis (link to Books2Read page). If any of my readers are stuck in self-isolation, I would remind you that my books are attractively priced, and available as e-books.

This is not to say that breakeven inflations will exactly match forecast inflation right now. This is exactly what happened in 2008 (as I discussed in Section 3.5). Inflation-linked bonds are de facto risk assets that can be purchased by many government bond funds. Overweighting linkers is a classic way for bond investors who are bearish on rates to position without blowing up other risk limits, and one of the adorable things about bond fund managers is that the vast majority of them are permanently bearish on rates. Meanwhile, levered long positions in inflation-linked bonds was a core strategy for "risk-parity" portfolios.

Another comment I have seen was to the effect that "breakevens have nothing to do with inflation, it is just oil." This is a puzzling sentiment, given the high sensitivity of headline inflation to gasoline prices in the United States. (I discuss this in Section 3.2, "The Role of Energy Prices".) I think the idea is that people want the market to price core inflation, but that would require a different investment product.

Short-Term Inflation Forecasting

I will now turn to the issue of inflation forecasting. The key is to eschew top-down techniques (e.g., any approach where the money supply appears), and go bottom up. This is discussed at greater length in Section 3.3 of Breakeven Inflation Analysis.

The first thing I noted is that I am skeptical about our ability to forecast the overall economy on an unconditional basis using any mathematical model. (Yes, that includes stock-flow consistent (SFC) models, which are the subject of another book that I am plugging.) The best we can hope for is to do conditional forecasts: given some scenario, what will happen to the economy? The current situation is a very good example: we could only have forecast the upcoming collapse in activity if we had a very good idea about the spread of COVID-19. Although a mathematical epidemic model might give insights, that model is not a traditional economic model.*

However, I carved out an exception for "short-term" CPI forecasting. We can quite often build a pretty good forecast for CPI inflation, conditional on gasoline prices. The various components of CPI are relatively slow-moving, and respond with a lag to underlying factors. We can stitch together partial models, and get a good estimate of the overall CPI. Obviously, these partial models break down over longer forecast horizons.

Why I'm Not Worried About Inflation

Although I am wildly uncertain about outcomes, I do not see CPI inflation as being a particular issue right now. The main reason is that in order to get an inflationary spiral, we need wages to rise. Although there are some pockets where workers are getting wage boosts (as well they should, as they are the front line workers taking the greatest risk), this will not happen across the board with expected double digit unemployment rates.

Anyone who looks at central bank balance sheets ("the money supply") is simply going to get wildly wrong inflation forecasts. These are just shifts in holdings of financial assets, and mean diddly-squat about the real economy. The only significance they have is relative to the counter-factual scenario where the central bank lets the financial system implode in a debt death spiral. Inflation is higher relative to that counter-factual, but it does not mean that prices are going to go up.

As for the fiscal response, some will just be used to fill in cash flow gaps of firms (and line rich people's pockets). This does not put demand pressure on anything (other than relative to the total implosion counter-factual). The rest is income replacement households, and I see no appetite for this to be a permanent universal basic income in any jurisdiction.

A temporary income replacement is just preventing the deflationary liquidation of the household sector. Once again, this is only "inflationary" relative to a disastrous counter-factual. (Right now, I would argue that the Canadian and American responses are too small, but that might be rectified as reality bites politicians in the nether regions.)

Even if money is sent to households that do not really need it, they cannot spend it on much of anything. Everything except grocery stores and pharmacies are closed, and physical delivery infrastructure is going to be maxed out. There is no sign of price gouging by physical retailers. Everybody with a couple brain cells to rub together knows that this is a shared event, and will be seared into everyone's memories for a very long time. Running around acting like a sociopath -- a course taken by a few idiot employers -- is going to be remembered by a lot of people after the dust settles.

As I will discuss later, some prices will be going up, but they are unlikely to be enough to move the CPI by a lot.

The easiest thing to buy are electronic downloads (like my books!). Since the marginal cost of production is nil, the usual strategy is to keep pricing fixed, and hope for a volume increase.

Supply Chain Horror Stories

The big potential scare story is the collapse in supply chains, and rising import costs. I have some sympathies for that story, but it is somewhat self-limiting. Right now, on-shoring production is catching a lot of interest. Overseas suppliers starting a price-gouging campaign would put populist protectionism movements on steroids.

CPI Weighting

I will now run through the sectors of the United States CPI. I will not attempt to give forecasts, but give a qualitative outline of my thinking. Although there are a few areas where price behaviour are different, it would be a similar story in at least some other developed countries (Canada and the United Kingdom at least).

I am using the weights from the February 2020 U.S. CPI report: https://www.bls.gov/news.release/archives/cpi_03112020.htm. I will keep the categories in the original order, which may make the discussion somewhat jumpy, and round off to one decimal place. I have skipped some smaller categories.

  • Food (13.8%). This one of the few categories where we will actually have legitimate retail prices, given the shutdown of other sectors. However, note that "Food" is not just groceries: it is split between food at home (7.6%), and away from home (6.2%). Restaurants will be struggling to survive, and so it is hard to imagine them ramming through price increases. As for food at groceries, a significant portion is processed, and thus prices are administered. Supply bottlenecks will almost certainly appear in fruit and vegetables that rely on masses of workers for harvest, but that categories is only 1.3% of the CPI. Grains require low levels of labour input, and energy costs are extremely important (fuel and fertiliser).
  • Energy (6.7%). Retail prices will not fall as much as wholesale crude prices, but the collapse in crude prices will blow a big hole in CPI. Outside the U.S., the larger share of gasoline taxes will reduce the deflationary shock in the CPI.
  • Household Furnishings and Supplies (3.7%). People stuck at home might see more things to spend on, but hardly a high priority given income uncertainty most households face.
  • Apparel (2.8%). People under stay-at-home orders are probably not worried about fashion trends. Office workers working from home just need a good shirt to give a veneer of presentability.
  • New Vehicles (3.7%): Automakers are desperate to survive. Nobody can go anywhere.
  • Used Vehicles (2.5%): Hawking a second car is probably going to be a standard way to raise cash.
  • Medical Care Commodities (1.6%): (Note: "commodities" = goods in CPI jargon.) There are some obvious shortages, but once again, most firms do not want to be seen as high profile sociopaths. The exception are pharmaceutical firms, but their prices are normally hidden behind the veil of insurance.
  • Recreation Commodities (2.0%). Probably some demand here, at least for delivered items.
  • Education Commodities (0.5%). Probably increased interest, but prices are administered.
  • Alcoholic beverages (1.0%). Low energy prices will reduce price pressure on grain inputs and processing, and bars and sporting venues will be shut for a long time, blowing a hole in demand.
  • Tobacco and smoking products (0.6%). Let's smoke in the midst of a killer pandemic that goes after weak lungs in a grisly fashion!
  • Shelter (33.1%). A category with a huge weight and extremely slow-moving price dynamics. Split between rent (7.8%) and owner's equivalent rent (24.0%). Rent contracts are negotiated on an annual basis. and we have a massive income shock to renters. Very hard to see how rents go up. In any event, will be extremely slow-moving, so even if rents somehow went up, won't show up for awhile.
  • Medical Care Services (7.2%). I leave researching what will happen here to the reader. I think this is largely mediated by insurance, and I would not hazard a guess as to what the numbers will be.
  • Transportation Services (5.4%). Travel is not exactly a hot spot for price pressures.
  • Recreation Services (3.7%). Largely digital, and follow the "keep prices stable, go for volume" strategy.
  • Education and Communications (6.4%). What happens with education is anybody's guess, but it is hard to see how hefty fees can be charged for remote education services. Communication services are a huge growth area right now, but once again, they are likely to aim for increased volume at unchanged prices.
  • Other personal services (1.7%). Largely the domain of small businesses, that are under severe pressure.

In summary, although we can see some problem areas, without wage pressures hitting across the board, hard to sound an alarm about inflation.

Footnote:

* There are various heterodox academics that insist that economics ought to be multi-disciplinary, and include things like epidemic models. Although I can agree with the sentiment, it is very difficult to see how such models can be calibrated to data. Why not include asteroid strike scenarios? Killer bees? Etc.
(c) Brian Romanchuk 2020

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One city held a mass passport-getting event

A New Orleans congressman organized a way for people to apply for their passports en masse.

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6 hours ago

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March 15, 2024

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While the number of Americans who do not have a passport has dropped steadily from more than 80% in 1990 to just over 50% now, a lack of knowledge around passport requirements still keeps a significant portion of the population away from international travel.

Over the four years that passed since the start of covid-19, passport offices have also been dealing with significant backlog due to the high numbers of people who were looking to get a passport post-pandemic. 

Related: Here is why it is (still) taking forever to get a passport

To deal with these concurrent issues, the U.S. State Department recently held a mass passport-getting event in the city of New Orleans. Called the "Passport Acceptance Event," the gathering was held at a local auditorium and invited residents of Louisiana’s 2nd Congressional District to complete a passport application on-site with the help of staff and government workers.

A passport case shows the seal featured on American passports.

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'Come apply for your passport, no appointment is required'

"Hey #LA02," Rep. Troy A. Carter Sr. (D-LA), whose office co-hosted the event alongside the city of New Orleans, wrote to his followers on Instagram  (META) . "My office is providing passport services at our #PassportAcceptance event. Come apply for your passport, no appointment is required."

More Travel:

The event was held on March 14 from 10 a.m. to 1 p.m. While it was designed for those who are already eligible for U.S. citizenship rather than as a way to help non-citizens with immigration questions, it helped those completing the application for the first time fill out forms and make sure they have the photographs and identity documents they need. The passport offices in New Orleans where one would normally have to bring already-completed forms have also been dealing with lines and would require one to book spots weeks in advance.

These are the countries with the highest-ranking passports in 2024

According to Carter Sr.'s communications team, those who submitted their passport application at the event also received expedited processing of two to three weeks (according to the State Department's website, times for regular processing are currently six to eight weeks).

While Carter Sr.'s office has not released the numbers of people who applied for a passport on March 14, photos from the event show that many took advantage of the opportunity to apply for a passport in a group setting and get expedited processing.

Every couple of months, a new ranking agency puts together a list of the most and least powerful passports in the world based on factors such as visa-free travel and opportunities for cross-border business.

In January, global citizenship and financial advisory firm Arton Capital identified United Arab Emirates as having the most powerful passport in 2024. While the United States topped the list of one such ranking in 2014, worsening relations with a number of countries as well as stricter immigration rules even as other countries have taken strides to create opportunities for investors and digital nomads caused the American passport to slip in recent years.

A UAE passport grants holders visa-free or visa-on-arrival access to 180 of the world’s 198 countries (this calculation includes disputed territories such as Kosovo and Western Sahara) while Americans currently have the same access to 151 countries.

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Fast-food chain closes restaurants after Chapter 11 bankruptcy

Several major fast-food chains recently have struggled to keep restaurants open.

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9 hours ago

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March 15, 2024

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Competition in the fast-food space has been brutal as operators deal with inflation, consumers who are worried about the economy and their jobs and, in recent months, the falling cost of eating at home. 

Add in that many fast-food chains took on more debt during the covid pandemic and that labor costs are rising, and you have a perfect storm of problems. 

It's a situation where Restaurant Brands International (QSR) has suffered as much as any company.  

Related: Wendy's menu drops a fan favorite item, adds something new

Three major Burger King franchise operators filed for bankruptcy in 2023, and the chain saw hundreds of stores close. It also saw multiple Popeyes franchisees move into bankruptcy, with dozens of locations closing.

RBI also stepped in and purchased one of its key franchisees.

"Carrols is the largest Burger King franchisee in the United States today, operating 1,022 Burger King restaurants in 23 states that generated approximately $1.8 billion of system sales during the 12 months ended Sept. 30, 2023," RBI said in a news release. Carrols also owns and operates 60 Popeyes restaurants in six states." 

The multichain company made the move after two of its large franchisees, Premier Kings and Meridian, saw multiple locations not purchased when they reached auction after Chapter 11 bankruptcy filings. In that case, RBI bought select locations but allowed others to close.

Burger King lost hundreds of restaurants in 2023.

Image source: Chen Jianli/Xinhua via Getty

Another fast-food chain faces bankruptcy problems

Bojangles may not be as big a name as Burger King or Popeye's, but it's a popular chain with more than 800 restaurants in eight states.

"Bojangles is a Carolina-born restaurant chain specializing in craveable Southern chicken, biscuits and tea made fresh daily from real recipes, and with a friendly smile," the chain says on its website. "Founded in 1977 as a single location in Charlotte, our beloved brand continues to grow nationwide."

Like RBI, Bojangles uses a franchise model, which makes it dependent on the financial health of its operators. The company ultimately saw all its Maryland locations close due to the financial situation of one of its franchisees.

Unlike. RBI, Bojangles is not public — it was taken private by Durational Capital Management LP and Jordan Co. in 2018 — which means the company does not disclose its financial information to the public. 

That makes it hard to know whether overall softness for the brand contributed to the chain seeing its five Maryland locations after a Chapter 11 bankruptcy filing.

Bojangles has a messy bankruptcy situation

Even though the locations still appear on the Bojangles website, they have been shuttered since late 2023. The locations were operated by Salim Kakakhail and Yavir Akbar Durranni. The partners operated under a variety of LLCs, including ABS Network, according to local news channel WUSA9. 

The station reported that the owners face a state investigation over complaints of wage theft and fraudulent W2s. In November Durranni and ABS Network filed for bankruptcy in New Jersey, WUSA9 reported.

"Not only do former employees say these men owe them money, WUSA9 learned the former owners owe the state, too, and have over $69,000 in back property taxes."

Former employees also say that the restaurant would regularly purchase fried chicken from Popeyes and Safeway when it ran out in their stores, the station reported. 

Bojangles sent the station a comment on the situation.

"The franchisee is no longer in the Bojangles system," the company said. "However, it is important to note in your coverage that franchisees are independent business owners who are licensed to operate a brand but have autonomy over many aspects of their business, including hiring employees and payroll responsibilities."

Kakakhail and Durranni did not respond to multiple requests for comment from WUSA9.

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Industrial Production Increased 0.1% in February

From the Fed: Industrial Production and Capacity Utilization
Industrial production edged up 0.1 percent in February after declining 0.5 percent in January. In February, the output of manufacturing rose 0.8 percent and the index for mining climbed 2.2 p…

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9 hours ago

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March 15, 2024

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From the Fed: Industrial Production and Capacity Utilization
Industrial production edged up 0.1 percent in February after declining 0.5 percent in January. In February, the output of manufacturing rose 0.8 percent and the index for mining climbed 2.2 percent. Both gains partly reflected recoveries from weather-related declines in January. The index for utilities fell 7.5 percent in February because of warmer-than-typical temperatures. At 102.3 percent of its 2017 average, total industrial production in February was 0.2 percent below its year-earlier level. Capacity utilization for the industrial sector remained at 78.3 percent in February, a rate that is 1.3 percentage points below its long-run (1972–2023) average.
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Click on graph for larger image.

This graph shows Capacity Utilization. This series is up from the record low set in April 2020, and above the level in February 2020 (pre-pandemic).

Capacity utilization at 78.3% is 1.3% below the average from 1972 to 2022.  This was below consensus expectations.

Note: y-axis doesn't start at zero to better show the change.


Industrial Production The second graph shows industrial production since 1967.

Industrial production increased to 102.3. This is above the pre-pandemic level.

Industrial production was above consensus expectations.

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