Rage Against The Machine

A pair of letters in today's Wall Street Journal question the validity of CPI and the Fed's wisdom only focusing on core inflation. One respondent states that higher food and energy prices are not a tax on growth and are being passed through to consumers. Let's discuss.

First, companies truly do not have much pricing power. Outside of fairly inelastic sectors of the economy, what prices have risen? Do televisions cost more? How about computers? Clothing? Nope, most prices are only modestly higher. Raise your prices and 100 producers are waiting in line to take your place.

What about the disconnect between PPI and CPI. PPI was 7.4% (YoY) as per the last report, but CPI was 4.3% (YoY). Sure doesn't look like producers can pass inflation through to me. Think there is a conspiracy in the numbers? If so, you should ask the people in the black helicopters buzzing your home.

Think that higher fuel and energy prices don't act as taxes on growth? If you are a family of four making about $75,000 total and your food an fuel bill is rising through the roof, where is the money coming from to feed your family and drive to work? It is coming from discretionary spending.

Think the Fed ignores headline inflation? Not at all, bit it knows that at best, food and energy prices sap funds from discretionary spending and, at worst, the Fed has no effect on food and energy prices. Dallas Fed President Fisher said as much today.

The truth is that the Fed could raise the Fed Funds rate to 10.00% and wit would have little effect on food and energy prices. People will eat, heat their homes and fuel their vehicles to get to work at the expense of discretionary spending.

All these are truths. However, although the Fed has trouble halting inflation, it can easily cause inflation. By lowering rates, it makes U.S. denominated securities less attractive and causes the dollar to weaken. If the dollar is worth less versus foreign currencies, foreign-made goods can cost more (China has enough margin to keep prices in check, but China is not the largest U.S. trading partner). Conversely, U.S. made goods cost less overseas.

The Fed IS helping to fuel inflation. It may even be contributing to higher oil prices. Why doesn't Mr. Bernanke take a page out of Paul Volcker's book? Because the banking system is in deep trouble and Mr. Bernanke knows it. Just wait until banks and brokers report earnings this month and next.