	Generational Dynamics
	Forecasting America's Destiny ... and the World's

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Generational Dynamics Web Log for 02-Feb-05
Fed expected to raise interest rates today

Web Log - February, 2005

Fed expected to raise interest rates today

The Fed is saying that inflation "can be contained," but the danger is in the other direction.

On January 20, the Wall Street Journal headline said, CPI Rose at Fast Clip, Erasing Many Pay Gains.

The next day, Jeffrey Lacker, one of Alan Greenspan's colleagues at the Federal Reserve, said that inflation was still a danger, but that the Fed could contain it with continued interest rate increases.

Thus, it's all but a sure thing that the Fed will announce an increase in the overnight bank interest rate from 2.25% to 2.5%, and that these increases will continue in the months ahead.

A deflationary period

Consumer price index (CPI) from 1870 to present, with an exponential growth trend line. The CPI is 185 in 2003, and 2010 has a trend value of 129.

Consumer price index (CPI) from 1870 to present, with an exponential growth trend line. The CPI is 185 in 2003, and 2010 has a trend value of 129.

We've been saying for two years that we're in a long term deflationary period, and that prices will be falling by 30% in the next few years. This assessment is based on the adjoining graph of CPI from 1870 to the present, along with an exponential growth trend. What most people don't seem to understand is that almost all growth trend values must maintain the long term trend; it's a law of nature, something like the law of gravity. Since the CPI is well above the trend line today, it has to start falling soon.

Now, we've been following the CPI (consumer price index - retail prices) and the PPI (producer price index - wholesale prices) in the web log for a long time. You can't always tell much from individual monthly figures, but the point is this: With interest rates close to zero for most of 2004, and with oil prices skyrocketing from to more than $50 a barrel for much of the year, inflation should be exploding. The fact that it hasn't been exploding is a sign that something's wrong, or at least that something strange is going on.

Here are the PPI and CPI values for 2004:


                        Changes from preceding month
                                    2004
                 Jan. Feb Mar. Apr. May June July Aug Sept  Oct Nov  Dec
---------------- ---- --- ---- ---- --- ---- ---- --- ---- ---- --- ----
PPI               .6   .1   .6   .7  .6  -.2    0   0   .1  1.7  .5  -.7
---------------- ---- --- ---- ---- --- ---- ---- --- ---- ---- --- ----
PPI "Core index"  .3  -.1   .3   .1  .2   .3  -.2  .3   .3   .3  .2   .1
---------------- ---- --- ---- ---- --- ---- ---- --- ---- ---- --- ----
---------------- ---- --- ---- ---- --- ---- ---- --- ---- ---- --- ----
CPI               .5   .3   .5   .2  .6   .3  -.1  .1   .2   .6  .2  -.1
---------------- ---- --- ---- ---- --- ---- ---- --- ---- ---- --- ----
CPI "Core index"  .2   .2   .4   .3  .2   .1   .1  .1   .3   .2  .2   .2
---------------- ---- --- ---- ---- --- ---- ---- --- ---- ---- --- ----

Notice how the values have been changing from month to month. Many months, including December, saw deflationary values. And notice that the "core index" values - which exclude volatile oil and food prices -- were much lower than the combined index.

What this means is that the spike in oil prices did indeed temporarily affect the CPI and PPI, but for all other products, the so-called "finished products" that people actually purchase, inflation was still extremely low.

Inefficient businesses

From the point of view of Generational Dynamics, this has been happening because America's organizations -- business, government, educational, and so forth -- have become increasingly bureaucratic and inefficient. When the 1930s Great Depression ocurred, almost all existing businesses went bankrupt, and the country started with almost a "clean slate," with all new businesses, where every employee had to perform and produce results.

Over the years, these businesses have become increasingly inefficient, often with whole departments and divisions producing products and services that could be done much more efficiently and cheaply using computer technology. Indeed, businesses in both China and India are doing that today.

So the products produced by America's inefficient businesses are overpriced, and that's why deflation must occur. (It's theoretically possible for the Fed to flood the economy with money and deflate the money supply so much that the dollar will become increasingly worthless, and thus increase prices, but that's not expected to happen.)

The stock market today is 100% overpriced, using standard price/earnings ratio measures, and the situation cannot continue for long. Public debt is astronomically high.

The Fed is raising interest rates in order to strengthen the dollar, in the hope of avoiding a panic collapse of the dollar on world markets. But in raising interest rates, it's becoming more difficult for people to borrow more money to make loan payments, it's more difficult for businesses to borrow money to stave off bankruptcy, and it's more difficult for investors to justify purchasing stocks, when they can buy short-term Treasury bonds at higher interest rates.

Since the end of WW II, the economy has always been "self-correcting," meaning that any serious economic problem solved itself through market forces. With public debt continuing to increase, it remains to be seen how long that can continue. (02-Feb-05) Permanent Link
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Generational Dynamics Web Log for 02-Feb-05 Fed expected to raise interest rates today

A deflationary period

Inefficient businesses

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Generational Dynamics Web Log for 02-Feb-05
Fed expected to raise interest rates today