USA INFLATION - Housing, energy, Food Prices

Inflation here in Japan is practically zero.  My favorite quart of 100% grapefruit juice still cost me only 100 yen (less than a buck) as it did 5 years ago.  As I prepare for the coming of the new year, I lament and reflect on how, how expensive things get ever year (in the USA) - food, housing, energy.   I find a number of things curious about this:

1. Inflations steals from people who have save cash all their lives or who are on a fixed income, yet most people do are not upset with or even concerned about it.
2. People irrationally think there is good inflation and bad inflation. 
   • Good inflation is the inflation that make your home go up in value
   • Bad inflation is the one where the things you want to buy (like the kid's college education) increase in price.
3. Amazingly enough, this perception of encouraged by the US government who does not include rises in the cost of single family housing in the "Consumer Price Index".
4. Financial commentator get all excited about small month to month changes in inflation, but none ever seem to give the historical context in which to evaluate the "news."  Perhaps, then it would not be news. 

Although I will not argue the point here, inflation in America is so embedded in the US financial system, I have concluded that inflation is necessary to make the system work.  America is addicted to low level inflation.  This paper will discuss "the history of inflation"

Anyway, the US government began "tracking and reporting prices" in it current form in 1921. From 1921 to year 12/1/2007 general price have risen 1005%.

• In the 20s, consumer prices decreased a total of 10%
• In the 30s, consumer prices decreased a total of 19% in the full decades that followed, prices increased 69%, 25%, 29%, 106%, 64%, 32% respectively
• From 2000 to year end 12/1/2007, consumer prices have increased 24%

One thing I find interesting about the data set is that during the two decade leading to WWII, the USA was stuck in a deflationary spiral with - consumer prices deceased a a total 27%.   This was not just a USA problem, but one shared with most all of the victorious WWI allied power except for Japan.   The Marist of the era had an explanation, and the capitalist feared perhaps that this was true.  ...(discussion omitted)...

There are all kinds of reasons for why and how this has been happening. ......(discussion - best for a different time and place)........... Inflation is not only systemic, Inflation is now politically acceptable and appears to be the "preferred" alternative" of policy maker's in the USA's "managed capitalistic economic democracy"

Of course, not all price for all products change at the same time.   Components:

• Food - rose 1074% over 86 year from 1921 to 2007 while general prices have price grew only 1005%

• Energy - was not tracked separately in 1921 but since 1957.  Prices actually declined compared to general prices for more than a decade thereafter but .....  

• Amazingly enough "Housing cost" included in CPI are not "housing prices"  but a number more approximating the cost of renting.  For my inflation studies, I include the Housing Price Index, an index that tracks the rise in the price of single family houses.  This data is not CPI data and tracked by a different US government office since 1975.  

Housing

1. Low Interest Rate.  .In 2007, the $1,500 bank loan payment a consumer might have available for a house payment buys 2.5 times it did in the early 80s when mortgage rate were in the mid teens.   Using aggregate national statistic, a different analysis shows that two factors - inflation and interest rates explains 90% of the move in housing prices over multi-year period of time.  Interest rates "work both ways.  When interest rates rise, the analysis shows, housing prices lag inflation. 
2. Leverage Factors.  Years ago they put 20% down, could only 28% of their income.  Changes in lending practice allow borrowers to be more leverage and have less at stake then in previous cycles.
3. Availability of Financing Factor.  Innovation in mortgage banking has resulted in the significant increase in the availably of home financing.  The current subprime mortgage debacle exposes how "low" underwriting standards have fallen. 
4. Availability of low cost (free) 3rd party valuations.  Supports the increase availability of home financing. 
5. Restricted Supply.  America likes to think that "free enterprise mavens" but the housing markets are not free enterprise.  They are a private public "partnership" where local jurisdiction resist supply and grant landowner "entitlements" to develop land after following certain development standards.  .  Supply is directly restricted through "zoning regulation" and indirectly restricted by costly new building safely standard that only apply to new residential construction or commercial remodels. 
6. My complete list of factors that that contribute to the recent housing boom number more than 20.  I firmly believe that it is very difficult to predict the future if one has a limited understanding of the present or past.  Enough for now.

Energy

The indices use in the chart involved a combination of numerous energy sources and use.  The following is a simple overview of some of the factors that contribute to the recent unprecedented rise in energy prices. 

1. Supply of Crude Oil.  Regardless of whether "peak oil" theorist are correct, most of the oil consumed in the USA in imported and thus at the whim of powerful cartels whose interest it is to control supply.  It is interesting to know that Russia, even when they were communist were never part of this supply cartel. 
2. Tightness in Distribution of Motor Fuels.  Not necessarily obvious to those who follow headline, but the USA doesn't even have enough refineries these days to supply in need for motor fuels.  Tightness in distribution allow fuel retails and jobbers to pass along price increase raw material price increase with improved profitability. 
3. Natural Gas.  Domestic supplies can not meet demand and thus the US now must import natural gas for Canada and liquefied natural gas (lng).  Unlike pipeline gas which is contract based and often regulated, LNG is a global market and the pricing has evolve to one that ties to global crude prices.  Furthermore, the world now has a global market for spot lng, which often traded at a premium to crude prices on a boe basis. 
4. Electrical Generation. Coal fired electric generation is significantly lower cost that turbine or engines that use natural gas or residual oil.  For numerous reasons, many of which are environment, new coal fired generation capacity in now keeping pace with demand.  This all get put in the price
5. Numerous other factors beyond the scope of the survey discussion. 

Energy and Single Family Housing

The chart to the right shows the interesting tracking of the energy indices and housing prices.  Intellectually, I know the drivers are much different, and in previous cycles the indices were somewhat  negatively correlated - meaning there moved in opposite direction.  Hence, the fact that they now have positive correlation is a bit eerie for me.   When I shared my concerned with one hedge fund manager this summer who took me out for an expense meal at an exclusive club (it was packed), he said "the world is a washed with liquidly".  Perhaps that is the answer, but I am still uncomfortable with it.  One friend from India (a Hindu) said to me "Perhaps the are now tied for reasons that will only be reveal to you in the next life - don't worry"  

Wonderful advice, but the question still bugs!

Housing we know is prompt up by credit policies; whereas energy seems to be responding to regional supply and demand imbalances.  Very different.  That said, housing, seems painfully over-priced (based on fundamentals) whereas energy still has more room for pain (i.e. price increase).  Housing on a technical basis looks "toppy" but so does energy.  Anyway, the new year approaches, I leave you with these thoughts to contemplate - my gift to you.

Have a nice holiday and new year.

All the best,

Wally Barker

Kobe Japan  .