Wednesday, November 18, 2009

October CPI: the end of the Deflationary Bust

- by New Deal democrat

This morning's CPI came it at +0.3%, slightly higher than estimates. YoY CPI is -0.2%. This is undoubtedly the swan song for deflation this year. Almost certainly we will find that this month prices increased about 2.0% YoY.

All things considered, that's a good thing. Here's a graph showing YoY inflation for consumers (blue), finished goods (red), and commodities (green):

When all three are rising, green more than red more than blue, that's bad and almost always triggers a recession (always in the presence of an inverted yield curve 1 year previously). That's because price pressures in crude goods can't be passed on to producers, who in turn can't turn them on to consumers, so there are cutbacks, triggering a recession. All three then proceed to fall, as demand slackens.

When demand hits bottom, crude increases can be passed on to producers with room to spare (so profits increase), and similarly producers can pass on increases to consumers. Increased demand and increased profits lead to economic expansion and hiring new employees. (Graphically this means all three lines rising, with blue higher than red higher than green.)

As I have repeastedly noted, this was also true of the Great Depression and the 1920's booms and busts.

In short, the K.I.S.S. signal -- a positive yield curve, a rising rate of price changes, and cpi exceeding ppi -- together with the positive LEI of the last few months, indicate the economy will show growth for the 4th quarter.