GDP Output Gap Vs. Inflation

The GDP Output Gap is a very nice indicator for inflation. It is a leading indicator for inflation and is based on the potential real GDP.

Potential gross domestic product (GDP) is defined in the OECD’s Economic Outlook publication as the level of output that an economy can produce at a constant inflation rate. Although an economy can temporarily produce more than its potential level of output, that comes at the cost of rising inflation.

Potential GDP = (natural rate of employment) ÷ (actual rate of employment) * (actual GDP)

So if you see that the output gap (potential GDP – current GDP) is narrowing, you should begin to see inflation. On the chart below we see that the output gap is narrowing and I expect inflation to start showing up in 2017.

//research.stlouisfed.org/fred2/graph/graph-landing.php?g=4ks8

Let’s take a look at the 1980’s. You can clearly see that inflation appears when the red line goes above the blue line.

Working Age Vs. Consumer Price Index

Working Age has effects on the P/E ratio as described here, but also has an effect on the inflation rate.
Yardeni describes this perfectly here. Younger people simply spend more than older people and contribute more to GDP and inflation. If we plot the percentage of younger people in society against the inflation rate we have a very nice correlation.

//research.stlouisfed.org/fred2/graph/graph-landing.php?g=2s5y

This explains why Japan had a deflationary environment for so many years due to its low fertility rates. Knowing this, we now can expect inflation to go back up in China because they just announced an end to the one child policy this month in 2015. But this inflation will only come when these babies start to work.

Bonus chart:

//research.stlouisfed.org/fred2/graph/graph-landing.php?g=2s5K

Chapwood Index

I read about this alternate calculation on the Consumer Price Index (CPI) for inflation: http://www.chapwoodindex.com/

This is how they calculate it and apparently the CPI is around 9% at this moment:

Financial experts at Chapwood Investments, LLC have spent the past 4 years engaged in groundbreaking research that uncovers the real cost of living percentage increase for every major metropolitan area in the United States.

Numerous organizations have struggled to reveal inaccuracies in the government Consumer Price Index (CPI) methodology by calculating alternative inflation rates.

No one, until now, has ever attempted to objectively determine the real cost of living percentage increase without the influence of the flawed government model.

Over two years, we collected data from friends and associates across the country on over 4,000 items to see what they spent money on in their daily lives. We then narrowed these items down to the top 500 most frequently used and relevant items. Those items became the basis of the Chapwood Index.

Every six months, we take the precise price for the same item quarter by quarter and calculate the increase or decrease, then developed a weighted index based on price. These items include basically everything that most Americans consumer during the course of their lives.

Inflation in Egypt

There is more evidence that inflation is created by the government. If we look at Japan and more recently Egypt, we see that countries with a large deficit are more inclined to raise taxes and print money. This is inflation, because the people will not be able to buy the same amount for the same price.

Take Egypt for example. Electricity prices are said to double in 5 years. Gasoline prices just doubled overnight. This is because the government wanted to reduce its budget deficit. We know that budget deficits are correlated to the trade deficit, so let’s take that chart up.

As you can see, the deficit started in the financial crisis of 2008 and hasn’t improved ever since. So the government is taking extreme measures now.

This is the result. I get stress already when the pumps are all occupied. I wouldn’t want to experience this.:

Inflation is everywhere, even in the U.S. To read about it go here.

Inflation expectation is rising

The latest CPI numbers are out and we see that yoy inflation rates are now at 2%. I expect inflation to go higher in the future, because I see that the capacity utilization rate for May 2014 has been up to 79.1 for the total industry.

For mining, the capacity utilization rate even goes to 91, the highest in decades. I guess the mining industry is working at near full capacity and that’s good for commodities to go higher.

Remember, when the CPI goes up and bond yields drop, gold goes higher. And that’s exactly what is happening now. Bond yields are lower and CPI is higher.

Capacity Utilization Points to Higher Inflation

Capacity utilization rate is a leading indicator for inflation. And the latest number is at 79.2, a new record high since the bottom of the crisis. If history is an indicator, we should see huge inflation rates in a year from now.

The chart below points to a year over year CPI rate of 5% in the coming future. And we’re already half to that number as the latest consumer prices pointed to a 0.2% increase in prices in the month of March, or a 2.4% inflation rate per annum.

You can be sure that inflation is coming and you should prepare for that accordingly.

Federal Funds Rate Vs. Consumer Price Index

From the first FOMC meeting lead by Janet Yellen, we noticed one important statement:

“The Fed Funds Rate will be kept low when inflation stays at this low level.”

Thus, we chart the Fed Funds Rate against the CPI and get this result.

There is a strong correlation between the Fed Funds Rate and the inflation rate (CPI).

So we expect that an increase in interest rates will only happen when inflation starts to rise. The unemployment rate is not on the radar anymore.

Notice that historically the Fed Funds Rate is higher than the inflation rate (positive real interest rate (above 0%)), but today the Fed Funds Rate is lower than the inflation rate (negative real interest rate (below 0%))

When will inflation in Japan show up?

People are wondering if the money printing experiment in Japan is actually going to be inflationary or not. As we all know, the inflation rate is measured by the CPI (consumer price index). If the CPI goes up, we have inflation.

The CPI of Japan consists of the items given in Chart 1. The items with the most weight in it are food, housing, transportation and fuel. Therefore, it is important to watch food and energy costs as well as housing prices in Japan.

Chart 1: Items in CPI of Japan (2010)

First, let’s look at food prices. Zero Hedge reports that McDonald’s has hiked the price of a burger in Japan by 20%. If we consider this price hike as a proxy for the overall food price in Japan, we could see a significant increase in the CPI coming.

Second, we take a look at the Japanese housing market. The Japanese housing market has always been in a decline for the last 15 years, but now we see signs of stabilization. Housing prices are about to rise in the coming years. In the metropolitan areas for example, we have seen land prices go up at an annual rate of 11.5% in 2012.

Third, fuel and energy costs are going through the roof. With the Fukushima disaster, a part of the nuclear energy had to be diverted to fuel. In fact, LNG imports soared to 86.9 million tonnes. Added to this disaster, the yen weakened considerably in 2013 which led to rising fuel and energy costs. We can witness this in the rising LNG prices in Japan. These events are a very good example of why a weaker yen is not a good thing, instead it creates an environment where people’s purchasing power declines. In this case the price of the imports of fuel are going up and this will add to the trade deficit of the country. The statistics bureau of Japan recently put out the latest numbers on the CPI. Fuel was contributing the most to the rising costs of living.

Table 1: Consumer Prices: Change from the Previous Year in 2012

So basically, we see that the 3 biggest components of the CPI are going up in Japan. It would surprise me if the CPI would decline in the coming months.

Continue reading here.

Money Supply

This page is created to monitor the Money Supply.

Base money is basically correlated to the Federal Reserve’s Balance Sheet (red chart). When base money is increased, the other monetary aggregates (M1 in green, M2 in yellow, MZM in blue) will follow suit.

The expansion of the money supply is the very definition of inflation. As long as these charts go up, we will have inflation.

Wage Inflation Vs. Unemployment Rate

This page is created to monitor the Average Hourly Earnings of Production Vs. Unemployment Rate.

When unemployment declines (yellow chart), wages inflate (blue chart).