There’s both more and less US inflation than meets the eye

The US Consumer Price Index rose by 3.4% in the year through December 2023, somewhat higher than the consensus forecast, mainly due to a big jump in the reported cost of shelter, which rose 6.2% year-on-year. The shelter number is bogus; rents on new apartments reported by Zillow and Apartmentlist.com have fallen during the past year, and during each of the past five months.

The Bureau of Labor Statistics, which calculates the Consumer Price Index, reports what it thinks is the average cost of renting a home. But the cost of a new lease as reported by Apartmentlist.com is falling. It takes about 12 months for the BLS estimate to catch up with the change in new rentals.

The official CPI shelter number will catch up to the observed cost of new rentals later in 2024, and the BLS will report a decline in the cost of housing, which makes up a third of the price index.

The price of goods also is falling after the Covid surge, when consumers scrambled to buy autos (to avoid public transport) and work-at-home electronics. An important factor is the falling cost of imports from China, due in part to the fall in China’s exchange rate vs. the US dollar. 

The Federal Reserve and Fed-watchers in financial markets focus on something quite different: In the Fed’s flawed economic model, wage growth is the main driver of inflation. Labor shortages during the Covid shutdowns pushed the year-on-year change in average weekly earnings to 7%, and the year-on-year rate is still around 4%.

Since the Fed wants 2% inflation, the Fed-watchers reckon, it will keep interest rates high until demand for labor shrinks and wage increases fall back to the 2% annualized level. That’s why Treasury yields jumped after the Bureau of Labor Statistics last week reported larger-than-expected December employment growth.

It doesn’t really work that way. Most of the employment growth during the past year has been in low-wage fields like health care, education, and leisure and hospitality, which showed very little wage growth during 2023. Sectors that showed very high wage growth like manufacturing had no growth in employment at all.

The sector with the highest growth in employment (up 4.2% in 2023) was education and health services, which had wage growth of just 2.4%. The sector with the lowest employment growth (almost unchanged during 2023) was manufacturing, where wages rose by almost 6%. 

As US manufacturing wages rose, largely due to a shortage of workers, Americans bought more goods from overseas. The US trade balance in goods jumped from a US$720 billion annual deficit just before the Covid epidemic to a $1 trillion annual deficit during 2023.

The fact that there isn’t much inflation according to standard statistical reporting is small consolation to consumers, who can’t afford to buy cars or houses.

The monthly cost of running a car now stands around $1,000 – about $700 average car payment, $150 insurance, and $150 to $200 in gas. In 2018, it was only $600. A lot of the difference is due to the much higher cost of financing cars, along with the jump in the price of new vehicles. 

The average cost of a mortgage on a new home, meanwhile, is $2,883, compared to a median cost of existing mortgages of just $1,775. That’s the result of the Fed’s interest-rate hikes. The Fed created a great deal of inflation that wasn’t there before by raising interest rates. 

The inflation burst of 2020-2021 had little to do with interest rates. The culprit was $6 trillion in additional Covid subsidies by the Trump and Biden administrations. Trump’s largesse was defensible given the shutdown of the economy. Biden doubled down on the Trump subsidies after the epidemic was largely over and the economy was recovering. Interest rates had very little to do with it. 

For US consumers, the bottom line is that the selling price of homes, the cost of new leases and the price of most consumer durables will fall slightly – but nobody will be able to afford to buy anything because the cost of financing will remain impossibly high for an extended period of time.

In terms of real cash outgo, there’s a lot more inflation than meets the eye, thanks to a misguided Federal Reserve.