Historically, interest rates are higher during inflationary periods. Despite what the government says about inflation moderating, it seems like price increases are commonplace.
Last week, I went to the market and found that the price of a carton of my favorite yogurt increased from 80 cents to $1. That is a 25% increase. The battery in my wife’s car died, and after spending a day shopping around, I found that the best price to replace it was $352. My car uses an identical battery and it only cost $130 to replace that battery 18 months ago.
According to the most recent official government Consumer Price Index statistics, July inflation was only 3.2%. The price of goods I purchase seems to reflect considerably higher price increases than that.
As I wrote in a column last January, this is because in 1998 the Bureau of Labor Statistics modified the way it computes CPI by reflecting changes in consumer preferences.
Unfortunately, this results in substantially greater subjectivity when computing CPI — thereby enabling data to be spun into more favorable results. This was done deliberately to preserve Social Security by slowing the rate of Social Security benefit increases, which are tied to inflation measured by CPI increases.
If the bureau calculated CPI using pre-1998 methodology, inflation would be much higher. There is a website called Shadow Government Statistics (www.shadowstats.com/alternate_data/inflation-charts) that tracks CPI using pre-1998 methodology.
As of May 2023, instead of the official CPI increase of about 4%, consumer price escalation using pre-1998 methodology was well above 10%.
The last time the official inflation was this high was in 1983 when the Fed Funds interest rate fluctuated between 9% and 11%. The Federal Reserve Board recently raised the Fed Funds rate to 5.5%, which is about half of the 1983 rates.
The current Fed Funds rate is approximately equal to the average rate for the period 1973-2022. So the current interest rates are not excessive when compared to the rates over the past half-century and are lower than during previous inflationary periods.
The artificially low interest rates set globally by central banks, including the Fed, over the past 15 years, along with pandemic-induced supply chain problems, are likely the root causes of today’s global inflation.
Historically, when we move into prolonged periods of inflation, workers demand higher wages.
We already see that with the entertainment industry strikes. Many union contracts will expire next year and those unions expect higher wages, which in turn will increase the costs of goods those workers produce.
In the 1970s wage increases outpaced inflation. Today we could see a similar phenomenon because in many industries, wages have not kept pace with the cost of living for many years and workers seek catch-up adjustments. Unlike the 1970s, many of today’s jobs can be offshored or replaced by technology. While that will place a damper on wage growth in certain industries, some wage increases are inevitable.
Central banks have typically dealt with inflation by increasing interest rates, which makes it more expensive to finance the purchase of goods and services. Theoretically that reduces both the demand and price of those goods and services.
During inflationary periods, interest rates have been higher than average, suggesting that the Fed is likely to continue increasing rates.
If 1983 is a benchmark, interest rates may still have a long way to go.
However, our economy in 1983 was not affected by globalization to the extent it is today, and consequently, the Fed historically exerted greater economic control. Thus, interest rates were a more effective way of restraining inflation.
Current geopolitical tensions are causing the price of oil, food and other raw materials to increase irrespective of the Fed’s actions.
Nevertheless, the Fed is likely to continue pulling the interest rate lever to a greater extent than people believe because inflation is greater than what the official CPI figures suggest.
Wall Street, which is heavily reliant on debt, does not like this and is trying to persuade investors that interest rates are near their peak. At least one private equity firm CEO recently argued that the rate of inflation is coming down rapidly and interest rates will soon follow.
History does not support that view. The illusion of lower inflation is largely the result of changing the mechanics of how inflation is measured.
Therefore, until inflation (as measured by pre-1998 methodology) returns to more acceptable levels, don’t be surprised if the Fed continues to increase interest rates.
Jim de Bree is a Valencia resident.