For some time now, the disparity between price
increases for imported goods and price increases for domestic goods and
services has been of great interest to me and, after working through all of
the applicable Labor Department data on this subject, it quickly becomes
clear that there is an interesting story to tell here about two very different types of U.S. inflation in recent
years - domestic inflation and imported inflation.
The data in the graphic above will be detailed in
the paragraphs ahead because it is deserving of close inspection. To be sure,
it is a quite fascinating subject for those not familiar with how
dramatically inflation in the U.S. has changed over the years.
But, the more important point to be made here first is that this disparity
between domestic and imported inflation was one of the primary reasons why
central bank policy in the U.S. had been steering us on a wayward course for
so many years. Clearly, two of the major factors that enabled the nation's
"easy money" policies for the past two decades have been:
- The fixation on consumer prices (while ignoring
- The irrational fear of falling
prices (today and in 2002-2003)
To a large extent, the Holy Grail of benign
inflation and the threat of deflation were not
what they appeared to be. In short, the deceptive combination of sharply
rising domestic prices combined with falling prices for imported goods has
been a major contributor to policy mistakes by the central bank, one of many
policy mistakes made over the years that have now come home to roost.
Breaking the Consumer
Price Index Apart
The Labor Department breaks consumer prices down into eight major categories,
weighted as shown below. This composition is intended to represent a
"basket of goods" that consumers purchase and the overall, weighted
increases in prices are intended to represent the "rate of
inflation" in the U.S.
For the purposes of this discussion and as the
source for all the charts that appear here, only original Labor Department
data is used and all issues related to such things as hedonic adjustments,
geometric weighting, and other factors that contribute to the
"reported" rate of inflation almost always coming in lower than the
rate of inflation experienced in the "real" world will be ignored.
Importantly, lower "reported" inflation goes a long way in limiting
government liabilities for such things as cost of living adjustments and
makes central bankers, the stewards of American fiat money, look better than
they otherwise might, so, this is not a subject that should be dismissed as
inconsequential because, clearly, it is not.
It just won't be part of this discussion.
As for separating the consumer price index (CPI) into "domestic"
and "imported" components, in looking at the top-level categories
above, one can clearly spot a few that are predominantly domestic -
education/communication, food/beverages, and medical care - and, while there
are surely some imported goods in each of these groups (e.g., the 0.214
percent weighting for personal computers within the first group), it can
safely be said that the "domestic" label fits all three.
Similarly, since the U.S. essentially stopped making their own clothes years
ago, it can safely be said that the apparel category consists of primarily
But, after that, things get a little trickier.
Making Sense of the Housing and Other Categories
The housing category breaks down as shown below and, as noted here many times
before, probably the single biggest blunder of all regarding the consumer
price index was the substitution of "owners' equivalent rent" for
the cost of homeownership back in 1983.
As far as monetary policy is concerned, this was one
of the major "enablers" for the late great housing bubble and its
subsequent bursting since there would have been little chance of short-term
lending rates resting at one percent back in 2003 and 2004 if home prices
that were rising at an annual the rate of eight to ten percent nationally had
been included in the calculation of consumer prices rather than the dubious
measure of what homeowners think their place might rent for.
In fact, owners' equivalent rent has so distorted consumer prices in the U.S.
that they, along with rental costs within the "Shelter" subcategory
of the CPI, are completely excluded from the domestic/imported inflation
[Note: For a complete breakdown of the CPI categories see this item at the BLS.]
With rents excluded from this list you are left with one sub-category of goods
that is mostly imported - household furnishings - and the rest can be safely
categorized as domestic.
Moving on to the transportation category we find cars, trucks, and the fuel
that is required to run them and, while these are clearly both domestic and imported goods, the task of separating the two
is nearly impossible. Since they are primarily
made in the U.S., for the purposes of this discussion they are considered
Similarly, the recreation and other goods and services categories contain a
mix of products, however, here they can be easily segregated. For example,
nearly all cameras and audio equipment are imported while movie tickets and
film processing are domestic services. And in the final
"other"category, tobacco products are clearly home grown while
personal care products are largely imported.
Prices for Imported Goods are Falling Faster Than you
Lo and behold, when only looking at products that are imported (mostly from
Asia), one sees that we've had "deflation" for quite a few years
now and not just the "one-off" variety where readings come in at
minus one percent and persist for only a month at a time.
For example, the apparel category has posted year-over-year price declines in
13 of the last 14 years and clothes cost a cumulative 15 percent less than
they did in the 1990s.
Now that's what I
call "deflation", though, it has more to do with cheap labor and
fixed exchanged rates in Asia than it does with anything else.
Prices for most imported goods have been declining consistently over the last
decade, however, you don't hear too much about this as most news reports and
analysts cite the headline inflation numbers or, worse, "core"
inflation, excluding food and energy.
Falling prices for imported goods have been a key factor in being able to
report overall "moderate" rates of inflation in recent years.
Prices for Domestic Goods and Services are Quite High
On the domestic side, when looking past the volatility that somewhat obscures
the underlying pattern in the chart below, prices are clearly rising much
faster than headline inflation has been indicating, particularly since the
turn of the century.
[Note: The scales are the same for the chart below and the one in the
previous section in order that the magnitudes can be more easily compared.]
While food price have been rising only modestly up
until last year, it probably won't come as a surprise to anyone to learn that
medical services costs have more than doubled over the same period of time
that apparel prices have plunged, as noted in the previous section.
It is not until you look closely at the individual components of the consumer
price index that you realize we really have been living in a world of "two
inflations" - tumbling prices for imported goods and rapidly rising
prices for domestic goods and services.
Combine these two inflations and throw in the huge "shelter"
component that neither rises nor falls much as home prices soar and then
plunge and the result is "benign" inflation.
What Does this all Mean?
For years, persistently low and falling prices for imported goods such
as electronics and apparel have been masking much higher levels of domestic
inflation in areas such as medical services and household energy.
Any economist with a spreadsheet and a web browser could have confirmed that.
But, what is significant about this is that this phenomenon should have been factored into monetary policy over
the last decade or so but it wasn't.
Low inflation, regardless of its source, was used as a justification for
keeping interest rates too low for too long and the unfounded fear of
"de-flation" was the reason cited for keeping rates at
"freakishly" low levels for several years in this decade.
Yes, pegged currencies in Asia play a role here, but surely the folks at the
Federal Reserve, even with their misguided focus on consumer prices to the
exclusion of nearly all other considerations, could have seen that inflation
in the U.S. was only as low as it was because of cheap imports.
Had this been understood and had interest rates been kept higher over the
last ten years, we probably wouldn't have near the number of problems that
we've seen in the last year or two.
all the other articles written by Tim Iacono
Tim Iacono is the
founder of Iacono Research which provides market commentary and investment
advisory services specializing in macroeconomic analysis and commodity based
investing. He also writes the popular blog The Mess That Greenspan Made.