The United States’ largest export: Inflation

Note from Ben:  The following post is courtesy of John in Ottawa

A couple of days ago, Jesse made the comment that China has been exporting deflation to Canada for years.  That’s absolutely correct and life has been easier ever since we became able to buy a dozen tube socks for six dollars.  But that’s not the current debate.

The current debate, and Jesse’s comment got me thinking about it, is the US exporting inflation to the rest of the world.  We have heard that food price inflation is helping to inflame much of the Arab world.

I wondered just how much Canada is being affected by the US exporting inflation.  By way of a little background, the US is fighting deflation.  To save themselves from the ravages of deflation, the Fed is flooding the financial markets with liquidity.  Their hope is that they can stabilize house prices and get businesses and consumers borrowing again.

Unfortunately for the Fed, and the US as a whole, consumers and businesses don’t want to borrow and banks don’t want to lend.  However all that liquidity has to go somewhere and it seems to be headed into the commodity and foreign markets.

So, the Fed is “debasing” the US dollar by “printing” money; that is they are buying up bonds and flooding the market with cash.  This should show up in exchange rates.

All of the charts I am going to show are taken from OECD statistics.

I’ve chosen to illustrate Australia, the Euro, and Canada.  We’ve been following Australia somewhat and the Euro has been in the news quite a bit lately.

Clearly, all of these currencies have increased significantly against the US $ and for much longer than the current QE experiments.  The US has stated that it is committed to a strong dollar, going all the way back to George W. Bush, but its statements and its actions are not correlating well.

Now let’s have a look at some selected consumer price indexes.  Intuitively, one would think that a strong dollar relative to the US would translate into being able to buy all sorts of goodies on the cheap, especially as the Chinese Yuan is pretty much pegged to the US dollar.

Hmmm.  That isn’t working out as expected.  You can see the severe deflation occurring in the US and even Germany is fighting deflation.  In spite of flooding the markets with liquidity deflation appears to be getting worse in the US.

Then look at Canada and Australia, two of the great commodity resource countries.  Ouch.  In spite of our strong dollar we are suffering from an increasing CPI.  To add insult to injury, as commodities are priced in the world market in US dollars, as our dollar strengthens we receive less for the commodities we sell in the world.  One begins to understand why China wants to hold its peg.

Just to help clarify the correlation that holds between our dollar and CPI, I have put them on the same graph, with CPI divided by 100 just so our dollar and CPI can be compared easily.   CPI equals 100 in June, 2005.

*Added:  This graph illustrates that there is a strong inverse correlation between the US dollar and our CPI.  That is, as the US dollar weakens, our CPI increases.

John in Ottawa

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19 Responses to The United States’ largest export: Inflation

  1. Leo Lee says:

    Quite frankly, I don’t follow that last chart. Please enlighten further.

    • John in Ottawa says:

      I probably should have made it clearer that the currency portion of the last graph is the value of our currency against the US dollar.

      It illustrates that there is a strong inverse correlation between the US dollar and our CPI. That is, as the US dollar weakens, our CPI increases. I was surprised by that.

      • backwardsevolution says:

        John in Ottawa – great post! Well done.

        The U.S. may be fighting deflation, but there IS inflation there in insurance costs, medical costs, food costs, education costs; in everything but housing. I do not trust any statistics from the U.S. (Canada included). They are all manipulated. The Central Banks of the world are all in collusion. Canada follows the States like a chick follows its mother.

        The Fed is printing money (which weakens their dollar) and giving it to the banks at 0% interest. Billions of dollars are chasing yield and they’re going into commodities, which get passed on to us.

        Australia and Canada’s housing markets have not taken the plunge yet – that’s the difference.

        Every single country’s CPI is climbing. The world is awash in too much money.

      • Mango says:

        if the world is awash in money, what you doing with yours? You are getting the hint after 100% correction in the equity markets. The Fed has been nudging people into equity with zero rate….

  2. jesse says:

    CPI has a large component based on imputed rent. If imputed rent is increasing due to asset appreciation in a flat cost of capital environment, there could be some other effects going on.

    • John in Ottawa says:

      There could be, but this correlation is just to perfect and has been going on for far too long, including periods of high cost of capital.

      I really wasn’t expecting to see such a perfect long term inverse relationship between exchange rate and CPI.

      I think we would have better luck trying to cross correlate this data with BoC interest rates. I have to wonder if the tail has been trying to wag the dog.

  3. John in Ottawa says:

    I’ve spent the rest of the afternoon thinking about this perfect correlation issue. I like to think because I hear it mitigates dementia, and the alternative this afternoon was to go out and fight my ailing septic system.

    The only possible way there can be such a perfect relationship between exchange rate and CPI is if there is a dependency, that is one is a dependent variable of the other. An example of a dependent variable would be if your child’s allowance was set as a function of age, say $1 for every year. You would expect a perfect relationship between age and allowance.

    The question here is, which is the dependent variable, and why does this relationship occur in two different economies a world apart. Which is the independent variable and what is wagging its tail?

    You folks just know I’m going to look further into this. If the US can export inflation with such precision, then we have virtually no control over our monetary policy.

    • backwardsevolution says:

      John – “…then we have virtually no control over our monetary policy.” That would not surprise me at all.

      Thanks for looking into it.

    • Mango says:

      No one is exporting anything. It is called dilution. Who holds most of the UST’s? China. They simply won’t listen to change the fx rate, so we dilute them by printing money and making what they own worth less (basically a default), they have finally caught on and are buying commodity assets to hedge QE3. This is then rasies raw material prices which the Chinese consume on the margin and we produce, they again get upset and go around the globe to buy the assets. Hmmm. They think they outsmarted everyone and used UST’s to buy the companies at crazy prices…

      Except the next stage is AltE, no more dirty energy for you. So, basically all the stuff China is gobbling up will quietly be worth less and less as the world focus on clean energy and we find another cycle…

      • jesse says:

        “they have finally caught on and are buying commodity assets to hedge QE3”

        If they aren’t buying USTs, they must relinquish their peg. The accounts have to balance. I’m near convinced China has significant inflation problems.

      • Dmitri says:

        @John at Ottawa
        China indeed has a huge inflation problem.
        I wish I could have some spare time to entertain your view further. However, I believe that the coupling (in terms of pricing) between CAN, USD and RMB is elastic only in specific directions. (although, CAN is not pegged to USD)
        I don’t think it is easy to see the empirically hard link in this relationship, but mathematical explanation exists.

        P.S.
        I remember my very shrewed and financially astute friend telling me that “the inflation rates too high for developed western economy matter not in developing…” one and a half months later, we’ve had a few developing economies shedding their political regime…

      • Dmitri says:

        Well it is a very popular premise predicated on the believe that devaluation can precede interest rates. Even though, you cannot escape the reality in which you can apply interest rate limits before the scheme of currency devaluation suddenly blows up.

        Lets be real.

        Although, I do “enjoy” the idea of pull-back of a carry trade currency (with which ever assets got snagged) back into developed economies… if everyone plays nice that is.

  4. jesse says:

    I don’t know if the US is exporting inflation by choice. It is doing what it needs to do to get its house in order. As an interesting aside, try adding Great Britain’s and Japan’s exchange rate and inflation figures to the graphs as well.

    One thought is that Canada and Australia, as well as other commodity-based currencies, are suffering a bit of “inflation stealing” from the US, due to other countries using currency pegs. That is, a country like China, by keeping its currency pegged to the USD, must experience inflation if its economy is growing faster than the US’s. Canada and Oz are effectively caught in between the two via current account flows, and a mild bout of inflation is the result. Does that make any sense?

    • John in Ottawa says:

      That’s my plan for today. UK and Japan are good candidates for some sensitivity testing.

      @Mango: The Fed is now the largest holder of USTs. Between agency debt that isn’t likely to pay out well and the Maiden Lane debt, the Fed has a real problem. I don’t know if it makes a practical difference, but the Fed is going to end up technically insolvent. “Diluting” USTs isn’t going to help the situation.

      Again, the Fed is in uncharted waters. We would probably have to examine the balance sheets of banana republic states to find comparables.

      Also, sabotaging the value of China’s resource acquisitions with AltE is a good strategy, but the recent advent of shale gas is going to test US resolve to pursue expensive AltE.

      When the US exported its manufacturing to China, it also exported its dirty industries. This fact isn’t lost on China when the US gets all high and mighty and green. China pollutes on America’s behalf.

      • Mike in Vancouver says:

        That last paragraph is one of the most idiotic I’ve ever read! Typical, though, of the “blame the US for everything” crowd. China is a communist government which unilaterally sets it’s exchange rate (about 40% undervalued), violates patents, hacks into Canadian computers, pollutes the environment, etc. But that doesn’t stop John from blaming the US. Unreal.

        Note to Ben: You’re posts are normally excellent. Please, no more posts from John in Ottawa!

  5. Dmitri says:

    Can you include Canada’s GDP on the last chart ?

  6. Speaking of inflation, I’ve been gone 11 years and when ever I return I just die at the cost of everything (except good old timmys) you really notice inflation when your gone. What is interesting is cheap things are still much cheaper states side.

    Also I moved to Spain 6 years ago just before the crisis hit and inflation peaked at 4%, around the same time I started really tracking my spending so I was very aware of inflation, particularly food inflation, we saw a big jump in food prices, but as the crisis and deflation started to bite I noticed the opposite, suddenly prices began to flat line and have stayed flat for several years (don’t ask me why but I have been tracking the price of Oscar Mayer Wieners for as long as I can remember 1.117€) Also with crisis I noticed that the local chain restaurants really started offering some super deals.

    Recently Misch Shedlock had a very interesting article on Huge Margin Squeeze: Restaurants, Hotels, Cruise Lines Unable to Pass on Rising Food and Energy Prices

    Well volia recently I noticed that McDonalds had raised their prices on menus and VIPS (large Spanish Chain) suddenly raised their prices. So far food prices have held steady but I expect that to change soon.

    BTW excellent post!

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