Why You Can't Have Both A Weak Consumer And Inflation

US consumer inflation might be less imminent than many believe.

This is because consumer inflation happens when too many dollars chase too few goods. They key word here is chase.

Yet currently we are no where near such a situation. In fact, there are probably too many goods chasing too few consumer dollars. We’re experiencing the first major consumer expenditure decline in 40 years.

Accrued Interest: The chart below shows Core PCE deflator [inflation] vs. the year-over-year change in consumer expenditures. The chart covers every monthly observation (of the 12-month change) since 1969. Notice there are exactly 8 observations where consumption growth is negative. Its the last 8 months!

Consumer Expenditure Inflation Correlation

The red trend line above shows a historical correlation between consumer expenditures and inflation of 0.82, which would be expected. Higher consumer expenditures tend to create higher inflation.

Thus perhaps easy money policies alone can’t translate into consumer inflation, if the easy money doesn’t cause commensurately higher consumer expenditures. The easy money of late hasn’t shown up yet in consumer demand. Rather, it’s being used to shore up peoples’ balance sheets.

Where is money flowing? To a large degree, its into “savings.”

Some think that the excess liquidity is flowing into risk assets, stoking another bubble. But this “savings” isn’t flowing into brokerage accounts so much as its flowing into money markets and paying down debt. 4Q 2008 and 1Q 2009 marked the only outright declines in household indebtedness since 1952!

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As long as the consumer is retrenching, we have a huge reason not to fear inflation.

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