Inflation and the central bank... again

Let's continue this exercise to prove a point, and because I find it interesting.

How Sticky is inflation

Here is the price increases/decreases for certain goods. Let's see how much well the the Bank of Canada has achieved price stability.

UP
Cereal products (excluding infant food): +5.1 per cent
-Cereal is produces in Canada, so the BOC failed to achieve price stability here.

Preserved fruit and fruit preparations: +5.6 per cent
-Most from Western countries, failed here as well.

Canned vegetables and other vegetable preparations: +12.6 per cent
-Same here

Sugar and confectionery: +8.6 per cent
-Wow, big increase here, and quite difficult to import confectionery goods, so failed here.

Telephone services: +5 per cent
-All Canadian companies here.

Pet food: +8.5 per cent
-I don't think we import much pet food from China anymore. failed.

Car insurance premiums: + 7.9 per cent
-Big failure here.

Rail, highway bus and other intercity transportation: + 9.3 per cent
-This is a made in Canada problem. Failed

Health care services: + 4.5 per cent
-Although I believe this to be the BoC's responsibility, this could be because government run systems will always get more expensive and inefficient. I will give them the benefit of the doubt here.

Tuition fees: + 4.1 per cent
-Here I will not give them the benefit of the doubt. Tuitions are increasing in large part because students are able to take on more debt.

I hope you notice the pattern, all services that cannot be outsourced are up quite significantly.

DOWN
Ham and bacon: -2.1 per cent
-Not too sure why this is. Let's give them the benefit of the doubt again, they achieved price stability here.

Pasta: -5 per cent
-Likely due to the appreciation of the dollar vs the Euro due to problems in the Euro zone. Not much influence here.

Potatoes: -21.7 per cent
-This is a pullback from the huge increase a year or so ago.

Mortgage interest cost: -5.8 per cent
-This is all BOC. Well done. Of course, this is a ridiculous inclusion. It's like including the interest rate on your car, and not the actual price of the car. The price of the car can double, but as long as the interest rate doesn't change, no impact on inflation. Just ridiculous.

Natural gas: -22.8 per cent
-BOC has little to no impact on Commodities.

Furniture: -4.25
-Thank our friends in CHINA

Women's clothing: -8.7 per cent
-China again.

Air transportation: -9.5 per cent
-I haven't notices a decrease, but let's give them the benefit of the doubt again.

Home entertainment equipment, parts and services: -8.0 per cent
-Thank you China.

Car rentals: -4.5 per cent
-Thank you US Government, keep on pumping out more cars to keep your union buddies working.

In conclusion, the Bank of Canada has a failed to achieve price stability. All products that have increased in price with the (possible but unlikely) exception of Health Care are due to the BoC's low interest rates, They only achieved price stability (giving them the benefit of the doubt) for Pork, mortgage interest, and Air Transportation.

I hope everyone can see that the BoC has had little impact on the low CPI numbers we have had in recent years. What should be clear to everyone is that if the money supply increases by 5%, our GDP doesn't change, and our CPI is 2%, that extra money goes somewhere. By ignoring this extra money, you risk creating huge bubbles and malinvestment.

Transparency and the Bank of Canada

This article was pretty interesting. At Bank of Canada, a debate on revealing less - The Globe and Mail

There are two comments I'd like to make, one about transparency and one about price-level targeting.


From the article.
There is an emerging opinion that central banks contributed to the financial crisis by making their intentions for interest rates too predictable. The best example is the U.S. Federal Reserve, which, under former chairman Alan Greenspan, raised its benchmark interest rate in 17 quarter-point increments starting in June, 2004, and ending with the Fed funds rate at 5.25 per cent in June, 2006.

The worry - it must be said, in retrospect - is that too much transparency causes investors to become complacent.

Thinking they have the central bank's interest-rate path figured out, investors put less effort into assessing economic fundamentals. This creates a kind of groupthink that removes an important check on exuberant behaviour: skepticism.

In 1996, Greenspan spoke about "irrational exuberance". "Irrational exuberance" would imply tightening ahead, and so it appears that Greenspan was very transparent of his intentions. Yet the market ignored this, and the Nasdaq went on to inflate and burst.

Could it be that what Fed does is much more important than what the chairman would say? Apparently not, according to emerging opinion.

The second point is about price-level targeting. As I have showed in previous post, the Bank of Canada has little effect on inflation, and what areas it does have an effect on, it is doing a poor job. So what price-level targeting do to the Canadian economy? It would only exacerbate any problems.

I work under a simple premise, that if the interest rate set by the Bank of Canada is lower than the interest rate that would be set by the market, then you have malinvestment, and malinvestment is bad and will eventually need to be cleansed from the economy. The most recent examples were the housing bubble and the Nasdaq bubble in the US. The 1% interest rate in the US, which would be below any reasonable estimate of a market interest rate, caused investors to act under false pretenses. Low interest rates should mean that there is a large amount of capital available (ie. people have so much money that they are willing to lend it out at 1%), but of course this was not the case, there was not an abundance of capital. Central banks misled investors by lowering interest rates to such levels.

So why will price-level targeting exacerbate problems in Canada? Well Canada currently has a CPI of 1.9%, lower than their target of 2%. Well if China's over-capacity allows them to sell us goods for lower prices, then Canada's CPI will be below 2% for the foreseeable future. This would mean that the Bank of Canada could keep rates at near zero, and will snowball the malinvestments. With a price target of 2%, you could simply ignore the year and look forward, but with price-level targeting, you will need to keep the interest rate at an artificially low level which of course would increase the amount of malinvestment. (And the more malinvestment, the worse the recession/depression will be)

Well, if the Chinese decide to pass on their inflation to Canada, our CPI could easily go up to 3%, and stay there. That means that for the foreseeable future, the Bank would continually increase its interest rates to fight a fire that it has very little control over. Again, price-level targeting, would mean the BOC will need to continually increase the interest rate to get the average to 2%. And this of course will cause the currency to appreciate, and destroy the economy.

Now if the BOC was really serious about price-level targeting (It would be really nice if the target was 0!!), it should first look seriously at how it calculates CPI and base the price-level targeting on only this items that it actually has control over (perhaps just services?).

What's the problem?

If there is no housing bubble, why worry?

reportonbusiness.com: globeinvestor.com - Don't tighten mortgage rules, Ottawa urged

The head of ING Direct Canada is warning against Ottawa mandating tighter restrictions, because "everyone" wants to avoid a swooning housing market.

The Bank of Canada already said that they will not raise interest rates until much later this year, why? Because apparently they do no consider a house to be good. House prices rose 19 per cent nationally last year, but according to the CPI, housing became more affordable. (Dear Bank of Canada? Don't you find it odd that reducing interest rates would reduce inflations? Could it be because inflation should measure the prices of goods, not the amount it costs to finance that good?)

So why would the head of a bank not want the government to intervene? Because the mortgage industry is a huge gravy train for banks. If it were up to the banks, they'd offer 60 year mortgages, with a negative down payment. The longer your mortgage mortgage lasts, and the more money you borrow, the more money they will make, especially if the government is there to insure you.

Of course, the saddest part is that the longer the Bank of Canada and the Federal Government let this go on, the bigger this bubble will get, and the bigger it is, the harder and the faster this deflate

Bankers get the bonus, and government takes the risk - The Globe and Mail

This is a really important piece and I ask everyone to read it. Bankers get the bonus, and government takes the risk - The Globe and Mail

Of course, the situation is much worse than the article states, specifically this point.

At the end of 2008, the latest figures we have, CMHC had $149-billion of investments in mortgage-backed securities on its balance sheet, up from $96-billion the previous year.

While the CMHC may only have 149 Billion of MBS on its books. It has a limit of $600 billion of mortgage loan insurance, up from the previous $450.

Adding to the article, the CMHC, as well as any other insurance such as the Canada Deposit Insurance Corporation, allow the banks to take huge risks that they otherwise would not be able to take (as well as get huge rewards).

Inflation within central bank comfort zone, good job right?

This is a follow up to yesterday's post.

So inflation is up a less-than-expected 1.3 in December? Great job, right??

Well, not so much when you look at the details. Everything the Bank of Canada has some control over rose, and rose quite dramatically.



Food prices rose 1.7 per cent, matching November's increase. Prices for dairy products and eggs rose 1.9 per cent while prices for non-alcoholic beverages went up 4.8 per cent. Food purchased from restaurants, sugar and confectionery, lettuce, and bakery and cereal products also rose.

Other goods that are getting more costly include communications, child care and domestic services, and paper, plastic and foil supplies.

Tuition fees, cablevision and satellite services, and recreational vehicles are also more expensive.

Homeowners' maintenance and repairs costs rose 3.3 per cent while property taxes climbed 4.3 per cent.


So why did CPI only raise 1.3 per cent?



Prices for passenger vehicles fell 3.3 per cent from last year while furniture and household textiles also saw declines.
Computer equipment and supplies and home entertainment equipment, parts and services prices continued to fall.

Overall shelter costs fell 1.7 per cent from a year earlier thanks to a 31.2-per-cent drop in natural gas prices and lower mortgage interest costs. The mortgage interest cost index, which measures the change in the interest portion of payments on outstanding mortgage debt, fell 4.9 per cent in December, Statscan said. Homeowners' replacement cost fell 1.2 per cent.

But the BOC's "policy" of a weak dollar actually increased the cost of natural gas. And most of the other costs are result of China and their fixed exchange rate, since Canada doesn't produce much computer equipment, home entertainment equipment or textiles.

So the BOC's policy is actually raising the cost of food and services, and have made houses unaffordable for those earning an average salary. They have, when you look at the big picture, punished the poor, who would otherwise be enjoying cheaper goods from China, and stable domestic prices, and affordable housing. Instead, they have benefited the rich (although not by much) by creating this bubble in housing. All the while they are applauding themselves for keeping inflation in check.

Note to the Bank of Canada, you don't control Inflation!!!

reportonbusiness.com: globeinvestor.com - Bank of Canada sticks to low interest rates

The Bank of Canada says that inflation is under control.

Interestingly, we had this article yesterday that read

China exports everything from jeans and T-shirts to toys and computers. Is inflation next?

Hmm, something doesn't add up. If the Bank of Canada controls inflation, how can China export inflation? And if China can export inflation, could they also be responsible for the lack of inflation?

And the answer to that is YES, China has a much bigger impact on inflation in Canada than the Bank of Canada. In fact, the only reason we've had any inflation is because the Bank of Canada doesn't acknowledge this fact.

If you look goods and services that the Bank of Canada does have an affect on (mainly, goods and services produced in Canada) you will see that they have a very poor record.

Housing is the prime example. A house is a good like any other, and yet housing prices have increased dramatically. Almost to the same level as it did in the US.

http://www.clevelandfed.org/research/commentary/2009/0909-1.gif


Let's take a look at some other numbers.

http://www.statcan.gc.ca/pub/62-001-x/2009011/t031-eng.htm
Since 2002=100%, you will see that Durable and Semi-Durable goods are actually more affordable now than in 2002 (thanks to China!!)

Services, food and shelter, the three items that I believe the Bank of Canada has the biggest affect on, are up substantially.

The Bank of Canada, through its influence on the dollar, also has a huge affect on the price that Canadians pay for commodities. This has lead to a large increase in cost for transportation and energy prices.

So what exactly is the Bank of Canada achieving through their policies? I argue that they didn't really achieve anything. Had they did nothing at all, the prices of good would have decreased thanks to China, and the prices of housing, foods and services likely would be much lower, which would have translated to a higher standard of living for all Canadians.

Obama unveils bank tax to recover ‘every single dime' for Americans

I can't believe I actually going to agree with a new tax, but I think this one actually makes sense.


Here's why.
According to Reuters

From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent.


I would argue that in a productive and free market, the total profits of financial institutions should be only a fraction of this. In fact, I think it's actually hurts the overall economy when main street is funneling so much money to wall street.

The function of the financial sector should be to more efficiently transfer funds from savers to borrowers who will either invest this money or consume it. Of course, banks should prefer borrowers who will invest this money rather than consume, because when you consume good does not earn anything.

Now for some reason, banks confused houses with actual investments. Houses are not investments in general because they do not bring in income. Yes, a house is an asset, but absence a increase in population, credit, inflation, tastes and preferences, etc, the value of a house will go down (go bid on a house in Detroit).

Also, add to this the "subsidies" that the banks are getting from the government though FDIC insurance, Fannie and Freddie, and their relationships with the Central Banks, I think (and hope) this tax will actually reduce demand for financial services and allow savings to actually go more productive means.

Yes, financial services are required for a healthy free market, but we don't have a free market, therefore, I believe reducing the "rents" that the financial industry gets from the rest of the economy will actually be a good thing.