Government Reports Wholesale Inflation Under Control

The Bureau of Labor Statistics reported Tuesday morning that prices at the wholesale level rose only modestly in August. After rising by one percent in July, the producer price index went up by only six-tenths of a percent in August, below forecasters' prediction of a seven-tenths of a percent rise. Excluding price changes in food and energy, the so-called "core" inflation rate at the wholesale level was zero.

With respect to the food and energy sectors, price increases were far less than some might have anticipated: the energy component of the overall index rose by only 3.7 percent for the month, and this was offset by declining food costs, which dropped by six-tenths of a percent.

The good news on the inflation front was widely seen as an indication that the Federal Reserve has been successful in its measured tightening of the money supply, giving hope to some analysts that the central bank might even pause in its incremental increases in the discount rate in the months ahead to allow the economy some breathing room as it recovers from the economic effects of Hurricane Katrina.

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The Federal Reserve uses "open market operations" to put money into or drain money from the banking system, thereby stimulating short-term economic activity or slowing it down.

  Already, many believe that the Fed has added short-term liquidity to the economy. Stock prices that rose in the days after the calamitous hurricane indicated that few on Wall Street saw the damage as broadly affecting the economy, but this seemingly perverse reaction of stocks going up after a major natural disaster could have been the result of the Federal Reserve executing open market operations to push money into the banking system. A similar result was noted after the London bombings in early July, with the major stock indices jumping smartly even as the world was shocked by the attacks. It became evident shortly afterward that the Federal Reserve had been aggressively pumping money into the economy since the last day of June, which stimulated strong positive reactions in the financial sector that could not be overcome by adverse political and social events.

The same phenomenon could explain the recent surge in stock prices: Hurricane Katrina made landfall early on the morning of August 29, 2005, leaving widespread devastation in its path through Louisiana, Mississipi, and Alabama; but stock prices moved notably higher in the following days, with the Dow Jones Industrial Average, for example, rising by 296.71 points, or 2.87 percent in the two weeks from the day the hurricane hit the U.S. mainland. The NASDAQ Composite index rose by 62.98 points, or 2.98 percent, and the Standard & Poor's 500 rose by 37.62 points, or 3.13 percent. These robust performance figures clearly show that Wall Street has taken a far more positive view of the tragedy in the Gulf Coast area than has the media in general, which has focused on the death, destruction, and hundreds of thousands of lives disrupted instead of keying on the potential business opportunities the newly cleared land will offer and the broader theme that the government and will place the nation further in debt to finance large-scale projects by select companies working hard to rebuild the area and to do so unencumbered by old regulations regarding workplace safety rules, environmental standards, and wage and hours laws.

In other news, the Mortgage Bankers Association reported on Wednesday morning that applications last week for home mortgages fell 1.4 percent after rising nearly seven percent in the week previous. Analysts attributed the slide to rising mortgage rates, which have only recently begun to show much sign of abating home buyers' and refinancers' appetites for new loans.

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A long-term interest rate has a related short-term interest rate embedded in it, but other factors—called "risk," "maturity," and "liquidity" premiums—make the long-term rate different from (and usually higher than) the related short-term rate.

  The average rate on a 30-year, fixed rate mortgage now stands at 5.72 percent, slightly higher than the 5.68 percent of one year ago, but still below the 6.08 percent that it reached in March of this year. The long-expected drop-off in home sales due to rising interest rates has yet to materialize, but concerns always mount when mortgage applications show a dip as happened last week. Although the Federal Reserve has maintained upward pressure on short-term interest rates, it has no direct say over longer-term rates, which have not moved upward in lock-step with the shorter term rates the central bank can control through its open market operations. This interest rate weakness at the long end of the so-called yield curve gives some economists reason to believe that recessionary pressures are continuing to build in the economy because historically, when long-term rates actually fall below short-term rates, an economic downturn almost always follows.

In any event, if data provided by the United States government is to be believed, the American economy has shown significant resilience in the face of recent economic challenges, not the least of which is the misperception by many average citizens that inflation has been, and continues to be, a growing threat to purchasing power. The latest report on inflation at the wholesale level by the Bureau of Labor Statistics should put to rest any concerns that prices are spiraling out of control. On Thursday, the BLS will release its figures for inflation at the consumer level.

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Most cost-of-living (COLA) adjustments calculated by the private and public sectors are based upon the inflation rate indicated by changes in the consumer price index.

  Should these numbers indicate that retail prices are as well under control as wholesale prices, there will be little justification for demands by workers and retirees for more than very modest cost-of-living adjustments in wages and retirement benefits from Social Security. Without the burden of having to pay more to people to compensate for the effect of inflation, both businesses and the federal government will be able to focus more resources on the important work that lies ahead in building a better America for the business community as it continues to thrive in an economy where even the largest natural disaster in more than a century cannot stop the stock markets from marching ever higher under the watchful help of an accommodating central bank and a fully engaged, one-Party system of rule.