Monday, April 25, 2011

Service Sector Inflation Remains Mild

According to BEA data, the U.S. economy has increasingly become more and more of a service economy (see top chart above).  In the early 1950s, less than half of the national output took place in the private services-producing sector of the economy, and more than 40% in the private goods-producing sector.  Now more than 2 out of every three dollars of GDP is produced by private service industries in the U.S. (legal, financial, management, administrative, technical, scientific, publishing, information technology, etc.), and the share of value added by private goods-producing industries has fallen to 17.7%, or less than half its share fifty years ago.  

CNBC reported last week:

"The annual change in prices for data processing, recreation, lodging, medical services and tuition are all showing a downward trend, according to David Rosenberg’s analysis of the government’s CPI data.

With all the hubbub about $100 oil, surging food prices, along with the comparisons to the 1970s, Rosenberg, who is chief economist and strategist at Gluskin Sheff, is trying to make the point that the U.S. is now primarily a service economy, with these industries accounting for much of our employment and two-thirds of our spending (see top chart above).

“Service sector inflation is now running at historical lows of little more than one percent, and here we are about to enter the third year of a statistical economic recovery,” said Rosenberg, formerly the economist at Merrill Lynch where he made his name by going against the perma-bullish Wall Street crowd (see bottom chart above). “Service sector inflation used to be sticky, because this area of the economy years ago was dominated by unions, was protected by entry barriers, and did not face much in the way of competitive pressures. The times have changed,” wrote Rosenberg in a note to clients Tuesday.

“Commodity-based economies have a serious inflation problem because food and energy are so crucial to that smokestack, low-income model,” said Steve Cortes of Veracruz LLC. “But in a services-based economy like the U.S., many areas are outright deflating, like technology — and many more key areas churning sideways: professional services, brokerage of all kinds, hotels.  Inflationary periods like the 1970s start with wage inflation, which is sorely missing from this recovery.”

Indeed, Rosenberg found there is an 88 percent correlation between wages and inflation —and wages today, adjusted for productivity gains, are declining on an annual basis. Don’t look for that to change any time soon with unemployment still above 8 percent. Maybe that’s why the Federal Reserve says it has a dual mandate of stable prices and full employment."

MP: I've made some of these same points before.  In the inflationary 1970s, almost every measure of prices was increasing: food, energy, core inflation, wages, services, interest rates, etc.  We now have a wide mix of inflationary, deflationary and flat inflationary forces, along with decelerating wage increases and low interest rates, and that's not a formula that results in overall inflationary pressures.  At least not yet.  And since inflation for services has been below 2% for almost two years now, there's not inflationary pressure there.     

HT: Bob Wright


At 4/25/2011 12:14 PM, Blogger Benjamin Cole said...

A superb post by Dr. Perry.

The Chicken Inflation Littles are squawking about phantoms.

Yes, gold is up; Literally hundreds of millions of Indians and Chinese are buying gold for traditional reasons. They have huge emerging upper middle class.

Commodities are up on strong global demand, and some crop busts. Solid global demand is a good thing, not a bad thing. The higher prices will yield more supplies.

OPEC and thug states have limited the supply of oil. We can deal with it--or suffocate ourselves with a monetary noose around our necks.

M2 has been growing at around 6 percent for a long, long time. There is no case to be made for a generalized inflation.

There is a case to be made that we might be in a mild general deflation, and a serious asset deflation, marked by a Dow still below 1999 levels, and real estate at one-half peak highs. In fact, we are suffering from asset deflation, if you look at the numbers.

Consult your local astrologer for Shadowstats latest inflation "forecast." Or wait from Morgan Frank's post.

At 4/25/2011 12:54 PM, Blogger MaggotAtBroad&Wall said...

P&G announced today it's raising prices on diapers, toilet paper, and paper towels by as much as 7%. And it comes just a month after rising detergent prices by 4.5%.

Kimberly Clark said it's raw costs will double from what it had originally forecast for the year. It has raised prices by about 4%.

We have home prices continuing to deflate somewhat. Stagnant to very low wage growth. But rapidly rising commodities and materials prices are causing consumer goods manufacturers to raise prices on final goods by amounts far larger than the overall CPI. Gas prices have doubled since Obama's election.

How elastic is the demand for diapers, toilet paper and gas? How much substitution can there be? It looks to me like the average guy on the street is watching his standard of living wither away as more of his wages are being eaten up by staples.

At 4/25/2011 1:17 PM, Blogger Benjamin Cole said...


And you don't use a cell phone? Send e-mails rather than postage stamp letters? Do you heat your home with natural gas (now cheaper than a few years back)?

When you take 100 pix of your kids wih a digital--how much did that cost? And then send to mother, online?

Are you able to drive a higher mpg car than ever before? Buy more housing than ever before?

Office rents in downtown Los Angeles for class A today are about where they were--in the 1980s. Under $3 a sf per month. If you want to perfectly reasonable space, you can space in the Petroleum Building (a nice older building) for $1.65 a sf. Downtown LA has undergone a boom in recent decades, and is actually a nicer place than in the 1980s. Far nicer.

How about your hi-def TV, with a million channels (and nothing to watch--that never got better).

Food is a smaller fraction of the family's budget than ever before.

I concede health care is just awful. They are talking $20k a year in L.A. to cover a family of four. Our h/c system is not working, except for the lobbyists of the h/c providors.

At 4/25/2011 1:23 PM, Blogger morganovich said...

that chart is not terribly meaningful.

whichever you think is correct, comparing pre 1992 CPI to post 1992 CPI is not valid. it's a different methodology which makes the comparison apples and oranges.

of interest, look at the chart. 1992 is a clear break point on CPI. that's when it began this downward trend.

given that any geometrically weighted series with sticky prices will do this, it's not at all surprising.

it seems to me to be an awfully large coincidence to pretend that right when we switched methodology, we also entered into a productivity miracle and perpetually low inflation...

what's healthcare as a % of US GDP? 16-17% what is it's weighting in the CPI? 4-6%?

gee, i wonder why we're not picking up that inflation?

if you underweight a major segment of the economy (and one experiencing very high inflation) by 2/3, is it any surprise that CPI comes out low? this is even more pronounced in services, as healthcare is about 25% of the service economy.

so bubble baby benji, enlighten us. what possible valid reason is there to ignore 2/3 of a major sector of the economy when calculating inflation?

i await your answer oh of oracle of bar tables.

your ignorance is really astounding. we are not suffering from asset deflation. we are suffering from repeated bubbles and then their aftermaths.

At 4/25/2011 1:30 PM, Blogger morganovich said...


and do you drive or use healthcare or eat?

those are all MUCH bigger categories than cell phones. your communication costs could drop to zero and it still wouldn't make a dent in the recent increases in food and energy.

i doubt you spend 10% of what you do on food on communications. i certainly don't.

you argue all the time about housing going down and reducing costs, but that's an inconsistent argument. housing went up in price more than any time in US history from 2000-7. if it should cause deflation now, why didn't it cause inflation then?

get your head out of the sand benji.

being underwater on a mortgage is NOT affordable housing. it's the opposite. it has frozen our labor force who cannot afford to move.

At 4/25/2011 1:52 PM, Blogger Benjamin Cole said...

Morgan, Head Rooster for the Chicken Little Farm:

Yes, methodology changed in 1992, It had to, to keep up with the times.

When a business can start up today in downtown Los Angeles, while renting space for $1.65 a square foot (monthly) for nice offices, I cannot see inflation as a threat, That is less rent than in the 1980s. Add to that, such a business needs only a one cell phone, and no secretary (thanks to answering machines and online services).

Capital is abundant, holding down borrowing costs. Capital is cheap.

However, I will consult with my local astrologer to see if you are onto something. He wears a nice swami hat. He talks about secrets revealed only to him. There is a lot of smoke in the air, and enchanting pipe music. Your kind of guy.

At 4/25/2011 1:59 PM, Blogger MaggotAtBroad&Wall said...

Even Pravda on the Hudson is reporting clothing retailers like American Eagle, Brooks Brothers, Ralph Lauren, Aeropostle, etc. are jacking up prices as much as 10% with more increases expected this fall/winter.

I saw another article about how paint manufacturers are trying to pass through big increases on know that stuff used on the outside of houses that nobody is building. If they can pass through paint prices with housing starts running at the lowwest level in about 5 decades, well.....

Not only are prices for commodities, materials and finished goods rising like crazy, but inflationary expectations are back as demonstrated by the parabolic move in silver; non-stop decline in the dollar (about to make all time lows); and the TIPS spread is back to pre-crisis levels.

It's going to be interesting to see how The Bernank addresses these issues on Wednesday.

At 4/25/2011 2:19 PM, Blogger morganovich said...


i notice that once more you duck the key question, so let me restate it for you:

what valid reason exists to understate healthcare by 2/3 in the CPI calculation?

as ever, you resort to insipid grandstanding because you do not understand the issues being discussed and have nothing of substance to contribute.

attempting to compensate for stupidity and ignorance with childishness is unlikely to impress anyone, least of all me.

At 4/25/2011 2:25 PM, Blogger morganovich said...


though it appears to be offline at the moment, the MIT BPP was showing inflation of about 2% in just the first q of 2011. (annualizing to over 8%)

we see this same trend in all the regional surveys and in the price component of imports and exports, but of which are up over 10% from a year ago.

it seems like every price of objective data points toward inflation. the only place it fails to show up is in the BLS numbers because they have been manipulated in such a way as to underreport inflation.

clowns like benji will never see this, but i suspect the proposed price hikes you are seeing are going to be the way of things for some time.

QE has failed miserably and driven nothing but inflation. using any kind of rational GDP deflator (such as BPP) will likely drive us into real contraction in q1.

i'm not sure the TIPS spread is that relevant. aren't they pegged to CPI? i would not use them as an inflation hedge because i do not believe the CPI. wouldn't their spread be limited in terms if usefullness by this issue?

At 4/25/2011 3:22 PM, Blogger Benjamin Cole said...

Morgan Frank:

You have piled up some anecdotes, swirled in a few misconceptions about the BLS and CPI, and farted, and called the result divine.

Once I get past the P.U., I call your insights "financial science fiction."

At 4/25/2011 3:30 PM, Blogger James E. Miller said...

John Tamny from Forbes and RealClearMarkets has a pretty good article on why the CPI measurement can be faulty:

Just a snippet:
"Conversely, if due to productivity enhancements a laptop computer today costs $1,000 when it previously would have set a consumer back $2,500, there would be no deflationary event to speak of there either. Falling consumer prices, be they the result of productivity innovations or due to low-priced imports from overseas, can in no way change the real price level. That is so because cheap goods merely expand the range of products we can buy. If a consumer has $1,500 extra after the computer purchase, either through savings or immediate consumption that money is used to demand other goods that were at one time out of reach."

Tamny concludes that in the end, watching the price of gold is a great indicator of inflation and that many countries who have their currency pegged to the dollar (he uses Vietnam and Qatar) have seen substantial rises in their CPI estimate.

At 4/25/2011 3:56 PM, Blogger Benjamin Cole said...

All Tamny needs is a swami hat and lifetime membership in the Flat Earth Society.

At 4/25/2011 5:35 PM, Blogger Bernie Ecch said...

"We have inflation now. If you go to the shop, whether it's groceries or education or insurance or health care, prices are going up for everything. The government lies about it in the US." Jim Rogers, April 22

At 4/25/2011 7:29 PM, Blogger juandos said...

Per his usual style pseudo benny is long on wind and seriously short on credible substance...

The price of gasoline alone will be enough to drive inflation...

The following is from the API: The average U.S. retail price for all grades of gasoline rose this week by 5.3 cents from the prior week to $3.896 per gallon, according to the Energy Information Administration (EIA). This was at the highest level since August 2008.

Compared with the December 29, 2008 low of $1.670, the all-grade average was higher by $2.226 per gallon, or 133.3 percent. The average has been above $3.50 per gallon since the beginning of March 2011. Nominal prices have been above the year-ago average for 58 weeks —and were up by 98.5 cents or 33.8 percent, from the year-ago average of $2.911 per gallon

At 4/26/2011 6:18 AM, Blogger geoih said...

Quote from Mark Perry: " We now have a wide mix of inflationary, deflationary and flat inflationary forces, along with decelerating wage increases and low interest rates, and that's not a formula that results in overall inflationary pressures."

Quote from Benjamin: "The Chicken Inflation Littles are squawking about phantoms."

The song and the supporting choir continues. The monetary base has been increased by trillions of dollars, but there is no inflation. The prices of food, energy, clothing, commodities and stocks are all climbing, yet there is no inflation. And high unemployment, low wages, falling property values, and increased government spending (i.e., debt) are good things (they keep the inflationary calculations low).

I really can't understand why people don't think the economy is recovering, when obviously modern macro-economics is telling us it is.

At 4/26/2011 9:09 AM, Blogger morganovich said...



you are a know-nothing loudmouth who cannot answer my one simple question.

what valid reason exists to understate healthcare by 2/3 in the CPI calculation?

you are the one who defends the new methodology so vigorously.

so defend it. give me a reason?

17% of the economy is hardly an "anecdote".

healthcare is going up at 3X CPI.

to understate such a trend by 2/3 takes about 23% off the inflation rate right there. note that this is more that the entire difference attributed to a shift to geometric weighting by the boskin apologists.

you appear to lack even basic algebra skills.

and you wonder why i doubt your purported economic credentials...

At 4/26/2011 9:17 AM, Blogger morganovich said...

this ought to poke some holes in the "housing is cheap right now" argument:

"The share of renters who spend more than half their income on housing is at its highest level in half a century and it’s no longer just low-income tenants who are feeling the pain, according to a Harvard University study scheduled for release Tuesday.

About 26 percent of renters — or 10.1 million people — spent more than half their pre-tax household income on rent and utilities in 2009.
Developers cut back on such projects when the economy deteriorated in 2009, which drove down vacancies and boosted rents.
In many areas, the demand is driven by families who lost their homes to foreclosure ... [and] as the job market recovers, more newly employed young adults appear to be seeking their own apartments instead of living with their parents, putting even more upward pressure on rental rates ...

Recent reports have shown the apartment vacancy rate is falling rapidly - and rents are rising - so this situation is probably even worse now than in 2009. Note: The Census Bureau's Q1 Housing Vacancies and Homeownership report will be released Wednesday and includes the rental vacancy rate for Q1. "

sure, housing prices are low and rates are still not too bad, but anybody tried getting a loan lately? not without 20%+ down and fantastic credit you won't. cheap drinks in the VIP room do not help most of the guests.

but don't worry, the insane and tortuous "owner equivalent rent" calculation will keep it out of CPI so head in the sand simps like benji can keep squawking about low inflation.

it's amazing how low inflation looks if you ignore the prices of all the things that get more expensive...

At 4/26/2011 8:54 PM, Blogger VangelV said...

Government is adding value!!! How can any economist take seriously any chart that made that claim?

And since when is the price of tuition, health services, or recreation going down? You ever been to a concert these days? My 12-year old wanted to see Neil Young but there is no way that I will pay $400 for two tickets. He will settle for Gordon Lightfoot but that will set me back $200. Add another $20 for parking and $80 for dinner and we are out $300 for a two person outing. Does that seem like prices are going down? And have you ever tried to get Leafs tickets? After more than three decades of mediocrity you are still looking at around $200 for a decent seat. (The average price is $115 a seat.) I sure as hell don't see ticket prices going down for either concerts or sporting events. And movie ticket increases have been running at more than the reported inflation rate.

Now you could argue that the price inflation is only seen in Canada but I am sure that the Celtics, Bulls or Lakers tickets are not exactly cheap and have not fallen or stayed flat over the past decade. And the last time I looked, service industries also used gasoline and electricity, which have risen in price over the past decade, and were responsible for regulatory compliance costs, which have gone up significantly over the past decade and are scheduled to rise even higher once the healthcare legislation is implemented. Unless you are arguing that the service sector will reduce margins prices will have to go up.


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