The Skeptical Optimist

Inflation is rising. No it isn’t. Yes it is. No it isn’t.

Inflation—too much of it—is highly undesirable, for a number of reasons.  I think the worst effect is that it diverts investors’ attention towards beating inflation, and therefore away from innovating and job-creating.  That’s why I habitually watch what the experts have to say about inflation, and that's why I post the USA Inflation Meter in tandem with the National Debt Thermometer. 

Recently I’ve been watching more closely than usual, because the bond market, the recent economic indicators, and the economic pundits are all throwing off mixed signals.  Result: Cognitive dissonance.

What’s cognitive dissonance?  Remember in the movie Alien, when freshly-decapitated robot Ash was uncontrollably spinning around the cabin, bouncing off walls, and squirting robot-juice all over the place?  Well, that’s what the economics profession does when it can’t agree on whether inflation is rising, falling, or treading water.  That’s cognitive dissonance.  (I do like it in one respect: it adds an entertainment dimension to economics.) 

To illustrate, here’s what a sampling of economists and pundits have said recently about the inflation outlook (in no particular ideological order):

Greenspan: “As I have noted previously, the federal funds rate must rise at some point to prevent pressures on price inflation from eventually emerging. As yet, the protracted period of monetary accommodation has not fostered an environment in which broad-based inflation pressures appear to be building.”  [link]  [By the way, this is also an example of why I think Greenspan should read this book.]

Reich: “...the Fed is fighting a ghost. Inflation is in no danger of getting out of control.” [link]

Kudlow: “Please allow me to express my skepticism over the likelihood of a significant inflation breakout to the upside.”  [link]

Kash: “. . . the market seems to expect no further increase in inflation. Myself, I'm less sanguine.” [link]

Krugman: “. . . inflation is creeping up, and it's doing so despite a labor market that is in worse shape than the official unemployment rate suggests.” [link]

Wesbury: “Despite recent weakness in economic data, our forecast continues to include robust growth accompanied by accelerating inflation.  As a result, we expect the fed funds rate to be 4.50% by year end.”  [link]

For what it’s worth, whenever the economics community as a whole is suffering from cognitive dissonance (as it is today), I usually rely on Brian Wesbury’s guidance.  Besides being correct a lot, his writings are brief, to the point, fact-based prognostications.  Objectivity overwhelms ideology in Brian’s writings; that, I'm noticing, is rare in the world of economics, which was recently called “politics masquerading as science.”  Visit Brian’s website and see what I mean; subscribe to his email reports, too.   

Anyway, at the bottom of my Debt Thermometer post for April, I added a chart of key interest rate trends, using the Fed's month-by-month data.  The chart below turns up the magnification by showing the weekly data (as opposed to the monthly data on the other chart).

Click to enlarge. 

If the market perceives rising inflation, we should see the interest on the 20-yr bond begin to rise.  Is it?  Even when I turned up the magnification (from monthly data to weekly), it was inconclusive.  If all I had to go on was the chart, I’d probably lapse into cognitive dissonance. 

Fortunately, the chart is not all I have to go on.  I also have Brian Wesbury’s guidance.  “Accelerating inflation” is what he sees, and that’s an ominous cloud looming over the economic growth landscape.  This bears close scrutiny in the coming weeks and months.

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UPDATE, 10:45pm Monday, May 2, 2005:  I just found out that Brian Wesbury will be co-hosting CNBC's Squawkbox tomorrow morning, 6-9am Central time.  Listen to him and see what I mean.  I'm going to TiVo it.  (FYI, "TiVo" is a verb now, not just a noun.)

National Debt Thermometer, 28-Apr-05: Ominous

The USA’s debt burden dropped this month, and I’m not happy about it.  Reason: It’s looking suspiciously as if rising inflation is the main reason it dropped.  First the chart, then I’ll explain what’s ominous about it.

Click to enlarge.

[Origin of Debt Thermometer]
[Full history of the debt burden]

The debt burden numbers above look like good news, don’t they?  The USA’s dropped a little, so did Canada’s, and the gap between us and several of the Euro area countries is widening.  The reason ours dropped is because nominal GDP is now growing at a 6.2% annual clip, and that’s faster than our debt is growing. 

What’s ominous is the Inflation meter (below all those happy-looking debt burden results).  Inflation of 3.2% is getting outside of the comfort zone, and it accounts for more than half of the nominal GDP growth.  Not the right way to reduce the debt burden. 

I have some research to do on this, and it will be the weekend before I can get to it (reason: swamped at day job).  Is the trade deficit starting to drive the bellwether (20-yr) bond’s interest rate up?  Until now, that bond—presumably a favorite of the mega-savers in China and Japan—has been bucking the inflation-pressure trend that the Fed has been seeing.  Look for more on this subject by Sunday.  In the meantime, here’s one of the charts I’ll be analyzing. 

Click to enlarge.

UPDATE:  See a blowup of this chart using weekly data in my subsequent article on this subject.

Butterfly at the Reagan Library

Here's the Berlin Wall picture I said I'd bring back from our visit to the Reagan Library.  Alongside is an excerpt from Reagan's speech at the Wall.  The prediction came true 881 days later.

As I looked out a moment ago from the Reichstag, that embodiment of German unity, I noticed words crudely spray-painted upon the wall, perhaps by a young Berliner: "This wall will fall. Beliefs become reality." Yes, across Europe, this wall will fall. For it cannot withstand faith; it cannot withstand truth. The wall cannot withstand freedom.

President Ronald Reagan
Remarks at the Brandenburg Gate, West Berlin, Germany
June 12, 1987

The perfect diet, based on a new study

Jim Glass has convinced me to adjust my eating habits.  He found out about a new study that says it’s not only bad to be too fat, but it’s also suboptimal to be “normal” weight; in other words, lifespan maximization happens when I’m a little overweight, but not obese. 

Okay, I got it now, and I’ve adjusted my plan accordingly.  This two-tiered diet should be just about right. 

1: Monday, Wednesday, Friday, and Sunday I’ll have a glass of wine with a plate of this stuff.

2: Tuesday, Thursday, and Saturday, I’ll shift to a few beers and one or two of these (click here).  That should do it, I figure. 

[Here’s the article Jim wrote that got me straightened out.]

Bid these with partner: 23-Apr-05

Call your bridge partner.  Then click on the red group below, while partner clicks on the blue group.  Each of you bids your two visible hands.  When finished, you can both discuss the hands using double dummy.  (Origin.)

•SouthWest, •NorthEast, and •DoubleDummy
(Click on a color group.)

The Flat Tax is Progressive

The Economist (April 16-22 2005) has reopened the Flat Tax debate, but this time with a potent weapon: facts and empirical evidence from other countries over the last ten years.  That’s a welcome new dimension to what has, until now, been mostly an ideological standoff.  It has boiled down to this: 

Proponents: “The Flat Tax is fairer, and its simplicity promotes growth; everybody gets richer.  Ironically, the rich end up footing more of the bill.”

Opponents: “A Progressive tax is fairer.  Under a Flat Tax, the rich make out like bandits, at the expense of the poor and middle class.” 

[To see which way the evidence is pointing, read The Economist's article.]

The debate is broad, and has too many facets to cover in this post.  For example: Should the EITC stay or go?  Should mortgage deductions stay or go?  Should we flatten the regressive FICA tax too, or leave it alone?  What about business taxes?  There are many more of those questions, and all of them have emotional and ideological dimensions that are arguably larger than their economic dimension.  I’m not tackling those here. 

However, there is one aspect of the Flat Tax debate that can be (and needs to be) clarified: It’s not a question about a tax system that’s progressive versus one that’s not progressive.  Why?  Because the Flat Tax is progressive, and that is a mathematical certainty.  Nevertheless, flat-tax-nonprogressivity is frequently an implied premise that’s permitted to go unchallenged.  Entire articles in prominent newspapers have been written under that false premise.

Here’s the key: Every “flat” tax proposal I’ve ever read contains an exemption of some size.  In other words, the first “X” dollars of anyone’s income is exempted from taxation.  (Moreover, any politician who attempted to propose a zero-exemption flat tax would face immediate extinction; it simply will not happen, you can count on it.)  Consequently, the effective tax rate (tax dollars as a percent of income dollars) always grows as income grows.  It asymptotically approaches the advertised “flat” rate, but never quite gets there. 

The chart below illustrates the progressivity of several hypothetical flat tax systems, simplified to illustrate the point.  Note that, in every case, anyone with a higher income pays a higher effective tax rate than anyone lower on the income scale.  The effective rate is a curve, not a straight line—and that is the definition of “progressive.”  The rich not only pay more dollars, but they also pay higher percentages. 

Click to enlarge.

Bottom line: There’s plenty to debate, such as the exemption amount, the tax rate on income above that amount, which deductions are allowed, etc.  But there’s at least one thing that’s not debatable, and it's this:

The Flat Tax is progressive.

Popcorn breakthrough at Purdue

At last, the mystery of old maids is solved, thanks to my alma mater.  The mystery: At the bottom of my popcorn bowl, there are always approximately twenty unpopped kernels per quart of popcorn.  Why is that?  It's been a minor puzzle to me for fifty years.  (If my experience is the norm, that means we Americans have to put up with a half trillion of those annoying things every year.)

Here's the breaking news on good kernels vs. bad kernels:

"They're sort of like little pressure vessels that explode when the pressure reaches a certain point," said Bruce Hamaker, a Purdue professor of food chemistry. "But if too much moisture escapes, it loses its ability to pop and just sits there."

It's fun to watch science continue to close those knowledge gaps.  Now we can move on to the next pressing issue. 

Why Californians pay more for gasoline

During my recent vacation to California (one of the best I’ve had, for a lot of reasons), my quick calculation revealed that Californians are paying ~30% more for gasoline than Texans are.  Okay by me; California air was a lot cleaner than it would have been otherwise—i.e., without the taxes and restrictions that I suspected had driven their state’s gasoline prices up—and I liked breathing cleaner air than they would have had otherwise.  Paying $2.70/gal for ten days of driving down that beautiful coast was no problem for me.

So, why did I hear several Californians, at different times during the week, complain about the price of their gasoline versus prices in other states?  Must be those greedy right-wing corporations secretly colluding with Rove to punish the big blue state, I almost said.  (When in Rome, do as the Goths do?  Nah, bad idea; better to be a polite, noncommittal tourist.  Why come across like a jerk when I’m in the middle of the best vacation in memory?  So I just shrugged and empathized each time.)

On my return to Texas, though, I double-checked my assumption about California’s taxes and restrictions.  Bingo: The DOE has a nice page explaining the California fuel price difference.  Here’s an excerpt (from a page that looks to be at least two years old by now):

The State of California operates its own reformulated gasoline program with more stringent requirements than Federally-mandated clean gasolines.  In addition to the higher cost of cleaner fuel, there is a combined State and local sales and use tax of 7.25 percent on top of an 18.4 cent-per-gallon federal excise tax and an 18.0 cent-per-gallon State excise tax.  Refinery margins have also been higher due in large part to price volatility in the region.

In short, cleaner air costs extra; personally, I'm happy to pay the premium while wearing a smile when I visit.  And when I'm in Texas, I'm happy to receive that cleaner air two days after Californians have used it.  Thank you, California.

[Incidentally, by vacationing domestically instead of in Europe, I saved a bundle of money.  Part of that money just went for a new laptop, to make mobile blogging easier next time I go to wine country.  The rest of it is still in the savings account, which is denominated in dollars.]

Thank me very much. Sincerely, Richard Nixon.

Ten days ago, my wife and I revisited the Schramsberg Vineyards in Napa valley; it’s our favorite stop every time we make a trip to wine country.  Don’t miss it next time you go.

I enjoyed a good chuckle while examining all the framed memorabilia hanging on the walls—specifically because of the contrast between two thank-you letters.  One was from President Ronald Reagan, who thanked the Schramsberg folks, in his typical style, for providing the superb sparkling wine that had made an important event at the White House such a success.  The other was from President Richard Nixon, who came up with an upside-down way of thanking them.  I remember both of those styles; they're like fingerprints.  Below is a picture of Nixon’s.  (The red underlines were added by me).

Click to enlarge.

Meteor Crater Caption Contest

Flight paths between Dallas and the west coast frequently pass within eyeshot of Meteor Crater, which is 19 miles west of Winslow, AZ.  Last week, as my wife and I flew to California for our drive down the coast, I made a mental note to post a caption contest after returning to Texas.   

Actually, it’s no contest at all.  We already have a winner, after one and only one entry.  It came to us from a Southwest Airlines pilot a few years ago, who told his passengers what one of their flight attendants said the first time she looked down and saw the crater.  What did she say?  See the caption below.

Wow, it almost hit that road!