The Economy, Inflation, and Interest Rates

With each passing week, the economic damage wrought by the Coronavirus and the resulting shutdowns grows larger. It's not just businesses, both small to large, feeling the pain. Educational institutions, hospitals, churches, not-for-profits, and state and local governments are all finding it hard to remain financially viable.

The US has essentially turned off broad swaths of the private sector – the ultimate and only source of income and wealth creation. Without the private sector, there is no money to pay for government, schools, healthcare, or charitable organizations. To make up for it, the US has resorted to an open-ended expansion of the Federal Reserve's balance sheet (and expanded their power) and huge increases in government borrowing and spending, the likes of which the US has never seen outside of wartime.

As in 2008, many are worried that huge increases in Quantitative Easing and money growth, along with the purchasing of debt directly from the market, will lead to much higher inflation. However, for today, that doesn't appear to be a problem. The consumer price index (CPI) fell 0.4% in March and is up only 1.5% from a year ago. This morning, West Texas Intermediate (WTI) oil was trading at $11 per barrel, the lowest level since the late 1990s, and 64% lower than its March average of $30.45. This suggests another negative number for the CPI in April.

But the drop in measured consumer prices in March was not just driven by lower energy prices. Other factors included lower prices for hotels, airline fares, and clothing. What do all these categories have in common? A massive drop in customers due to the shutdown.

Sure, hotels are cheap today, but almost no one is using them; hotel occupancy rates are down about 70% from a year ago. Yes, anyone who flies can get cheap seats, but the number of people going through TSA checkpoints is down 96% from a year ago. Clothing prices fell 2% in March as sales at clothing & accessory stores fell 50%. Who had time to buy clothes when you had to stock up on groceries and toilet paper?!?

In other words, prices for the actual items people bought in March probably did not fall as much as the CPI report suggested, and the same argument will probably apply to April, as well. Bottom line: in the near term, while it may look like deflation, that's not true for the average consumer.

As we look further out, official measures of prices will eventually turn back up. We see multiple broad forces at work on consumer price inflation, which should prevent us from lurching into either high inflation or Great-Depression-style persistent deflation.