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Wednesday, November 19, 2008 11:05 PM

CPI Drops Most On Record, What's Ahead?

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For many months now I have been saying the CPI was going to go negative and stay there for quite some time. This was an easy call to make given the plunge in commodity prices in general and gasoline prices specifically.

The effect would be even greater if housing prices were properly reflected in the CPI. For more on housing in the CPI please see CPI and CS-CPI vs. Fed Funds Rate.

Here is the BLS Consumer Price Index October 2008

On a seasonally adjusted basis, the CPI-U decreased 1.0 percent in October following very little change in September and August. The large October decline was the largest one month decrease since publication of seasonally adjusted changes began in February 1947. Compared to a year ago, the October index was up 3.7 percent. The energy index fell 8.6 percent in October following declines of 1.9 percent in September and 3.1 percent in August.

Motor fuel prices continued to decline in October, with the gasoline index falling 14.2 percent. Despite the decline, gasoline prices remain 12.0 percent above their October 2007 level. The index for household energy items declined 0.9 percent following a 3.4 percent decrease in September. Petroleum based household fuel prices continued to decline, but the October decreases were moderated by an increase in the electricity index. The food index increased 0.3 percent in October, a smaller advance than the average monthly increase of 0.7 percent during the June through September period.

Compared with a year earlier, the food index was up 6.3 percent. The index for all items less food and energy turned down in October, declining 0.1 percent to a level 2.2 percent above October 2007. Contributing to the decrease in October were declines of 1.0 percent in the apparel index, 4.8 percent in the airline fare index, 1.6 percent in the index for lodging away from home, and 0.7 percent in the index for new and used motor vehicles.

click on chart for sharper image

The CPI is still rising year over year, but this may be the last month for it to do so. Looking ahead year over year comparisons will become increasingly easy to beat, especially in energy and transportation. And with the drop in food prices at the commodity level some relief in food prices may be coming, possibly with a lag.

Gasoline Futures

Gasoline futures are back at 2004 prices.

Heating Oil Futures

Heating oil futures are back at 2005 prices.

Live Cattle Futures

Live cattle futures have been in a rising flag pattern since 2003. The recent channel break could be a headfake as in 2005 or it could be the real deal. I suspect the latter given falling grain prices.

Corn Futures

Weather and harvest dependent, there is no reason corn prices couldn't or even shouldn't fall back to $3.00 or lower.

Looking at food, energy, and transportation, as well as easy year over year comparisons, expect to see increasing talk of deflation in the mainstream media. They are way late to the ballgame of course, because

1) Prices are a very lagging measure of monetary policy
2) Inflation and deflation are about money supply and credit, the latter being more important.

After predicting deflation for several years, on March 17th 2008 I stated it had arrived.

Deflation Call Timeline

March 17, 2008 Now Presenting: Deflation!
Current accounting rules allow banks to pretend. And certainly the Fed is going out of its way to bend the rules to allow new forms of pretending. Expect to see still more accounting rules that allow broker dealers to pretend.

However, all the pretending and misdirection about the sinking dollar and the price of gold cannot stop the fact that deflation is about contraction of money supply and credit. The former is not growing and the value of the latter is collapsing no matter how many pretend otherwise.

It's time to face the facts: Deflation is right here right now.
April 22, 2008 Deflation In A Fiat Regime?
The mad scramble by some corporations to raise capital, the scramble by others to play "hide and seek" with level 3 assets, and the scramble by virtually
everyone to play swap-o-rama with the Fed supposedly just to prove the process works tells the real story. The real story is deflation.
August 10, 2008 The Future Is Frugality
We are in deflation now, but few see it because they do not understand what deflation is: a net contraction of money supply and credit.

The only question now is how long deflation lasts, not whether it gets here.
October 10, 2008 Roubini Discusses the Double D's, Deflation and Depression
So far, none of the liquidity measures taken by the Central Bankers have worked.
The reason is simple: You Cannot Patch a Busted Dam With Water no matter how hard you try.
November 11, 2008 Industrial Bond Yields Strongly Support Deflation Thesis
Those harping about prices of consumer goods, food, services, etc., are missing the boat about what deflation is and what one should expect in deflation. Trillions of dollars of debt are being wiped off the books via bankruptcies and foreclosures while inflationistas worry about the price of eggs going up by 35 cents.

The data are crystal clear. We are not in a period of inflation, we are not in a period of stagflation, we are not in a period of disinflation. If you exclude all the options proven to be impossible, the remaining option no matter how unlikely it may seem at first glance, must be the correct answer. That answer is deflation. We are in it, and have been for some time.

The S&P 500 is down about 45% this year, credit is collapsing, foreclosures are at all time highs, credit card defaults are soaring, unemployment has risen from 4.4% to 6.5%, short term treasury yileds have collapsed to 0%, and the long bond yield has fallen like a brick, yet only in the last couple weeks has anyone in the mainstream media been talking about deflation. That alone should tell you how silly it is to be focusing on prices as a measure of deflation.

Auto manufacturers, insurance companies, banks, and brokerages are all effectively bankrupt. Banks have lent out 10 times more than can be paid back, and brokerages are in even worse shape

Those who focused on Peak Credit and its counterpart Peak Earnings saw this coming. Those blindly looking at prices or money supply alone are still trying to figure out how and why treasury yields are where they are, the stock market has collapsed, commodities have plunged, and banks are scared to death to lend.

Looking ahead, there is every reason to expect increasing foreclosures, rising unemployment, rising bankruptcies, rising defaults, and rising corporate bond yields. Yet Bernanke cannot cut rates other than symbolically as the Fed Funds Rate is effectively trading at zero.

Welcome to deflation Ben Bernanke. You, Greenspan, and the Fed caused it with your serially bubble blowing activities.

Mike "Mish" Shedlock
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