Starting this week, Sunshine Notes will have a regular weekly report focusing on money supply statistics and selected economic data. The purpose of this blog entry will be to provide data and analysis that is otherwise underreported in the mainstream media.
On July 17th, the Federal Reserve disclosed that M2 actually declined during June. In its weekly report titled Money Stock Measures, the Fed indicated that its estimate of M2 showed a decline in June to $7,686.7 billion from $7,688.1 billion in May. In addition, nominal annualized growth of M2 for the 3 months from March to June, 2008, was +1.2%. Since the reported inflation rate (which is the headline CPI as reported in the June, 2008, BLS CPI release) for the same period was 7.9% (compound annualized adjusted), that means that in real terms M2 shrank at a 6.7% rate for the March to June period!
June’s money supply shrinkage is indicative of the continuing credit crisis and if the Fed does not move quickly to keep money supply rising in real terms the result will be both deflation and recession. This will happen despite high energy and other commodity prices and will translate into declining living standards for many Americans.
Barron’s reported on Friday, July 18th that the official calculation of CPI may be overstating actual increases in prices. In Inflation Readings May Be Inflated
(subscription required), Barron’s reports that owner equivalent rent (which has approximately a 30% weight in the calculation of CPI) may not correctly reflect falling home values. Over the last 12 months the owner equivalent rent component of CPI has risen 2.6% despite a large drop in the value of 1 to 4 family homes. Owner equivalent rent is supposed to track the “real cost” of owning a home. The idea is that the replacement cost of a home is the amount that it would take to rent an equivalent home and by tracking rental cost, inflation in home values is estimated. Utility and other home ownership costs are reported in separate CPI categories.
CPI is the most widely reported and used measure of domestic inflation. If it is not accurate, business and government leaders will make poor decisions because of flawed data.
If Barron’s analysis is accurate, core CPI will moderate in the next several months and investors should have a more benign future view of inflation.