A Buck for the Barber

Story Highlights:

• With Tuesday and Wednesday's release of US producer and consumer price data, many will inevitably ponder inflation risks.
• Given the deflationary risks we've faced over the last year or so, some inflation is exactly what expansionary monetary and fiscal policies aim to achieve.
• A number of economic indicators bode well for economic growth while high unemployment and low capacity utilization continue to restrain inflation.
• As denoted by continued demand for historically low-yield Treasuries, the market little fears future inflation just yet. 

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It's been said, "Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair." Exactly right. Mostly (with a few notable exceptions) inflation in developed economies is gradual and typically (though not always) accompanied by economic growth. That means by the time we've got no hair and a pricey haircut—we can afford to pay the barber, even if the price seems novel.

However, with Tuesday and Wednesday's release of US producer and consumer price data, many will inevitably ponder inflation risks. November producer prices rose year-over-year for the first time since November 2008 and added 1.8% since October. Higher energy costs (+6.9%) accounted for most of the rise. But stripping out volatile food and energy, core prices still grew 0.5%—more than any month this year.

Rampant inflation is rightly a frightening prospect. But in the last century, unchecked inflation in the US has been the exception not the rule. In fact, of the three worst cases in the US, only one (during the ‘70s) took place outside a world war. That doesn't mean a major monetary error couldn't put us back there again—but we think that's unlikely in the near term. For now, moderate inflation is a good thing. In fact, with the deflationary risks we've faced over the last year or so, some inflation is exactly what expansionary monetary and fiscal policies aim to achieve.

Many will focus on CPI (the basket of consumer prices). But it's good to pay heed to producers too—business investment accounted for most of the recession's decline. And arguably, higher producer prices (i.e., the welcome absence of deflation) signal businesses are getting back to making things in anticipation of a brighter future.

But higher prices are just one symptom. There's more direct evidence business investment is recovering. Companies began restocking inventories in October for the first time in over a year. Industrial production added an unexpected 0.8% in November. Manufacturing capacity utilization rose to 71.3%—higher than the expected 71.1%. Even unemployment improved slightly in November. But because capacity utilization remains below its long-term average (80.9%) and unemployment is still elevated, the economy should be able to continue expanding comfortably without spiking inflation risk—at least for some time. Beyond anecdotal economic evidence, continued demand for historically low-yield Treasuries recounts the same tale.

Neither economic indicators nor market-based signals tell us it's time to fear inflation just yet—and that's largely true globally too. That means next year's haircut probably won't cost too much more than this year's. And it's likely a healthier economy and continued bull market will line pockets with a few extra bucks for the barber to boot.