One of the things that makes inflation so painful for households is the feeling that you are constantly paying more for less.
You know how it goes. You fill up your gas tank two-thirds of the way for what it used to cost for a full tank. Stop at the grocery store, skip the pricey produce section, fill the cart up with the private label goods, and somehow get rung up for more than you did last week. Downgrade the summer getaway from the beach to a house on a nearby pond and find it costs you twice as much.
This is what is happening throughout the U.S. economy, and it is bamboozling analysts and economists. On Monday, the Commerce Department reported that durable goods orders were up seven-tenths of a percentage point in May, far more than the one-tenth expected. The usual suspects reported this as evidence that the U.S. consumer remains a pillar of strength for the economy and demand continues to fuel growth.
Yet we know from the regional Fed reports out of Dallas, Richmond, and New York that activity declined in May. The May report from the Federal Reserve on industrial production showed that factory output declined on a national basis in May. None of these reports suggest that the manufacturing side of the economy is continuing to grow. They suggest stagnation at best, and most likely outright contraction.
So what’s going on? How can orders be up if output is down? The answer is that customers of U.S. factories are seeing exactly what customers of travel agents, grocery stores, and gas stations are seeing. Pay more, buy less. The durable goods orders are reported in nominal dollars, which means they are not adjusted for inflation. Once you adjust the 0.7 percent gain in order for inflation, you see that orders were either flat or declining in May. The nominal figure went up; but real orders, adjusted for inflation, were down.
It’s actually harder than it looks to adjust the nominal durable goods orders for inflation because the categories used to track orders are not the same as the groupings used for inflation. One option is to use the price change for consumer durable goods. This matched the change in orders, meaning prices of consumer durable goods rose 0.7 percent. This is an imperfect stand-in, however, because it misses the fact that quite a lot of the durable goods we are tracking in the orders numbers are not consumer goods. They are goods purchased by businesses, governments, and foreigners.
Steve Hanke, the Johns Hopkins University economist, indicated to us last year that he would look to a category called “processed goods for intermediate use” in the Producer Price Index. This would exclude the goods sold to consumers but include those picked up by businesses. Here we see that prices were up by 2.3 percent in May. This would indicate a pretty massive real contraction in orders, completely concealed by the nominal gains.
Economists often like to look at a sub-category called “core capital goods” as a bellwether for business investment. This excludes transportation and military orders. In May, core capital goods orders rose 0.5 percent. But the relevant category in the Producer Price Index data shows prices were up 0.7 percent. In other words, real business investment fell in May.
One of the other things that makes inflation painful is the chaos it causes in the economy. What looks like growth may actually be a monetary illusion. Contractions can be hidden beneath inflation. You might have a recession that no one notices until you are already months into it.