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Friday, July 18, 2008

That 70's Show? PPI vs. CPI

Yesterday, we took a look at Headline vs. Core CPI. Today, lets see how the difference between PPI and CPI stacks up against historical norms.
Again, we haven't seen this type of differential since the early 1970's, when:

The central problem was that the US was engaged in a costly war it could not afford. One result was a weakening of the currency which – at a time of fixed exchange rates – chiefly expressed itself in a fall of the dollar versus oil and gold.
Sound familar? As can be seen below in a logarithmic chart of the Goldman Sachs Commodities Index, the recent spike looks very similar (albeit longer running) to that of the early 1970’s.

So are we headed towards 1970's level inflation? Not necessarily. The big difference between the current period and the 1970’s has been the inability of wages to keep up. For example, in June, real average weekly earnings were down 0.9% for the month, the third straight month when wages have not kept up with rising prices and the sharpest drop in real earnings since August 1984. For the year real average weekly earnings have fallen 2.4%.

Looking at the chart below, which shows U.S. average weekly earnings in nominal terms, one can see that wage pressure associated with the 1970’s hasn’t emerged. I see this trend continuing as a result of globalization (jobs can be moved around at a much easier level), a slowing U.S. economy (reduces demand for employees) and a significantly smaller presence of unions, especially compared to the 1970’s (less bargaining power).