Friday, December 14, 2007

Inflation vs. Unemployment

Here comes the most obscure roller coaster ride charts I've done yet. Please make sure your seat belt is securely fastened.

The x axis represents the average unemployment rate over the previous 12 months. The y axis represents the average year over year change in the CPI over the previous 12 months. In other words, it is a moving average of the last 12 months worth of year over year CPI growth figures. I know it is a bit confusing, but I wanted to smooth out the data enough to make sense of it.

This is what it looked like when we were on a gold standard. If unemployment picked up in the long-term, you could pretty much expect inflation to turn down in the long-term. Note how the blue linear trend line tilts down. Not shown on the chart is the Great Depression. Picture that blue line extended out with very high unemployment.

This is what it looks like now that we are not on a gold standard. If unemployment picks up in the long-term, it isn't as clear to me that inflation will turn down in the long-term. Note that the blue linear trend line tilts up. The 1970s are shown on this chart. What a wild ride that was! The good news to me when I look at this is that someone was at least trying to tame the beast.

Had I been investing in the 1970s I would have been very inclined to panic. Right or wrong, I'm determined not to panic if we relive that era. I'm going to try to ride it out. That could be a very big mistake though. Hopefully inflation will stay somewhat tame and save me from testing my resolve.

As far as current inflation goes, we're in a relatively sweet spot (using the rear view mirror). Unemployment is still relatively low. Inflation is still relatively low. There's some pressure due to recent inflation and higher unemployment numbers though. All things being equal, we should therefore start drifting up and to the right a bit from where we currently are. Let me zoom in on the chart and show that to you.

One has to wonder if all things are being equal. I have a very uneasy feeling about the housing market. However, I also have a very uneasy feeling about our dollar and oil. Two wrongs are very much trying to make a right it seems. Then again, they've been doing that for as long as I've been bearish (over three years).

I also want to remind you that our current point on these charts is not where we currently are. There's a lag imposed by using moving averages to smooth the data. Therefore, the current point on the chart is under pressure to slowly move to where we actually are. In other words, up and to the right is somewhat baked-in.

See Also:
Trend Line Disclaimer

Source Data:
St. Louis Fed: Civilian Unemployment Rate
St. Louis Fed: Consumer Price Index for All Urban Consumers: All Items


Anonymous said...

In 1998 I thought that thing's had gone too far and started to sell our small investment in equities. My timing was pretty good: I'd sold almost the lot when the dotcom bubble burst. I hadn't bargained on Mr Magoo deciding to replace that bubble with a monster property bubble. A huge bust seems to be unavoidable.
"Greenspan's ma name
Asset-inflatin's ma game" should have been his motto.

Stagflationary Mark said...



I was much more naive in 1998 (or so I think anyway). I was 80% in the stock market when it finally crashed. At least I didn't own dotcom stocks though and actually managed to turn a decent profit by 2004.

I will say that banks are what got me to sell my stocks in 2004. I didn't see any way that ride could continue. Citigroup and Chase were the first to go.

Ever see Force 10 from Navarone? I swear we must be watching the dam right now and are simply awaiting the cracks to get bigger.

Yes. Well, they're probably experts at building things, whereas I'm an expert at blowing them up, and you can take it from me that one would need a good eight hours to make a decent job on that bridge. - Miller, Force 10 from Navarone

Picosec said...

You do such good work that I'm not hesitant to suggest even more.

On these charts have you considered creating a lead or lag between the two variables to see if a higher degree of correlation can be obtained?

Stagflationary Mark said...


Sounds like a good idea. I'll see if I can spot a pattern.

If nothing else, I was wondering how I could turn some of my most complicated charts yet into something even more complicated, lol. ;)