Friday, January 16, 2009

The CPI Plunge Is a Great Thought

Today’s consumer price index dropped for the fifth consecutive month. This is part of the unwinding of the great oil shock that was an important, if overlooked, factor in the current economic downturn.

I noticed today that there is not much talk about the CPI amidst the hullabaloo of the government effectively nationalizing Citigroup and the Bank of America. Making these giant banks wards of the state is a terrible idea.

But the plunge in consumer prices is a great thought. It is a tax cut of massive proportions. The drop in retail gas prices alone has been variously estimated at $350 billion in new consumer purchasing power. In fact, real average weekly earnings have now risen four straight months on the back of the CPI drop. Over the past year, this key measure is up nearly 3 percent.

And while consumer prices are deflating, producer prices — which represent wholesale costs to business — have been deflating even faster with the plunge in energy and other commodities. Consequently, corporate profit margins are improving as costs drop faster than prices. This important development is also overlooked.

Inflation is the cruelest tax of all. It is a prosperity killer. But the inflationary decline is the most pleasant tax cut of all, and is a key part of the recovery process.

Although the stock market has stumbled in the new year, it too will benefit from the inflation tax cut. Remember, the capital-gains tax is un-indexed for inflation. As prices moved up towards 6 percent last summer, stocks moved down big-time. Now, however, the decline of inflation is reducing the effective tax rate on real capital gains from roughly 40 percent last summer to only 15 percent through December. This is a huge tax cut on stocks and wealth-creation. While President-elect Obama appears to be willing to leave the Bush tax cuts untouched in 2009, and perhaps 2010, the falling consumer price index is slashing the cap-gains tax rate in real terms.

In fact, this whole process of disinflation and its tax-cut impact on the economy is vastly more stimulative to future growth than the entire $825 billion so-called stimulus package announced by the House Democrats this week. Taxes matter. So does inflation. Recovery by mid-year looks more and more likely as a result.

And one of these days there’s gonna be a panic rally in stocks that will signal the next economic boom.