Those who fear inflation is set to take off have some explaining to do, considering the latest news on US producer prices. Meanwhile, the chances of a second dip in US house prices, possibly sparking off another recession, grows.

US producer prices rose by 0.7 per cent in March. That may seem pretty alarming. But then again, when you consider that food prices surged 2.4 per cent in the month and gasoline prices were up 2.1 per cent, the overall rise in the index seems quite modest. In fact core prices, that’s with food and energy taken out, rose by a mere 0.1 per cent, and the year on year rate fell from 1 to just 0.9 per cent.

There is a school of thought that says rising oil and food is actually a deflationary pressure. That if all else is unchanged, then a rise in food and oil means affordability becomes stretched and we spend even less on other items, forcing their prices down. In fact, in some ways a rise in oil has a similar impact on the economy as a rise in interest. A number of people fall into the trap of thinking 1970s inflation was down to rising oil. In fact, this is not the case at all. Inflation during that era rose because consumer spending increased faster than economic capacity. This was caused in part by the US government funding both the war in Vietnam and the space programme via the creation of new money, and in part down to rising levels of credit.

People make the mistake of assuming that because the Fed and Bank of England are printing money, inflation is inevitable. But the fact is, the credit crunch has not ended, and for as long as credit remains short, underlying inflationary pressures will remain muted.

Meanwhile, sales of existing homes in the US rose by 6.8 per cent in March, eliciting claims that the US housing crash is over. But these claims are wrong. The rise in sales is down to a rush to buy before a temporary tax credit expires. In this sense it is a little like the rush we saw in the UK in 1987, when people queued up to buy properties before the removal of mortgage double tax relief for couples. But there is one difference. In the US, despite the surge in sales, house prices according to the FHA index have been down for three months in a row. With the stocks of unsold properties still way too high, and with foreclosure notices on the up again, it seems that big falls in US house prices later this year are inevitable.

The IMF has been busily forecasting impressive growth for the US this year and next, but it is tempting to conclude it has learnt nothing. When US house prices began to fall in 2007, a chain of events was kicked off which eventually led to the worst economic crisis in over half a century. Economists totally failed to call that crisis, largely because they failed to grasp the link between house prices and the rest of the economy. The banking system and consumer confidence hinge on rising house prices. They didn’t realise this then, and the penny still hasn’t dropped today. Unless Uncle Sam can find a way of exporting a lot more, next year will be a tough one for the US.

© Investment & Business News 2013