The Producer Price Index, its latest iteration issued today, is calculated by the Bureau of Labor Statistics to show in which direction intermediate or wholesale prices are heading.  The FRED database puts the change in easy-to-read and understand graphical form, here’s the index for all commodities:

Graph: Producer Price Index: All Commodities

 Latest Observations:

Date 2010-10 2010-11 2010-12 2011-01 2011-02
Value 186.6 188.0 189.9 192.2 195.5

 

And this is the PPI for agricultural commodities:

Graph: Producer Price Index: Crude Foodstuffs & Feedstuffs

Latest Observations:

Date 2010-10 2010-11 2010-12 2011-01 2011-02
Value 164.6 165.3 166.5 173.6 185.3

 And because monetary velocity is closely tied to economic performance, here’s monetary velocity:

 Graph: Velocity of M2 Money Stock

 Latest Observations:

Date 2009:Q4 2010:Q1 2010:Q2 2010:Q3 2010:Q4
Value 1.678 1.698 1.702 1.702 1.692

What does this mean?  First, notice how prices have continued to climb even after velocity has started declining (the tail of the three graphs).  This also happened in 2008–prices climbed going into the recession until finally the weight of collapsing demand caused them to crash.  This could be happening again, as the economy appears it may have topped out in its recent growth trajectory.  The correlation between economic performanace and monetary velocity is not perfect.  It’s too early yet to tell whether the down-tick in velocity is just an anomolous lag downward on its way back up.  The post-2001 recession and post-seventies recessions each experienced velocity that declined for a while after the economy had begun expanding and in the sixties and eighties, velocity declined mid-decade without a correlative recession.

But fuel prices may be better than monetary velocity at signaling recessions.  As the following graph shows, fuel price increases are closely correlated, or have been since the seventies, to economic contractions, and fuel prices have increased substantially since just last year:

Graph: Producer Price Index: Fuels & Related Products & Power

Latest Observations:

Date 2010-10 2010-11 2010-12 2011-01 2011-02
Value 187.6 189.8 194.7 197.7 201.9

The rapid advance in fuel costs could very well portend the next leg down in aggregate economic performance.  But employment is increasing, albeit slowly, and aggregate employment levels have an almost perfect correlation with economic performance–when employment expands, so too does economic activity, and vice versa, except that employment lagged a bit coming out of the previous two recessions (1991 & 2001):

Graph: Total Nonfarm Payrolls: All Employees

Latest Observations:

Date 2010-10 2010-11 2010-12 2011-01 2011-02
Value 130015 130108 130260 130323 130515

The past is not necessarily prologue, but there is ample reason to be concerned about which direction economic performance may be headed, as the domestic economy is buffetted by international events that increase the risks of employment and growth stalling out sometime in the near future.  In some respects, both the Japanese earthquake and the socio-politico unrest in Arabia are events unique to this age, at least in magnitude, and even more so for having appeared at the same time.  While the events have little direct affect on US economic performance, the uncertainty inherent in the uniqueness might alone be enough to detrimentally impact US economic performance.

If worldwide demand contracts, or even just quits growing due to the earthquake and social unrest, commodities prices should decline, perhaps even crashing, as happened in late 2008 and into 2009.  Such a crash will be accompanied by a steep decline in monetary velocity, effectively shuttering a goodly portion of the money supply (hence the crash in prices).

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