Thursday, August 05, 2010
One sector that is glaringly not singing to the Deflationistas' hymn sheet is commodities. While a rapidly-growing global population continues to compete, like bacteria on a Petri dish, for the basic resources of food and energy, the input component to basic living will keep local prices firm even in an environment of other localised deflationary pressures.
The world is still steadily competing for raw materials, so any slow down in the West can only express deflation through lower wages as competition for jobs tightens and hence labour cost inputs fall. So whilst service sector (higher labour component) may see a higher relative price deflation, the basic cost of survival, food and energy to the individual stays the same, or rises as we are now seeing.
That isn't an individual enjoying deflation, that’s an individual suffering poverty.
Look at what happened in 2008 in the UK to inflation (chart below - white line) on the gas (UK Gas Prices - brown line) and electricity price spike and we know what happened to wealth functions (UK Real Disposable Income, lagged 9months, inverse scale - green line).
And we must not forget that food production nowadays is almost all a matter of converting fossil fuels to food, as solar energy isn't enough alone to make the fertiliser and drive the machines and transport. So food is not only being competed for directly but via energy costs too - see below chart of Wheat (white line) and Oil (brown line).
This could all be looked at as a symptom of the big big macro picture that we mustn't lose track of. The one of the flattening of the global wealth gradient based on the rule that if someone is willing and able to do your job for less than you , you are stuffed. As the pressures on labour costs in the West are falling we see the Chinese wage costs rising. The labour costs balance one way facilitating the wealth balance going the other. I would suggest that there is still a long way to go but it was interesting that local UK TV was running a piece on some small UK companies coming home from India and China and 7/10 UK cos now saying UK is competitive. The Global Gods of the Big multinationals and the super-rich have become so mobile these days that their national boundaries vanished years ago and they are left to happily exploit the disparities that the rest of us mere mortals are bound by. One reason why major stock indices reflect local economies less and less. But these smoothing functions can only occur whilst there are no barriers to free trade. And the worse the effects for the mortals the more they will vote for something to stop it. Sanctions?
Or perhaps macroeconomic policymaking will change with respect to the unholy trinity of money supply, interest rates and FX. Targeting FX, rather than other two which are now effectively globally driven. Of course the first people to do this, or be PROVED to be doing this (looking at you Voldemort) trigger a trade war. Go back to "Sanctions". So we let money supply & interest rates be controlled by the market with banks controlling money and central banks reverting back to purely to being lender of last resort, leaving governments to follow FX policies that pursue zero current account balances (God forbid we mention SDRs or gold linkages). It all sounds too familiar.
The alternative is to let the rebalancing continue which, without true social, cultural and business mobility for the masses, will remain a painful process.
Of course whilst this argument of external pressures preventing a dramatic deflationary function in the West suggests less likelihood of bonds going higher (see Yesterday's post) one can equally argue that if you are suffering poverty and the inflation function is external and not controllable by domestic rates then you are NOT going to be wanting to raise them. HOWEVER, this could be countered by the risk premium function. If you are suffering poverty then folks are not going to be happy to lend to you. If you are able to repay then its only by printing money or by growth and both functions counter the original deflation argument.
So whilst TMM look forward to cheap haircuts, none of them is enjoying an increase in wealth. As with the markets, it may be summertime, but the living is squeezy.