Thursday, August 05, 2010

I'm not enjoying deflation, I'm too busy suffering poverty

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.


Leftback said...

You're right about a lot of this, but you're way early about rates. Arguably a decade early... and the price pressures (more evident in the UK than the US) will probably prove temporary.

LB is thinking about the "spikelet" in commodities (steep, admittedly, but brief) that preceded the 2008 collapse. There we were, knowing full well that the banks had stopped lending to one another in 2007, and yet somehow crude managed to be bid up to $125, largely because the Squid decided to squeeze the living daylights out of a small trading firm.

With equities not looking cheap here, is it not likely that the Dinosaurs of Broad & Wall and the Greenwich and London HFs have decided to make some coin by bidding up commodities again for the summer? Of course this only works until it doesn't. The spike in crude in 2008 was one of the factors that precipitated the Great Recession.

The Cure for High Prices is High Prices. Once we reach the tipping point, then demand destruction is going to ride to the rescue and the dominance of deflationary forces will resume. Deflation might be quite enjoyable if we stopped fighting it. If the US accepted a shorter work week, longer vacations and lower pay, we could even have full employment.

Bob_in_MA said...

The problem with supposing that supply/demand of commodities will drive inflation is that inventories are at decade-high levels.

And why is it so hard to fathom a slowdown in Chinese demand? Car sales seem to leveling off, even with extensions of big incentives. And is there really no limit to the demand for empty apartments as a store of wealth?

The real price of commodities has generally fallen for over one hundred years. I remember how much people were freaked out by rising food prices in the 1970s, but the fact is, the proportion of the median family's income devoted to food commodities is much smaller now than in the 1960s, when it was much smaller than in the 1920s.

Polemic said...

LB - we don't think we are too soon short term re yesterday and we are happy with the big big picture for later... the middle bit may be harder we agree.

MA - we are more than happy to see commodities fall as part of a global, maybe china lead, slowdown. We just think that commodities going up while bond yields fall isn't sustainable. SO, pick one to sell or even sell both.

Leftback said...

Short-term (esp. August) is always difficult to call, but LB would not be all that surprised to see a modest sell-off in bonds, especially at the short end, and that's why we don't have any 2y or 5y. However, today's claims number was not much to write home about.

Given the state of inventories (esp crude and products), it seems likely that a lot of the mini-commodity spike is just liquidity and leverage seeking an outlet (wheat being an exception). So we would tend to favor selling commodities instead.

Without organic job growth or a currency collapse, it is hard to see inflation expectations rising significantly, and there is clearly a precedent for the yield curve to flatten further. If so, the long end of the curve seems to have the most favorable risk/reward profile. Obviously the risk in holding govies remains higher for gilts than USTs, at least for the time being, due to higher UK debt levels.

Patrick said...

I must correct you on this:
"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."

When the cells are blades of grass, the fertilizer is manure-based and the machines are animal labor, solar energy actually provides a better energy ROI.

For more information, I'll refer you to the writings of Joel Salatin:

Bruce in Tennessee said...

I think as this goes on longer and longer, it may be that it is as simple as deflation is in the demographics. Period.

BinT reads a lot about deflation and demographic trends, but here in the US we argue back and forth that we either are or are not like Japan. It may be as simple as our aging poplulation is less risk embracing than they were 20 years ago and two equity collapses in a decade or so has truly made them so much more disinclined to take chances that deflation is the outcome.

Polemic said...

Hello folks. Late night out in London so forgive any typos or overt brevity. The organic food horsedrawn idea is great but I really can't see it feeding the masses. If it could we wouldn't have moved away from it. Yields fall and acreage farmed would have to rocket and everyone is against switching wildlife to farmland. I have no idea how many fields of grass a horse needs per mile but I bet it cuts into the acreage yield for human food. So all the additional production is subsidized by fossil fuel. By the way I live very close to some famous organic gardens. The cabbages are always are stumps due slugs. We have to choose . Efficient farming or less people and the less people argument is apparently currently morally abhorrent. So match up moral arguments and decide. You can't have a moral acceptance of "as many kids as you like" whilst at the sametime telling others to cut consumption to cope with the new mouths. The pyramid selling of having to have a growing base of youth to pay for the elderly must stop. Expansionist economics runs into a wall once the earth is full. And it fills at the subsistence point. The guys that'll fight for your lifestyle. Flapping fish in a drying pond. Right sleep time.. goodnight happy campers..

FX said...


Just catching up on a handful of your latest posts.

In your swipe at the Swerve,I was suprised you did'nt add Money Supply and Mortgages( AVG 10yr) in your GBP TWI - Core CPI charts, may have been interesting looking back from 85.

Was'nt the BOE praised for being on the front foot in regard to ring fencing the banks and QE, I'm sure I heard at the time how BOE was waaaaaay ahead of the curve in regard to the FED.

I love the Swerve , I picked his tell long ago,bit like knowing what a dicey jockey is going to do from a thousand meters away before he does, actually I think there is a HF manager that'd go pretty good at that caper.

That jockey is a "Socialist Jockey" hes always getting the favourite home in the last.

That jockey is a "Capitalist Jockey" hes a "Team" rider.

Anyway, IMHO , the BOE are shitting, period, skewed heavily to downside risks.

The USA rates seem to have been reset to the real world we live in at the moment,imho, was fun watching the equities guys try and front run job growth until recently,
maybe now we can set the stage for some true valuations, but while their doing this I'm sure the Jobs data will now be even more volatile, definitely skewed to the

Who knows , maybe China is really different, you get or you don't.

cpmppi said...


I didn't include money supply because as far as the data goes, there is no discernable relationship between the two. Not sure what you mean with respect to mortgages?

The BoE did not ringfence the banks, that was the UK Treasury with its bail-out plan. Yes, I do remember the BoE being praised for being first to do QE, with the Fed behind the curve. But I don't think they would necessarily have had to get to this point had they acted earlier on in the crisis (recall the BoE base rate was still sitting at 5% when Lehman went under, while the Fed were at 2%. I view this action as them finally getting ahead of the curve having been consistently behind it for a long time.

My view of Merv is that he is desperately trying to rescue his reputation for History's sake. The trouble is that he is always fighting the last war.


Nic said...

There is quite a thoughtful post about the wheat thing on Wilmott's blog Strategic Reserves
Wheat could be quite a nice sell when (if) bucky finds his feet.