Thursday, 17 March 2011

Some thoughts on the inflation front...

Another quick post, a bit more relevant this time, since inflation fears are on the up and people let their imagination run wild. I am not an expert on that stuff but I think that some of these fears, at least in the short-term, are overstated.

Producer prices are mostly affected by commodity prices and to a lesser degree by other factors like wage hikes. In the current environment, with unemployment in the US at record highs, I don’t think that overly high wage hikes are in the cards. Something else that can easily be observed is that during periods when commodity prices are elevated (which were increasingly frequent during the 00s) producers could not pass through the whole of producer prices increases to consumers so, in most of the cases, they see their margins compress. This can be measured by the producer prices-consumer prices differential. Here’s the chart.

source: Federal Reserve Bank of St. Louis

As you can probably see for yourselves, the Producer Prices – Consumer Prices differential is already pretty elevated, not far from the levels witnessed at the 2008 extended oil price rally. There is a crucial difference though, consumer process are much lower, although rising somewhat faster during the past 2 months. In my mind this is a clear indication of how fragile is private consumption (with such high unemployment it couldn’t be any different).

My humble opinion is that we will most likely see the producer prices – consumer prices differential rise to levels higher than those observed during 2008, provided that things do not get out of hand (I will explain what I mean here later on). If this materializes, then consumer prices will also rise but my view (for what is worth) is that we won’t see the CPI at the levels that we did in 2008. The continuing unrest in Middle East or MENA (Middle East North Africa),if you prefer, is pushing things in this direction, but I think that nobody knows how far will things go.

On the other hand, if the heart-breaking events unfolding in Japan, work like a dampener for the already fragile global growth, we could see a move in the opposite direction. A simple growth scare could send oil lower, now couldn’t it?

One of the deficiencies of the human mind is that it linearly extrapolates the present into the future. The unfolding drama in Japan and the markets’ reaction to it are a testimony of just that. At first, only the most direct consequences can be identified, but as time goes by, people realize that there are other maybe equally obvious consequences that weren’t identified at first. By that I want to say that I cannot picture what will come out of the Japan earthquake and that it could prove to be a lot (or even less) important than we can now grasp.

Global uncertainty is definitely on the rise lately (quite sadly since these are human lives that we’re talking here) and global growth is pretty fragile, so I think that it ultimately is a question of stagflation (negative growth coupled with high infllation) or modest inflation (but most likely higher than the present levels). These are just some quick thoughts and I could very easily be totally wrong here or I could have overlooked something important. 

For now I don’t want to delve deeper into this because I consider it a bit harsh to try to quantify or chart possible effects of the drama in Japan when at the same time people lives are at stake and unfolding events could negatively affect people lives for years to come.  Spare a thought for the brave Japanese people and pray for them…

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