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Investing Life Wealth

How Can Inflation Coexist with Deflation?

The inflation vs deflation debate isn’t so simple. Two major trends are influencing the global economy. These trends will likely exist for the rest of our lives.

How does one explain a world in which macro trends are deflationary (DumbWealth: The Case for Deflation) yet the basic necessities of life are increasing in price?

While it sounds contradictory, the two paradigms can coexist. Look at housing prices and healthcare costs over the past 10 or 20 years. Look at commodity prices during the 2000s.

From the late 1990s to early 2010s commodity prices across the board were going through a super-cycle, driven by rising Chinese demand. Commodity prices were booming, yet – despite some cyclical bounces along the way – the secular disinflationary trend that began around 1980 continued until present day.

Medium Term Crude Oil Prices

Makes no fucking sense, right?

There are those who argue the CPI stats don’t reflect reality. The thing is, price ‘reality’ for one person isn’t ‘reality’ for another. We all have different baskets of goods and all spend different proportions of income on those goods, so our true experiences will differ.

ShadowStats has re-calculated CPI based on its own interpretation and has consistently printed double the reported inflation rate:

So, despite the long-term deflationary pressures of debt, demographics, productivity and imports, one must still respect how quickly commodity prices have risen lately. We’ve seen this battle before.

Over the near term, we’re going to see rising prices. Perhaps the scariest part of all this is how quickly global food prices are rising. Over the past year, the FAO Food Price Index has risen almost 40%!

This doesn’t necessarily mean that you’ll witness a 40% price increase in the grocery stores or a huge impact to your food budget. However, for the poorest portions of global society this could mean the difference between paying rent and feeding their kids.

In the end, the cure for high prices is high prices. This means two things.

  1. Much of the current increase in commodity prices is caused by supply chain issues created (exposed?) by the pandemic plus growing shortages of raw commodities. Higher prices are incentivizing production (and delivery) to quickly come back on line, which will eventually mitigate further price increases – potentially even lowering prices.
  2. Higher prices could break demand. At some point people simply can’t afford to pay higher prices. There’s an argument that the final straw that broke the housing market’s back prior to the 2008 Global Financial Crisis was higher gas prices. People could no longer justify longer drives, eroding demand for new suburban sprawl developments. Simply put, higher prices eventually erode demand somewhere, somehow and this can have a domino effect on the economy, ultimately replacing rising prices with a deflationary shock. This is what we saw in 2008.

Final thoughts

Although the ‘peak oil’ movement seems to have disbanded with the influx of lower quality, relatively expensive American shale oil, it is quite possible the world is riding a deflationary low-tide coupled with broad resource shortages that result in inflationary waves.

My prevailing shower theory (i.e. something I came up with in the shower) is that the secular deflationary forces will remain omnipresent, but most of the world will fixate on the boom/bust cycles driven by resource demand and shortages, exacerbated by fragility in the global just-in-time supply chain.

There will be rotation from good times to bad and back, but ultimately there is no end to this inflation-deflation battle. We can’t make more easily accessible, high quality oil, copper, etc. Yet, ‘economic progress’ requires us to use more and more. However, demographics and debt will continue to act as a counterbalancing force for our destiny.

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