By Mark Rossano (Originally Published Feb 5th, 2021)
We have constantly heard the narrative that inflation is low, and the Fed wants to maintain an “average” of 2% (meaning we can exceed the key level for an extended period of time). This would imply that we aren’t currently experiencing something well over 2%, but how many times have you picked up a product in the grocery store and thought to yourself, this feels lighter, but the price is the same, or in some cases even higher? Or tried to pay for health insurance and seen the relentless rise of prices year over year (my healthcare costs more than my mortgage)? You may be sitting there questioning your sanity . . . . well, don’t. We have had many conversations around inflation on the Primary Vision YouTube Channel, but here is a quick synopsis to show you: yes, inflation is real, and it’s here to stay.
There are several important leading indicators for inflation, but the key one is “prices paid,” because a large part of that cost will be passed on to the consumer. When we look at the below chart of “Inflation v ISM Prices Paid,” there is a clear follow of U.S. inflation as additional costs are passed on to the consumer. Over the last decade, we have benefited from the growth of automation and technological advancements that have reduced some prices, or at least held them constant year/year. Those benefits are ending with semiconductor prices rising in response to China hoarding, increasing demand, and computing complexity reaching new heights and costs. There is an important distinction as we talk about “prices paid” and “prices received,” which just means that businesses will also eat some of the cost. It all comes down to what can be passed on to the consumer, or what the market can tolerate before a person shifts to a replacement product. The replacement product is the caveat that can be used to explain why the Fed-quoted Consumer Price Index is below what everyone is experiencing. But COVID19 has created a significant amount of supply chain issues that are widespread across the system, increasing the costs of logistics and underlying shipments on ALL products. For example, when you are in the grocery store or pharmacy or retail outlet- all brands will be moving in one direction- HIGHER. The broad-based movement in costs that we experience each day will quickly appear, even in the manipulated CPI- which claims inflation of 1.4%! Just a trip to the grocery store/ a look at commodity prices/ a quick glance at Zillow/ health care statement/ Child’s tuition or daycare… will make you question how valid is this number?
All regions of the U.S. are seeing the same type of rise—here are just two examples of record-level price increases that are already at a store near you.
The issues aren’t purely locked in manufacturing. Service prices are also seeing pressure to the upside- even as many large ticket service items have seen price cuts due to lack of demand.
You might ask, but why is it manipulated? The Fed (and other central banks) need an excuse to continue printing and maintaining very low rates, and the ONLY WAY this would pivot to raising rates would be a sustainable move higher in inflation. The numbers are also being held down by a decline in the velocity of money: V= PQ/M. This is simplified as the price * quantity of goods and services produced (a unit of GDP) divided by money (keep it simple with M2). Even though prices have risen, GDP activity has declined and been stagnant over the last 10 years, while we have seen the denominator move higher month by month. So the velocity of a dollar isn’t going as far, which helps hide the fact that prices are moving up, because it isn’t being registered by lackluster GDP and surging money supply. By using the below excuse mixed with the perceived ease of moving to a replacement product, the Fed can claim suppressed inflation. If you eat concert tickets and drink oil, sure, you have experienced great deflation and are saving a ton of money! But you don’t. You live in the real world where things you are consuming day in and day out are going up exponentially as wages are stagnant or down for most of the U.S.
The U.S’s largest trade partner is China, where we import a significant amount of product. China has experienced a huge increase in product pricing that has been subsidized to a degree, but as China faces more economic hurdles, prices will be passed on through rising export prices. The below chart highlights the close correlation to China PMI Composite Output Prices and U.S. CPI. Some large firms, such as Apple, have shifted some of their supply chain into Vietnam to help reduce costs, but shortfalls in semiconductors, shipping prices, and other input costs might help shave some of the China price increases. It won’t be enough to negate these type of levels.
Well, you say, maybe it is just a U.S. and China problem—but it isn’t. Globally, delivery times remain a growing problem as inventories stay low, but employment has stayed in either a contractionary state or holding steady and not seeing a real expansion. The fact that it is a global issue while jobs are depressed keeps wage growth muted, causing savings to dwindle as prices rise on all daily goods.
Powell said it himself, “CHAIR POWELL: “[Lower interest rates] make it cheaper to borrow, they do raise asset prices, including the value of your home. But for people who are really just relying on their bank savings account earnings, you’re not going to benefit from low interest rates.” If you own a home, stocks, real estate, or commodity: Congrats! You are crushing it! But if you are the other 80% . . . well . . . Sorry? Instead, you are one of the many people that can’t benefit from the rise in prices to help offset the struggles you are seeing.
Single family rent in homes and apartments has only moved higher in the past year, except in some of the big urban areas, which are actually starting to see some support after brief price discovery. The below chart looks at “Median Asking Rents” vs. “CPI Primary Rent.” I think the growing discrepancy drives home the point . . . CPI will start to reflect what we all know so well- rising prices well above 1.4%. We can show charts of lumber as well just to drive home the insane pricing that is getting passed on to the consumer… But don’t worry, rates are low!
The rate of expansion in home prices is only expected to continue as the Fed maintains its goal of driving the U.S. closer to Japanification (massive government and central bank support and ZERO growth.)
You could sit there and say, Well this is all driven by COVID and won’t everything revert back to normal once the supply chain catches up? When we look back through time, some of the biggest monthly payments for the average American family: Healthcare/ Housing/ Education and Childcare have moved higher EXPONENTIALLY vs wage growth since 2000. The charts below demonstrate just how much costs have risen within this time frame. Wages will remain under pressure as hours worked, small business revenue, and amount of business open remain under pressure. Now we face further pressure on wages and, given the competition in the job market and other commodities starting to move higher, most importantly: food.
The world is facing a growing shortfall in food as nationalism rises within countries looking to protect their own citizens first. We have seen several Biblical sized locust swarms, swine flu, avian flu, droughts, floods, and other acts of God that will cause you to ask the question: Do the four horsemen ride? The world has more and more mouths to feed, and we face a food crunch that will take more than one growing cycle to replenish. This assumes that EVERYTHING goes perfectly. So far, it isn’t. Brazil has been slow to harvest and plant new crops, Thailand is facing severe weather that is impacting rice, and Russia is raising taxes over concerns in the wheat harvest—just to name a few issues. This has pushed the UN Food and Agriculture World Food Price Index to multi-year highs, and given the current backdrop, the price rise is far from over.
UN Food and Agriculture World Food Price Index
Price increases are already being felt at many income levels—especially the bottom three quartiles. Any type of stimulus would most likely go to replace what people have spent from savings in order to cover their rising costs. The below charts show how people are pulling more from savings as employment pressures remain throughout the system and are going to be much slower to recover. In 2019, we believed there was going to be real pain across the system as many “zombie” companies were looking for any reason to shrink their employment base. Our belief was: if 100 employees were laid off, the company would quickly hire back about 20% post lockdown and 30% over the course of the next 12 months. But 50% would not be working in the same firm, and many not in the same industry. The pressure on wages is going to mount as more people end up in Pandemic insurance/ Extended benefits and fear rises about potential work, pushing people to accept lower wages.
At the peak of COVID lockdowns, we briefly saw some deflation, but now the proof is everywhere: inflation is kicking back up with a vengeance. But we face a bigger correction coming in the markets. Tough comps with refined product prices rising, failed political and economic policies, a rise in poverty and falling food security—it’s easy to sit here and say we are in a bubble, but when or how does it end? In the past year, the U.S. saw the most people added below the poverty line since the 60s, and 43 million Americans are currently on food stamps. A lack of food, economic expansion, and social mobility around the world is creating a powder keg of geopolitical uncertainty that is playing out everywhere: especially in Asia. This next decade is going to be a weird amalgamation of the 30s and 70s, consisting of inflation, deflation, and borderline hyperinflation. The Fed has destroyed price discovery and has attempted to hold back the “invisible hand” with endless liquidity, or “market support” as they describe it. But market forces are greater than any one entity, and the spring-loaded hand will come around to slap us all.
