Thursday July 14, 2005 - 11:27:05 GMT
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Black Swan Capital - www.blackswantrading.com
A deflationary world?
“As an illustration, let us take the American economy during the 1920s. This economy was, in fact, a mixture of two very different, and basically conflicting forces. On the one hand, America experienced a genuine prosperity, based on heavy savings and investment in highly productive capital. This great advance raised American living standards. On the other hand, we also suffered a credit-expansion, with resulting accumulation of malinvested capital, leading finally and inevitably to economic crisis.”
Murray Rothbard, America’s Great Depression
US Treasuries are approaching a key support area—the next move could have something to do with the “inflation” news associate with the release of the CPI data at 8:30 a.m. EST.
And strong inflation news would do much to put the market back in the aggressive Fed camp—possibly adding again to the already growing yield differential argument favoring the dollar. We don’t want to play the guessing game on the number—but we do believe despite today’s CPI and tomorrow’s PPI release, over the longer-term we are staring into a deflationary abyss globally.
There seems to be this belief that higher energy costs are inflationary. However, we see it as deflationary. Simple stated: Consumers choose to put gas in their cars and the additional money they spend goes to producers of energy—therefore Mr. Consumer have less to spend on other items. We think higher energy costs become inflationary when non-energy producers are able to pass-on the additional cost of production. And despite some budding optimism that manufacturers are gaining pricing power traction—it is hard to believe.
Real wage growth isn’t there for consumers. And there’s a place called China, and another named India, that continue to pressure final goods and services prices lower globally for as far as the eye can see.
We note this tidbit of news from The Standard this morning:
“’China's private-sector companies will probably trim investment because earnings aren't growing as fast as the economy,’ said JPMorgan Chase economist Frank Gong.” Private sector companies account for an estimated 60 percent of economic production in China. Hmmm…! And this is the interesting part: “There have been a lot of upstream price increases [imported raw material] that haven't been trickling down to consumers because downstream [Chinese] companies don't have pricing power,'' said Mr. Gong.
If Chinese companies don’t have pricing power given their relatively low cost of production, why should we assume US companies are gaining price-power traction?
The following summation of the situation in Europe and response by the European Central Bank (ECB) is an example of central banks’ using higher energy as cover for interest rate policy, despite the underlying dynamics; it comes from Greg Weldon’s excellent Weldon’s Money Monitor:
“Gee, rabidly rising energy costs, AND deflating income … means that even WITHOUT final goods inflation, and in fact, with price DISCOUNTING (as defined within the recent series of EU PMI Surveys) … domestic European demand is FAILING, and now, falling. Still, the ECB makes NO distinction between finished goods CPI and energy CPI, thus all they focus on is the overall rise in the year-year rate of pan-EU consumer inflation back ABOVE their ceiling of 2%.”
Maybe we get a surprise on inflation this month—and maybe the dollar rallies—or maybe it doesn’t. We seem to be in one of those zones whereby even if you guess the number right, you could be very wrong on the market reaction. But, given the US economy will probably be the last bastion of some growth relative to its competitors, should creeping global deflationary pressure rise, as we suspect, the dollar would seem to be the beneficiary over time.
Black Swan Capital
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