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“I keep my eyes wide open all the time I keep the ends out for the tie that binds.”
                                          Johnny Cash

Commentary & Analysis
What does inflation look like? Same question. Different answer.

I was listening to a Reuters interview with David Bloom of HSBC where he revisited an idea he said was already recently posed on Reuters. To paraphrase:

We continue to ask the same question [What is inflation?], but we have changed the answer. Before, inflation was bad and meant higher interest rates; now, inflation is bad and means a squeeze on real incomes and lower interest rates.

Also in on that Reuters interview was Shahid Ikram of Aviva Investors. To paraphrase one of his ideas defining inflation:

Higher headline prices of food, fuel, electricity and the like are reducing disposable incomes.

And then today we received this comment from a reader in response to our just-released May edition of Global Investor where we re-made the case for deflation:

1 problem, have you bought groceries or filled up your tank lately? Carrots and chicken are not commodities, but they sure as heck cost more- same for cheerios.

Mr. Bloom and Mr. Reader seem hung up on inflation that sounds an awful lot like deflation … or at least an environment that has opened the door to potential deflation. Only Mr. Ikram acknowledged the fact that this kind of squeeze on income will keep the consumer subdued and threaten economic contraction without further monetary stimulus. Here is a small excerpt from our May edition of Global Investor:

One can argue it is rising commodities prices driven by producers outside the US that is raising headline inflation. There is little inside the US that seems to argue for a serious inflation threat. Wages are subdued. Labor is abundant. And though some companies have raised prices, their ability to do so is still quite hampered given global competition.

In fact, one could make the case, and I will right now, that rising commodities prices (driven more by speculation than anything else, as I will show later) is sowing the seeds for stronger deflation ahead. Why? It’s because consumers are not seeing a commensurate rise in wages as the cost of essentials, food and energy costs, are rising. Therefore, they must curtail spending on other things in order to transfer that money to things they must consume—food and energy. Thus rising prices only transfers the same amount of money inside the system to food and energy producers at the expense of other producers of more discretionary products.

Changing the answer to the same question may be one way of proving one’s thesis correct. But regardless of how inflation is defined, it seems important to respect the potential for a major shock to the global economy and global markets at the hand of what could once be considered deflationary pressures.