Category Archives: Deflation

Why central bankers are completely wrong about inflation

Central banking is built on an outdated idea that could prove to be the undoing of the global economy.

Disastrous models are built on simple assumptions.

That idea in central banking is to target inflation in goods and services. The consumer price index is the holy grail of inflation watchers.

Here is the assumption, here is the part where it works in the model, heck it even worked in practice in the 20th century world. The assumption is a rising CPI is driven by domestic demand. The assumption is that workers are making more in a hot economy and buying up scare goods. Because the economy is expanding those workers will be asking for wage hikes and before you know it you have a wage-price spiral.

In a globalized world, that assumption is wrong. Inflation is coming from currency weakness, bubbles like housing and commodity shortages. Almost any non-commodity good can be produced in near-unlimited quantities at far below the cost of manufacturing. A factory in China can re-tool to produce more in a month so there’s hardly even a lag.

Meanwhile, inflation is non-existent in wages. Real median household income in the US is 8.3% lower than in 2007 — that’s wage deflation at more than 1% per year.

US real median household income in 2012 dollars
US real median household income in 2012 dollars

The borrowing function is also broken

Central banking models work great in a localized economy when central bankers could choke out domestic inflation or spur the local market with interest rates. The idea of low interest rates is that it gives companies and incentive to borrow and invest. Globalization has changed the model: borrowing is done in the US and  investing in China and the developing world.

Picture yourself owning a corporate in the United States: the Fed cuts rates so now your borrowing at cheaper levels. You’re ask workers to take a pay cut because the economy suffering or you announce layoffs.


You refocus on selling globally where economies are stronger and eventually the economy picks up. Soon you have some pricing power for your product and business is good. You raise prices and that creates some domestic inflation.

In the meantime you’ve opened new markets. It’s time to invest so what do you do? Borrow money in the US and expand where there is growth and where wages are cheapest. One thing you don’t do is hire back those workers or give them a raise. No way, no how, no chance. If the Fed burns another $3 trillion to knock 80 basis points from long-term rates it doesn’t change the equation. If you need to replace skilled workers, hire a new graduate with $100K in debt and train him. He’ll work for whatever you want with those monthly payments looming.

students no layoffs

The Fed has the power to create inflation but it can’t create wage inflation in a globalized world.  At the same time, Fed-fuelled bubbles have pushed up the prices of hard assets and devalued the currency so it hits workers on both sides.

Governments should be targeting wage inflation

Japanese PM Abe
Japanese PM Abe

Japan has been fighting this conundrum for more than 20 years. The only way the central bank has been able to stimulate the economy with quantitative easing is by devaluing the currency. Even then, a 30% decline in the yen last year only created 1.7% growth and 0.3% inflation.

They have tried everything to create inflation and prices are still well below 2008 levels.

What’s Japan doing now? It’s targeting wage inflation. In the spring tax package Prime Minister Abe will offer tax breaks for companies that increase total wages of workers by more than 2%. The government is also trying moral and nationalistic persuasion.

For sure these are clumsy first attempts but they will be the future of inflation targeting.


Economists only care about one kind of inflation — and it’s not coming

Economists  don’t care about rising prices

If your gas or grocery bill is higher, it doesn’t matter to central bankers. What they dread is a wage-price spiral. That’s a fancy way of saying they don’t care about inflation as long as it doesn’t mean higher wages. If prices rise without corresponding demands for higher wages, it’s a finite move — consumers will eventually have no more money to spend. If wages rise along with prices the cycle can be endless and they need to halt it.

The thing that inflation bugs miss is that wages aren’t rising, in many cases they’re going to other way. MarketWatch profiles American Axle as a symptom of the Michigan manufacturing industry.

Base pay for new hires at Axle in Three Rivers is $10.50 per hour, half the going rate of 10 years ago.

Does that sound like inflation? The story also talks about ‘huge turnout’ at a company job fair for those positions.

Globalized manufacturing has been a tremendous force to keep consumer goods cheap but it’s also leading to major competitive pressures on US wages.

This was originally published at ForexLive on August 20, 2013


The trend is deflation, not the other thing

The most misunderstood phenomenon in macro economics in the past decade has been deflation

It’s a story that has been missed by almost everyone.

In short: Moving manufacturing and  has allowed companies to reap tremendous profits but consumer prices have been sticky. As a result, a bubble in retail square footage has formed. Over time, it will slowly correct as companies compete for consumer dollars. It’s the great unseen long-term trend in developed economies.

Don’t believe me? Visit a dollar store and marvel at the quantity, quality and complexity of the things you can buy there. In addition, realize that dollar store margins are around 32%, meaning it’s only costing the company 68-cents to get those items on the shelves.

Today’s evidence the trend to lower prices is accelerating: A UK 99-pence store has just cut its prices to 97-pence.

On Thursday, US CPI is expected to fall to 1.3% y/y — the lowest since 2010.


This post was originally featured at ForexLive.


The massive US bubble that no one talks about

My belief that we are in a long-term cycle of disinflation and deflation is one of the things that sets me apart. I have written about this theme frequently and wanted to preserve some of my commentary here. This was originally published Dec 5, 2012 at ForexLive.

The US has a massive oversupply of retail floor space.

Retail square footage per capital globally
Retail square footage per capital globally

The US has 23 sq feet per capita of retail space (but as much as 46.6 sq feet). It’s difficult to come by reliable numbers, but that compares to 14 sq feet in Canada, 6.5 sq feet in Australia, 2.3 sq feet in France and 1.1 sq feet in Italy.

It’s no coincidence that the spike in retail floor space coincided with the rise of cheap imports. The US has embraced globalization more than anywhere else.

The retail pharmacy business perfectly illustrates the change.

A pharmacy used to be a little shop that dispensed prescriptions. They have grown to 20,000 sq foot (1900 sq m) stores where you can get anything.

Conventional wisdom says get people into the store and you can sell them anything but there is more to it. It’s about margins. Cheap Chinese goods have made retail margins incredibly attractive.

Goods that once cost $4 to manufacture and sold for $10 now cost $0.50 to manufacture and still selling for $10. The rise in retail square footage has been all about ripping off consumers who have been slow to adjust.

This is part one of a series. In part two I will talk about how the coming years will be payback time and the enormous ramifications for the economy.