The Global Economy - The Greatest Of All Evils
- The argument for inflation.
- The argument for deflation.
- Is it really stagflation?
- Commodity prices tell us it's a stag party.
The joke goes something like this, inflation, deflation and stagflation walk into a bar...
There is no punchline to this joke; in fact, it is really no laughing matter these days. I have heard lots of arguments for inflation and many for deflation as the current reason for market volatility. It is like a situation where a murderer is condemned to death and he has to choose between three rooms where the final fate awaits. The first room is full of raging fires; the second is full of assassins with loaded weapons. The third room is full of lions that have not eaten in weeks. This is how I see the current state of the global economy; pick your poison because all choices are ugly.
Prognosis all looks ugly -- Pick your poison
While the United States is experiencing moderate growth after difficult conditions requiring stimulus measures in the post-2008 period, other nations have been having tremendous travails. Europe has been suffering, and the current program of quantitative easing announced early in 2015 has yet to improve the European economy. Last week, ECB President Mario Draghi said that growth prospects in the emerging markets and "external factors" are dragging the outlook for growth and inflation. Draghi said the ECB is "willing and able to use all the instruments available" to deal with the current state of economic lethargy in Europe. Europe also faces internal factors, a continuation of pouring euros into weak nations like Greece and the humanitarian refugee crisis that continues to dilute the economy in Europe.
In China, while the stock market has improved, it is likely because of government influences such as stimulus and new rules and regulations on equity markets. China has made a bear market very difficult due to strict regulation. The Chinese central bank has cut interest rates six times so far in 2015. The knock-on effects from a Chinese slowdown means that demand for raw materials has fallen. China has used many commodity-producing nations as a veritable Costco for their natural resource needs over past years. The slowdown in China has had serious consequences for the economies of these nations. Brazil, Australia, Canada, Russia and other major producers of staple commodities have seen their currency values plummet as revenue from selling production has plunged due to both lower prices and demand.
Meanwhile, this has made the U.S. dollar the strongest currency in the world. As the world's major reserve currency, the dollar is the pricing mechanism for most commodities. The higher dollar has put further pressure on commodity prices as have lower energy costs, which has lowered the cost of production for many raw materials. This has lowered the bar in terms of breakeven costs for some producers, who continue to sell to maintain or even increase market share. In a bear market for commodities, low cost producers tend to sell more to capture as much revenue as possible while improving their position for the future as high cost producers go out of business.
The bottom line is that it ain't pretty out there in the global economy, and many analysts are now arguing about what awaits us in the weeks and months ahead.
The argument for inflation
One can make a case for inflationary pressures that could be right around the corner. The stimulus programs over recent years have created unprecedented low interest rates around the world. Even in the U.S., where the economy is better than in the rest of the world, short-term interest rates remain at around zero. In Europe, they are negative; it costs money to store money in the bank. While stimulus has helped the U.S. out of the economic malaise that followed the collapse of the housing market and global economic crisis of 2008, many argue that the short-term fix comes at a price. That price is inflation.
The theory is that more cash and low financing rates creates an environment where more cash winds up chasing finite goods. In the worst case, this type of scenario can spiral out of control.
Throughout history, we have seen examples of this in South America (Argentina), the Weimar Republic that suffered a three-year period of hyperinflation in the aftermath of World War I and in post-World War II Hungary.
There is some evidence that more money is chasing fewer goods these days. The prices of certain foods have increased over recent years, causing the price of feeding a family to rise, even though many agricultural commodity prices have moved lower since 2011/2012. In any case, while the measure of inflation employed by central banks and monetary authorities around the world remains low, and in many cases below targets, many costs are rising. The measurement is often an art rather than a true science. The cost of medical care, educational tuitions and many other services have increased, making it difficult for many average citizens to keep up with the ascending prices.
Few would argue that inflation is currently a huge problem, but many feel that it is what the world will face in the years ahead.
The argument for deflation
Deflation is the environment when the price of everything goes lower because demand dries up and output becomes uneconomic as it falls below production cost. In many commodity markets, the bear market that began in 2011 has caused prices to plunge to levels where output has become uneconomic. The price of NYMEX crude oil, which was trading at $107 in June of 2014, has fallen to below $50 per barrel. Some shale oil production in the United States has become uneconomic. The number of oil rigs in operation in the U.S. currently stands at 572, down from 1,568 just one year ago, according to Baker Hughes. Around the world, nations are suffering from the decline in the price of the world's most popular and ubiquitous energy commodity. Venezuela, a country with the largest oil reserves in the world, has slumped into a depression as oil revenues plunged. Russia, another major oil producer, has seen the value of its currency, the ruble, plunge with the price of oil.
Commodity prices are down sharply, across virtually all sectors. The price of copper has moved from over $4.60 per pound in 2011 to under $2.25 recently. Gold has moved from $1920.70 per ounce at the highs in 2011 to just under $1,090 per ounce. Gold is often an excellent inflation hedge, and the price action in this commodity that also acts as a currency exhibits deflationary pressures, as does the price action in other precious metal markets.
Meanwhile, many agricultural commodities have moved lower as ideal weather conditions over recent years have resulted in bumper crops. This could change in the near future as the potential for weather disturbances and events due to the strongest El Nino since 1997 may wreak havoc with future crops in certain areas of the world. However, the overall state of natural resource markets is bearish, and this is deflationary. Moreover, one of the biggest problems with economies around the world these days, including in the U.S., is that wages have not increased. In the U.S. and other areas of the world, unemployment or underemployment continues to present roadblocks for economic growth.
I believe that more analysts today explain the current state of the global economy as exhibiting deflationary pressures. Meanwhile, the worst-case scenario is what we may be facing in the months ahead.
Is it really stagflation?
Stagflation is a condition of persistent high inflation with high unemployment and stagnant demand.
Stagflation is the worst nightmare for central bankers and politicians. It is the hardest type of economic condition to handle. Even though commodity prices have moved lower, the prices for finished goods and services continue to rise. Unemployment around the world, particularly in Europe, continues to be a huge issue faced by the ECB. In the U.S., while the official rate of employment is consistent with a growing economy, many workers have dropped off the radar due to prolonged periods of joblessness and others are underemployed in the current economy.
Additionally, we are currently in earnings season in the United States, and the third quarter is shaping up to be the worst since 2009 as profits from oil and gas and commodity related companies have evaporated.
Meanwhile, with interest rates at historic lows, there is plenty of cash floating around the world in the interest of stimulating economies. The ultimate price for this cheap money, given the global nature of economic lethargy today, could be stagflation. Stagflation has devastating effects on both economies and individuals alike. In the U.S., a national debt of $18.5 trillion poses an increasing danger of stagflation.
In the 1970s in the U.S., a continued rise in the price of goods and services raised demand for increased wages. We are currently seeing demand for higher wages; some politicians have called for an increase in the minimum wage to $15 per hour.
Commodity prices tell us it's a stag party
While commodity prices continue to fall and the dollar rises, deflationary pressures are present in the global economy. However, these lower prices will result in job losses around the world in the mining and natural resources industry and all related fields. There could be an exponential effect on the global employment picture given the nature of the bear market cycle in commodity prices.
Meanwhile, all those cheap currencies continue to float around chasing finished goods that are not going down in price. Did you ever notice how long it takes for prices at the pump to go down when oil and gasoline falls, and how quickly they go up during market rallies? Lower prices have been feeding corporate profits recently, however, this has filled the pockets of a small group of well-heeled investors and CEOs, while technology and efficiency has eliminated many job functions. The division between haves and have nots in the U.S. and around the world continues to widen.
This might sound like the ranting of a card-carrying socialist or communist. I am neither -- I am a diehard capitalist -- but at the same time, I am a realist. The price of medical care and even insurance continues to rise. As a self-employed individual, I just received notice that I will have to pay 25% more for my health insurance come January 1. The price of college tuition continues to rise, making certain colleges out of reach for qualified students. Thankfully, I have already sent my boys to college. Opportunity seems to be becoming more concentrated in the hands of a few. This is leading to mass calls for more entitlements and government assistance that will increase deficits and compound problems.
While some argue we face deflation and others inflation, it all smells like stagflation to me. If that is the case, sell everything and stock up on food. No matter how the governments around the world massage the economic statistics, it could be the situation that we face. A stag party is often a great time where a bunch of guys get together and get out of control in the lead-up to wedding nuptials.
This stag party is also out of control, but it is no fun at all. Think about it as the strippers raising their prices as the money in your pocket naturally decreases. When it comes to the global economy, it is the greatest evil of all. I hope I am wrong, but I am scared I am not.
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