Minyan Mailbag - Pricing Power, Commodities, & Inflation
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Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.
- The dollar is the key to USA 'flation destination.
- This cycle is globally different.
- Inflation is defined by too much money chasing too few goods.
- Global capacity is currently nowhere near being exceeded by global demand.
Greenspan had a hard time figuring out how unemployment could be so low in 1999 without triggering the inflation that his models were indicating would result. The models were built on historical relationships that didn't encompass the new reality of massive volumes of global trade. Historically, international suppliers were a drop-in-the-bucket for domestic demand. When money was plentiful, domestic capacity was quickly strained, and inflation would result. In 1995-2000, the strong dollar made imports cheaper and cheaper, global supply was plentiful, (particularly with some emerging markets trying to export their way out of deep recessions or depressions), and pricing power was non-existent in the U.S. within the global competitive environment.
The "oil tax" could be deflationary in that it slows the domestic economy by diverting spending away from other areas of the economy. The unique problem in this cycle, however, is dollar-linked. A possible outcome would be for capital flows to initially react traditionally, (moving money into bonds as the economy weakens), but ultimately the government is going to create the money to pay for our deficit spending and fund the government's programs. If corporate America slows as the trade deficit grows, (due to our imported oil needs), foreign confidence in the U.S. economy is likely to falter, resulting in further dollar declines, making oil and imported goods more expensive and exacerbating the trade deficit...
Imported inflation will ultimately create the opposite environment that we faced in 1999 - U.S. companies will have substantial pricing-power as foreign goods rise in price due to currency translation. (yes - stagflation)
China and Japan are major players in keeping economic gravity from immediately moving the U.S. into this eventuality. They have thus far determined that it is better to sell their stuff to a country with bad and deteriorating credit, than to no one at all. But the recognition of the U.S.'s imbalances has them working hard to build trade with other countries. Once they wean off their dependence on U.S. consumption, the day-of-reckoning will be upon us. If China chooses to combat an overheating economy by allowing their currency to float, the process will be underway. As with equity over-valuations, corrections can occur gradually or violently. Gradual change is almost always the lesser-of-evils, and this process "could" just begin and slowly build over the coming years.
The U.S. is currently countering the negative effects of rising oil, commodity, health care, etc., with massive liquidity. The dollars that are being created to hold things together continue to be substantially valuable because there continues to be very strong foreign demand for them. Foreigners are holding inflationary forces for the U.S. economy at bay. As long as the U.S. can continue to create a virtually unlimited supply of dollars and have foreigners continue to view them as valuable and exchange cheap goods for them... the U.S. will be able to handle almost anything that the economy dishes out. How long foreigners are willing to continue supporting the dollar in the face of increasing imbalances is difficult to predict.
Unlimited dollars + cheap foreign goods = no serious inflation problems (& the "possibility" of deflation?)
Thus an optimistic non-inflationary outcome is based simply on "foreign hospitality."
I, (for the record), believe that market forces will at some point prevail and I DO believe that the U.S. is on a course to inflate away our unmanageable debt. I also believe that inflation is a U.S.-specific risk, not a global problem.
Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at firstname.lastname@example.org.
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