How Inflation Begins

I am a large volume importer of industrial hardware, mostly out of Asia. I just received my April ocean freight rate update. Container cost up 5% from March and up 21% from April 2009. For my products, the YOY increase represents a 3% increase to cost of goods. Cost of steel as we know is going up significantly and these price increases for us -- contrary to what the popular spin may be -- are effective immediately. Obviously, as we are replacing fast-turning inventory, we are passing on these increases immediately. About a year ago, I reported to you that our business was extremely slow and our inventories very high. Despite price increases going on offshore, I pointed out that in our world, these increases would take time to trickle through due to the high inventory levels that we and our competitors were sitting on. Our position was that if we had it in stock, we would sell at basically any price for cash flow reasons. Any new inventory would be sold based on actual current cost. Needless to say, the purchases we made through the year were very minimal as we (correctly) were not optimistic about business looking forward.

Now, business is still terribly slow but inventories have been depleted to the point that shortages are occurring. These shortages are exasperated by the fact that no one is buying any significant volume of replacement inventory. Our statistics would show that our purchases in March (for delivery this summer) are up about 400% from any given month last year but are still only about 30% of our peak going back before all hell broke loose. Can you imagine how this data can be spun by focusing on the former and conveniently ignoring the latter? We feel that we have hit bottom and have reasonable expectations to survive this debacle simply because we have downsized to about 20%-25% the company we once were. Our domestic competitors and vendors overseas basically report the same... (The) bottom line is this: No one is (all that) busy but prices are literally skyrocketing. Smells like stagflation to me. Anyone who tells me that there is no inflation on the horizon is delusional and in for one hell of a shock.

-- a post on Bill Fleckenstein’s website, Ask Fleck.

Annualized inflation in India is running at about 15% and China isn't all that far behind. In the Philippines, March’s inflation figure was just reported at +4.4%, up from the previous month’s 4.2%, with the cost of Philippine fuel/electricity/water up 14.6% over the trailing 12 months.

In our country, since January 2009 the price of copper is up about 185%, crude oil is better by about 118%, and rubber is higher by about 167%. Moreover, from August of 2009 until now hog prices have rallied about 75%, while cattle prices have lifted about 19%.

Such actions caused the Reuters CRB Commodity Index to travel above its 200-day moving average in June 2009 and stay there ever since (read: bullish and inflationary). Meanwhile, economists continue to insist there is no inflation because wage inflation is nonexistent. That, however, may be changing given some of the recent “worker strike” announcements.

To us at Raymond James, inflation is assuredly returning, yet the degree of inflation is unknowable. Why are we so sure inflation will return? It's because for decades that has been the easiest political solution for the debt accumulation of our citizenry and our government. To wit, pay back the debt with “cheaper” dollars.

Given the recent geometric rise of debt, we see only three ways out for our government: sovereign default (unimaginable); severe economic contraction (unlikely); or, currency debasement (read: inflation). We choose door number three as the most likely course. In past missives I've suggested that a 10% per year inflation rate, for the next five years, would go a long way in solving the nation’s debt problems. As one savvy seer writes:
 

In 1979 the government ran a deficit of more than $40 billion -- about $118 billion in today’s money. The national debt stood at about $830 billion at year’s end. But because of 13.3% inflation, that $830 billion was worth what only $732 billion would have been worth at the beginning of the year. In effect, the government ran up $40 billion in new debts but inflated away almost $100 billion and ended up with a national debt smaller in real terms than what it started with.