QE2, Inflation and the Great Margin Squeeze

Don't confuse speculation with inflation

Global food prices are soaring. Market speculation fueled by QE2 as well as one-off events like the Great Queensland Floods in Australia and US subsidies for ethanol have driven up prices from coffee beans to prime beef, from coal to corn, and just about everything else. The WSJ reports that eateries have little pricing power, so they have to scramble to avoid a big margin squeeze.

Mish takes it a step further, noting how commodity prices have increased across most industries, especially driven by oil and energy prices. Finished goods prices rose 1.1% in December, driven primarily by a 3.7% increase in energy inputs. Finished food rose 0.8% while wholesale inputs rose 23%. Mish concludes that "every step of the way, a decreasing portion of costs are passed along."

• prices are up 15.5% for crude goods
• prices are up 6.5% for intermediate goods
• prices are up only 4% for finished goods

Even less gets to consumer prices. The great margins squeeze is on. And the rise in oil could scuttle the recoveryless recovery. (Picture courtesy Pierre du Plessis.)

This is NOT inflation. Inflation is a general rise of prices, whereas this is a rise among commodities but not end prices or wages.

Let me use an analogy. A while back I discussed "good" deflation vs "bad" deflation. The steady drop in HDTV or PC prices is an exemplar of good deflation - price drops due to the ruthless pursuit of productivity and efficiency. A general drop in prices is a symptom of bad deflation - the rise in the purchasing power of the currency. Good deflation can continue for years in certain factors of production - such as oil in the 1890s, autos in the 1910s, PCs in the 1990s and HDTVs in the 2000s - without in any way presaging or sparking bad deflation.  

Similarly, a rise in classes of prices, such as commodities, is not the same as a general rise in prices. The commodities rise is likely to spill over into inflation gauges, such as the CPI, as energy and food prices tend to get passed through. But the core CPI - excluding food and energy - is unlikely to budge much. This commodities bubble echo (an echo of 2008) can continue for months without causing or presaging any general inflation.

When it bursts, it might paradoxically accelerate deflation. In our economy, debt creates money, and commodities speculation that uses margin piles on more debt. As the positions unwind, the margin is paid off and money disappears. If the effect is large enough, it can lead to deflationary pressure. 

This is not to downplay very real inflation outside the US. China in particular is seeing the inflation monster threaten to swallow their economic miracle. Some argue this Godzilla is caused by Bernanke and QE2, and certainly the commodities bubble contributes to inflationary pressure inside of China, but the source of Chinese inflation is much more prosaic: their money supply is growing too fast, fueled by a credit bubble from Chinese banks, not the Fed. Chinese M2 is up 55% in two years, and its PPI is up 5.5% year over year. Chinese steps to quell inflation have been tentative so far, as they seek that elusive "soft landing." If inflation crests double digits, they may need to find their own Chairman Volcker to slay the inflation beast. Andy Xie, one of the best observers of Chinese financial markets, suggests that China may need to devalue the Yuan, slowing capital inflows and likely causing internal interest rates to rise. 

What the Great Margin Squeeze means going forward is pressure on domestic US profits, headwinds from rising oil prices, and the possibility of a bursting Chinese credit bubble shocking world markets.

Comments

[rc]

"Credit card rates at record highs near 15%". This is a headline I just read. Unemployment is over 9% (and U6 close to 20%). The Case-Shiller index shows a double-dip in housing is underway.

How can the consumer be spending based on the above? And, if the economy is mostly dependent on consumer spending, then how can it be on the mend -- as is widely acknowledged?

And this is not to mention our incredible gov't debt. We hear astronomical numbers all the time and become numb to them, but it hit me again when I read that our current deficit will be 1.5T on top of 1.4T the previous year. And, that we're borrowing 40 cents on every dollar spent. That really is shocking.

And yet... the stock market has been climbing relentlessly (omitting the recent few day's downturn).

Is being bearish wrong? Is it just a preference for "gloom and doom"? Is the glass really half-full instead? Are bears spending too much time in the company of other bears and missing a bigger, more optimistic picture?

It's much better to be on the right track than to be going against the tide. What is the true, realistically guessed, direction of the tide?

[Hockthefarm]

What really stood out for me was the rabid nature of the bulls on Kudlow's show last night. They were actually indignant that anyone with an ounce of brains could rationalize a correction here lasting beyond Monday. Their answer is to hold, hold and then hold.

A definite shift in mindset imo. To me it says the market could go any where next week. The real tell will be the month of February.

A guy picked up my truck this morning for detailing. He is Mr Fixit, owns his own realty company and property management company. Yet there he was knocking at my door 2 hours early to spend the day detailing my truck for 200$. Hard working people are having a tough time making ends meet.

Hock

[da bear]

rc quote: '"Credit card rates at record highs near 15%". This is a headline I just read. Unemployment is over 9% (and U6 close to 20%). The Case-Shiller index shows a double-dip in housing is underway.'

Wow, rc. 20 and 15. Those are Kevin Love type numbers. lol

Yesterday I put out a Report on gold and silver trying to analyze both markets from an elliott wave perspective. My count may seem strange but my silver count jibes with EWI's new long-term count on silver (at least as of a couple of months ago).

here is a link: http://www.phpbbplanet.com/damessageboard/viewtopic.php?t=25606&mforum=damessageboard

da bear

P.S. yelnick, I know you like to follow Tesla, and if you discount the initial move up and down, the move off the first $15 low appears that a possible wave 5 of an Elliott Wave advance is imminent. It's not a bad set up, so perhaps there is a trade in Tesla.

link to a basic Tesla chart courtesy of bigcharts.com: http://bigcharts.marketwatch.com/charts/big.chart?symb=tsla&compidx=aaaaa%3A0&ma=0&maval=9&uf=0&lf=1&lf2=0&lf3=0&type=2&size=2&state=8&sid=5041988&style=320&time=8&freq=1&nosettings=1&rand=8578&mocktick=1&rand=3326

[Account Deleted]

MSFT Chart: http://niftychartsandpatterns.blogspot.com/2011/01/microsoft-chart-analysis_29.html

[Mamma Boom Boom]

As I look over the chicken entrails, I can't help but wonder if I should put on my steel toed shoes, Monday morning.

Neo-Mamma

[Wave Rust]

"Hard working people are having a tough time making ends meet.
Hock"

Hock,

I have found that the hard-working people having the toughest time are those with too much CC debt, who refi-d their home at the top (2007-2008), and, or, had not prepared for any bad times.

The recession proof people are like the guy who repairs my shoes. He works many 16 or 18 hour days to get his work done in his shop. He does well in a good economy and better in bad times.

He's getting closer to retirement and can't find anyone to take over his business of 30+ years. He's highly regarded for his work. Plus, he's a nice guy too.

He'd apprentice a younger person, but he has found that nobody wants to work that hard. He says 3-5 years of work with him and a kid would see it all, and have the skills to take over a good business that paid off 2 houses, put his kids through college, allows him a few weeks of vacation every year and a good retirement savings.

NOBODY wants to be the "shoe repair" guy bad enough to work for it.

He has more business than he can handle. Talk about a Palin "WTF moment"!

How can the Future Be Won if nobody wants to play?

wave rust

[Wave Rust]

all this chatter about spx 1260, 1270 or 1220, etc. is just that ,,,, chatter.

IMO, let the market shine the light down the path it's going to take, then jump in. Set your stop losses, and your profit targets. continue to adjust profit stops as the market or stock goes your way.

I may post a comment about price targets but none are carved in stone. Keep your outlook simple and flexible.

I do think 1190 spells more trouble than I want to see as a bull, but I'll go with it if spx gets there and then dives below it.

Monday shapes up as a nasty for bears who stayed short over the weekend. quite often closing on the lows raises the potential for a short covering rally on the next open.

Look at what RUT did. Nasty.

wave rust

[JT]

"JT, I tested your 1261 scenario and it failed. In the 1270/1263 zone monday, yes a bounce starts. The pattern and formula's this month showing me a pattern wich in the past pinpointed big declines with a very high accuracy. I don't know where this decline bring us, but the first stop should be the 1220/1200 area. If this is the bottom, it's only a correction of 6%. But your 1261 will be smashed after the bounce." - MT

Looks like 1261 was the LOW.
Looks like it was YOUR SYSTEM that FAILED, not mine.

:)

[sedona tours]

Overhead height should be at approximately sixteen feet, but the open ceiling to the peak makes horse and rider feel more comfortable.