Not only is there a complete absence of inflation in most major inflation barometers, but deflation is still a problem in some quarters.
We’ve already seen that several major commodities are under intense selling pressure, including agricultural commodities like corn and wheat. This is all the more amazing when you consider that crop conditions are less than ideal in many parts of the country and ag prices should be rising if the fundamental factors are to be believed. Instead we see plunging prices for several major commodities along with a worrisome trend in China’s producer price index.
Economist Ed Yardeni points out that China’s monetary and fiscal stimulus has, ironically, produced the unintended result of excess capacity. “The result,” he writes, “has been deflation in China’s various PPI measures.” China’s overall PPI fell 1.1% year-over-year during the latest reporting period. The decline was precipitated by an 11% drop in the coal industry, a 6.5% drop in ferrous metals and a 5% decline in chemicals.
With the world’s number two economy experiencing such deflationary currents, it’s no wonder that global growth has been lackluster in recent years. If the Kress Cycle theory is a reliable guide, this trend should reverse starting in 2015 or shortly thereafter as deflation gives way to re-inflation.
The pathway to re-inflation is likely to be a gradual one. There are two potential scenarios which could cause inflation to become a problem much sooner, though. One is an outbreak of major war. Normally it takes at least 10-15 years after the bottom of the 120-year Kress cycle before inflation becomes firmly entrenched in the economy. But following the 120-year cycle bottom of 1774, inflation was a major problem in the colonies during the U.S. Revolutionary war in 1777-79. At that time a pound of butter cost $12 a pound while flour fetched nearly $1,600 per barrel in Revolutionary Massachusetts. Keep in mind this was only 3-5 years after the long-term Kress cycle bottomed.
In his commentary of Benjamin Graham’s classic book, The Intelligent Investor, Jason Zweig observed that inflation was also a major problem during the U.S. Civil War. During the war years in the early-to-mid 1860s, “inflation raged at annual rates of 29% (in the North) and nearly 200% (in the Confederacy),” he writes. He also points out that immediately following World War II, inflation hit 18.1% in the U.S.
The other possible scenario for a rapid re-inflation in the next couple of years would be if the world suddenly became smaller, i.e., if China and the other major components of the global economy inexplicably decided to withdraw and restrict imports and exports. If this ever happened it would reverse the trend toward excess capacity and would eventually lead to the classic inflationary problem of “too much money chasing too few goods.” It should be emphasized, however, that this scenario is a major outlier and not at all likely to occur.
The most important lesson to take away from this is that the deflationary undercurrent is still very much alive and appears to be accelerating as we head closer to the long-term Kress cycle bottom this fall.