Deflation hedges

[Jurgis]

Unless we all just retire to the beach while the machines do everything.  I'm surprisingly intellectually and spiritually prepared for that ;)

 

Second!  8)

[no_free_lunch]

Broadly speaking I agree - there'll be a continued skilled/non-skilled wage divergence anyway.  I am no Luddite, but I do wonder when we get to the point where machines can do most things (bar maybe the arts) better than humans...and what happens then?

 

We will need to provide means of living for 80%+ non working population.

I don't think we are prepared for that at all (intelectually, spiritually, morally, economically, politically).

 

I acree with the intellectually/sprititually.. but not economically.  I mean if we are in a position where there are no jobs due to technical obsolescense it is because we don't need people to work.  If we don't need people to work then what is the economic issue?  However, politically it could be a bit turbulent as you will need to move towards a more socialist model. 

[gary17]

 

You would be amazed how many things in Star Trek are coming true LOL.

 

 

Broadly speaking I agree - there'll be a continued skilled/non-skilled wage divergence anyway.  I am no Luddite, but I do wonder when we get to the point where machines can do most things (bar maybe the arts) better than humans...and what happens then?

 

We will need to provide means of living for 80%+ non working population.

I don't think we are prepared for that at all (intelectually, spiritually, morally, economically, politically).

 

I acree with the intellectually/sprititually.. but not economically.  I mean if we are in a position where there are no jobs due to technical obsolescense it is because we don't need people to work.  If we don't need people to work then what is the economic issue?  However, politically it could be a bit turbulent as you will need to move towards a more socialist model.

[ERICOPOLY]

-cost of production of imports to the US will be in free fall... if oil stays here USD hold

 

The winners

US treasury and muni bond holders at the long end

US dollar

companies that can hold their price-Hershey was a huge winner in the 30's deflation

Gold eventually

 

any others? (I don't know if any other company besides Fairfax with deflation hedges)

 

Okay, so... the Chinese goods on US store shelves will be cheaper now.

 

Therefore people who buy those goods have more remaining money in their pockets to spend at Chipotle, or Starbucks, or pretty much anywhere. 

 

So shouldn't a whole raft of companies benefit from this, other than Fairfax?

 

A US company who manufactures in China will spend less to get his product onto US shelves and it will also sell for that much less -- same profit though right?  So where do US workers have their incomes hurt because of this, and if their incomes are the same and by habit they spend it all, well then many companies will benefit since the cost of their Chinese purchases will take less out of their wallets.

[gary17]

 

The U.S. Has an economy that's very domestically driven I believe.

 

But in the case of Canada. We would be hurt because we are an exporter.

 

How much of US gdp is export ?

 

 

 

-cost of production of imports to the US will be in free fall... if oil stays here USD hold

 

The winners

US treasury and muni bond holders at the long end

US dollar

companies that can hold their price-Hershey was a huge winner in the 30's deflation

Gold eventually

 

any others? (I don't know if any other company besides Fairfax with deflation hedges)

 

Okay, so... the Chinese goods on US store shelves will be cheaper now.

 

Therefore people who buy those goods have more remaining money in their pockets to spend at Chipotle, or Starbucks, or pretty much anywhere. 

 

So shouldn't a whole raft of companies benefit from this, other than Fairfax?

 

A US company who manufactures in China will spend less to get his product onto US shelves and it will also sell for that much less -- same profit though right?  So where do US workers have their incomes hurt because of this, and if their incomes are the same and by habit they spend it all, well then many companies will benefit since the cost of their Chinese purchases will take less out of their wallets.

[ERICOPOLY]

 

The U.S. Has an economy that's very domestically driven I believe.

 

But in the case of Canada. We would be hurt because we are an exporter.

 

How much of US gdp is export ?

 

 

Using this 2013 data...  https://www.quandl.com/collections/economics/exports-as-share-of-gdp-by-country

 

13.49% of US GDP is exports

 

vs

 

30.08% of Canada's GDP is exports

 

[mcliu]

Wouldn't the impact on domestic incomes come from domestic manufacturers?

 

If you produce widgets in the U.S., your overseas competitors' products just got 5% cheaper, so you would need to lower your own prices causing higher unemployment, lower wages, etc.

[ERICOPOLY]

Wouldn't the impact on domestic incomes come from domestic manufacturers?

 

If you produce widgets in the U.S., your overseas competitors' products just got 5% cheaper, so you would need to lower your own prices causing higher unemployment, lower wages, etc.

 

I thought US manufacturers (the domestic ones) were the ones making those widgets in Chinese factories.

 

Is Apple going to pass along the IPhone manufacturing savings to US consumers or will they just report fatter margins?

[rb]

Wouldn't the impact on domestic incomes come from domestic manufacturers?

 

If you produce widgets in the U.S., your overseas competitors' products just got 5% cheaper, so you would need to lower your own prices causing higher unemployment, lower wages, etc.

 

I thought US manufacturers (the domestic ones) were the ones making those widgets in Chinese factories.

 

Is Apple going to pass along the IPhone manufacturing savings to US consumers or will they just report fatter margins?

I think Ericopoly is right. I don't think at this point a lot of made in America products are in direct competition with Made in China products. So the Chinese products do not displace American products. That ship sailed long ago. Furthermore, savings from made in China products may make their way into lower prices or higher profits. As Ericoploy points out in the case of Apple, they'll sell the iPhone for the same price and pocket the extra savings. For products with higher competition you'll probably have a bit of trickle down.

 

Another thing to keep in mind is that generally at a minimum 70% of an economy is not tradeable. So that Chinese product that one purchases it isn't really Chines. It has a lot of local value added in it. The Chinese value add could actually be microscopic in some cases. So cheaper Chinese goods could actually (depending on the value add %) drive US growth.

 

I don't want to go too deep on this one, but I can elaborate if anyone cares.

[meiroy]

 

The bigger picture here is that if "faith" is lost in the RMB it means there will be runs on other currencies of EMs. Fundamentally, the export reliance on China is correct  (Australia, Brazil etc.) but the resulting outcome will go far beyond an adjustment according to fundamentals.

Might not be tomorrow, might be 5 or 10 years from now. Who knows.

 

This of course will have great impact on the US economy.

 

I think a warning about RE is due, the size of capital outflows from China will be enough to keep up bubble RE in various countries even if fundamentals say otherwise. So this is not something that I's risk shorting without serious conviction.

 

 

 

 

 

 

 

[beerbaron]

Well, from my limited understanding of macroeconomic I think Chinese devolution is bad for the US. It does reduces the competitiveness of the US, no argument there. Also it puts the US in a though spot because they will have a hard time raising rates as it will further increase the value of usd. This low interest rate issue will over time fuel bubbles which is very destructive for the economy.

 

Finally a short term increase in consumption is unlikely to offset the loss of competitivity. From my experience as a product manager, currency fluctuations are passed to the consumer. Tales some time and in happens. Apple is not a good example, their products are not commoditized yet.

 

 

[ERICOPOLY]

Well, from my limited understanding of macroeconomic I think Chinese devolution is bad for the US. It does reduces the competitiveness of the US, no argument there. Also it puts the US in a though spot because they will have a hard time raising rates as it will further increase the value of usd. This low interest rate issue will over time fuel bubbles which is very destructive for the economy.

 

Finally a short term increase in consumption is unlikely to offset the loss of competitivity. From my experience as a product manager, currency fluctuations are passed to the consumer. Tales some time and in happens. Apple is not a good example, their products are not commoditized yet.

 

What are the implications for the price of imported Chinese beer?

 

[rb]

Well, from my limited understanding of macroeconomic I think Chinese devolution is bad for the US. It does reduces the competitiveness of the US, no argument there. Also it puts the US in a though spot because they will have a hard time raising rates as it will further increase the value of usd. This low interest rate issue will over time fuel bubbles which is very destructive for the economy.

 

Finally a short term increase in consumption is unlikely to offset the loss of competitivity. From my experience as a product manager, currency fluctuations are passed to the consumer. Tales some time and in happens. Apple is not a good example, their products are not commoditized yet.

I'm not saying that the Chinese devaluation is good for the US economy. I'm pretty sure it's not. My point was that I don't think that it's as bad as one might think. Things have changed a lot over the past 10-15 years. It's probably worse for other emerging economies with whom China competes directly.

 

Also I don't see how it's bad for the US economy is the Fed has to delay tightening.

[petec]

Well, from my limited understanding of macroeconomic I think Chinese devolution is bad for the US. It does reduces the competitiveness of the US, no argument there. Also it puts the US in a though spot because they will have a hard time raising rates as it will further increase the value of usd. This low interest rate issue will over time fuel bubbles which is very destructive for the economy.

 

Finally a short term increase in consumption is unlikely to offset the loss of competitivity. From my experience as a product manager, currency fluctuations are passed to the consumer. Tales some time and in happens. Apple is not a good example, their products are not commoditized yet.

I'm not saying that the Chinese devaluation is good for the US economy. I'm pretty sure it's not. My point was that I don't think that it's as bad as one might think. Things have changed a lot over the past 10-15 years. It's probably worse for other emerging economies with whom China competes directly.

 

Also I don't see how it's bad for the US economy is the Fed has to delay tightening.

 

I'm sure it's worse for other countries but Chinese labour just got cheaper and that's a source of competition for the average US worker.  It is unquestionably deflationary for the US, but only marginal (so far).

 

It is all part of a currency "race to the bottom" that several observers have been predicting for years (not me - I only started to understand it recently, and I have nothing intelligent to add about how it plays out.)  Seems to me that these predictions have been right but have taken *years* to play out - they were all the rage in 2009 it seemed to me, but have become the preserve of diehard nutters since then because they played out over such a long time and the markets were rising.  Those hurt worst are probably Japan and the other Asian exporters: I recall reading (Kyle Bass or Hugh Hendry I think) arguing that RMB depreciation would be very tough for Japan to cope with.  But I can't imagine that a couple of percent does much.  What will be interesting is where the RMB is in 6/12/18/24 months.

 

What fascinates me is how currency races to the bottom look inflationary (everyone printing to devalue) but end up being deflationary for a while at least.

 

I do think it's bad if the FED can't tighten, because I think endless ZIRP a) erodes confidence that Central Banks actually have this under control b) reduces the FED's options if there is another downturn, and c) encourages malinvestment.

 

And I totally agree that Apple isn't a good example - commoditised companies won't be able to protect margins.

 

And +1 to meiroy's comment about RE if Chinese capital outflows accelerate further.

 

 

[petec]

Actually, let's just go with a Munger quote:

 

"This has basically never happened before in my whole life. I can't remember 1½ percent rates. It certainly surprised all the economists. It surprised the people who created the life insurance industry in Japan, who basically all went broke because they guaranteed to pay a 3% interest rate. I think everybody’s been surprised by it, including all the people who are in the economics profession who kind of pretend they knew it all along. But I think practically everybody was flabbergasted. I was flabbergasted when they went low; when they went negative in Europe – I’m really flabbergasted. How many in this room would have predicted negative interest rates in Europe? Raise your hands. [No hands go up]. That’s exactly the way I feel. How can I be an expert in something I never even thought about that seems so unlikely. It’s new territory….  I think something so strange and so important is likely to have consequences. I think it’s highly likely that the people who confidently think they know the consequences – none of whom predicted this – now they know what’s going to happen next? Again, the witch doctors. You ask me what’s going to happen? Hell, I don’t know what’s going to happen. I regard it all as very weird. If interest rates go to zero and all the governments in the world print money like crazy and prices go down – of course I’m confused. Anybody who is intelligent who is not confused doesn’t understand the situation very well. If you find it puzzling, your brain is working correctly."

[petec]

Randomly listening to this and it is very relevant from 30 minutes in:

 

https://www.youtube.com/watch?v=HZB5IWFK3XA

 

(Russell Napier)

[ERICOPOLY]

And I totally agree that Apple isn't a good example - commoditised companies won't be able to protect margins.

 

The commoditized companies -- those are the ones who moved their manufacturing to China a long time ago, because they couldn't protect their margins.  Chinese manufacturing has been so cheap for so long that we've been through this cycle already.

 

So are there any of them left here in the US to get hurt by this? 

 

What I'm looking for here are companies that will be firing their US workers -- if we already went through that phase, then the US workers will not be hurt by this devaluation.  Therefore they keep their jobs and their pay, buy cheaper (deflated) commoditized Chinese goods from Walmart, and have extra disposable income left over to spend (stimulative).  That's what the Chinese want, right?  They want the overseas consumer to have extra money to buy more things from China.  But the US consumer will also spend more in restaurants.  Or on whatever.

 

 

Also, if finished goods from China are cheaper, we buy more of them -- doesn't that provide any support for the pricing of the raw materials inputs that go into those goods?

[TwoCitiesCapital]

And I totally agree that Apple isn't a good example - commoditised companies won't be able to protect margins.

 

The commoditized companies -- those are the ones who moved their manufacturing to China a long time ago, because they couldn't protect their margins.  Chinese manufacturing has been so cheap for so long that we've been through this cycle already.

 

So are there any of them left here in the US to get hurt by this? 

 

What I'm looking for here are companies that will be firing their US workers -- if we already went through that phase, then the US workers will not be hurt by this devaluation.  Therefore they keep their jobs and their pay, buy cheaper (deflated) commoditized Chinese goods from Walmart, and have extra disposable income left over to spend (stimulative).  That's what the Chinese want, right?  They want the overseas consumer to have extra money to buy more things from China.  But the US consumer will also spend more in restaurants.  Or on whatever.

 

 

Also, if finished goods from China are cheaper, we buy more of them -- doesn't that provide any support for the pricing of the raw materials inputs that go into those goods?

 

I don't think the yuan devaluation in and of itself hurt America in much of any way. I think a strong dollar in general (which a weaker yuan contributes to) hurts America. Corporate profits will be crimped in USD terms as overseas earnings translate to lower USD amounts. That may impact the hoped for rising wage argument if corporations can point to a lower bottom line even before wages have increased. Also, it's hard to sustain elevated multiples on an equity market that has shrinking earnings which has the potential to hit the so "called wealth effect" (if you actually believe that has been working). There would also be certain domestic exporters who could be majorly impacted depending on where the bulk of the currency delta is felt.

 

But what is probably the worst is a strong dollar's impact on oil - shale states have made up the majority of the paltry growth that we've seen over the last 5-7 years. Strong dollar, ceterus paribus, means lower oil prices and probably a negative contribution from areas/industries that have been providing the biggest boost to the U.S. economy. If we couldn't get above 2.5% GDP growth with shale booming - how high can we really go with shale collapsing? Sure it's a few bucks in the pocket of every other working American, but something has kept those working Americans from spending over the last few years and I would be seriously surprised if the answer was as simple as prices at the pump....

 

 

[ERICOPOLY]

But what is probably the worst is a strong dollar's impact on oil - shale states have made up the majority of the paltry growth that we've seen over the last 5-7 years. Strong dollar, ceterus paribus, means lower oil prices and probably a negative contribution from areas/industries that have been providing the biggest boost to the U.S. economy. If we couldn't get above 2.5% GDP growth with shale booming - how high can we really go with shale collapsing?

 

Yes but 7 years ago it was 2008 and can we talk about the headwinds of what transpired during those years of epic collapse if we're going to talk about the tailwinds from shale?

 

It's not 2008 anymore and things are not collapsing.  And there is no more shale tailwind.

 

Where does that leave us?

[merkhet]

I must be bored because I'm wading into a macro discussion...

 

So, let's roll this back two years or so when oil was above $100. Shale was booming precisely because of the high oil price because a lot of it isn't economical at current prices, right? And the higher the oil price got the more shale boom we created because that's the nature of those kinds of markets.

 

If you think of the U.S. economy as a giant machine/system, then what is going on when oil hits $100? Well, gas prices are high across the board for consumers of oil. Where does that money go? It goes from the consumers to the producers (and the rest of the chain, refiners, etc.) --> so the question is what's the multiplier on that spending? Do the profits that are flowing into the shareholders, employees, etc. of oil producers (et. al.) get spent? Or are they saved? What's the general impact of that?

 

Think about it another way. Let's say oil & gas is 6% of GDP. (That 6% is energy as a whole which is over counting, but let's roll with it.) So roughly 94% of the country is pouring an elevated amount of money into the coffers of 6% of the country -- would it be better to have 94% of the country have a little more money in their pockets or better to have 6% of the country have a lot more money in their pockets? (Simplification, I know.)

 

Also, think about the following -- the roughnecks on these rigs are getting paid $100K+ which bumps them up into a pretty high tax bracket. The vast majority of the remaining 94% of the country are in a lower tax bracket than the roughnecks -- so not only do you think about the 94%/6% cash in pockets dynamic, you also have to consider the after-tax amounts being higher in the 94% as a whole than in the 6%.

 

All this is to say that I have a theory that insanely high oil prices actually choke off productive growth in the non-oil parts of the economy by siphoning money away (through COGS and lowered consumer spending) to the oil parts of the economy.

[rpadebet]

I am bored too...

 

This is too tough to predict though..

 

There is a race to the bottom in terms of currencies, but it is happening because of deflationary threats. Lots of people assumed when US was doing the QE that inflation would be an inevitable consequence. We saw inflation in Fixed income assets but little else. Now with potential for rising rates, lower oil, china devaluation the fear is for deflation. In a perfectly symmetrical world we should see deflation of fixed income assets and nothing much.....

 

however, we could also easily see wage deflation and hence consumer deflation with some asset deflation and some other asset inflation. Who knows where the deflation happens? It will most likely happen where most people are not looking right now, that I am sure of.

 

Bottom line world wide growth will be a function of population growth and productivity growth.

 

Population growth is pretty stable and wont change overnight unless there is a big war/uncontrollable disease. Last i checked it still takes at least 9 months to produce a human, so short term upside to population growth is not a concern.

 

We have some more things to do about the productivity growth. The last paradigm shift here was with the information revolution. I don't know what phase we are in of this revolution, but it seems to be slowing. Cloud computing, mobile computing, social sharing economy etc will continue to add some productivity growth for sometime. Maybe the next revolution is in health care, who knows, but even this takes a lot of time.

 

As a planet we are slowing down from the rapid pace of past 3 decades yet still growing. Some parts are growing very fast while others are rapidly declining and countries like US are somewhere near the average.

 

I am in the camp that we have a muddle through economy for a long long time. Inflation and Deflation will be equally threatening and rational policy makers will keep adjusting the dials.

 

the risk here is something irrational or out of the ordinary happening like a big war, some new very powerful technology, big disease or some crazy person/group being given the control over some significant part of the global economy. This by definition cant be predicted as it is a black swan, but I think it will eventually have to happen to disturb this uncomfortable equilibrium we are in. I don't know when.

[TwoCitiesCapital]

I must be bored because I'm wading into a macro discussion...

 

So, let's roll this back two years or so when oil was above $100. Shale was booming precisely because of the high oil price because a lot of it isn't economical at current prices, right? And the higher the oil price got the more shale boom we created because that's the nature of those kinds of markets.

 

If you think of the U.S. economy as a giant machine/system, then what is going on when oil hits $100? Well, gas prices are high across the board for consumers of oil. Where does that money go? It goes from the consumers to the producers (and the rest of the chain, refiners, etc.) --> so the question is what's the multiplier on that spending? Do the profits that are flowing into the shareholders, employees, etc. of oil producers (et. al.) get spent? Or are they saved? What's the general impact of that?

 

Think about it another way. Let's say oil & gas is 6% of GDP. (That 6% is energy as a whole which is over counting, but let's roll with it.) So roughly 94% of the country is pouring an elevated amount of money into the coffers of 6% of the country -- would it be better to have 94% of the country have a little more money in their pockets or better to have 6% of the country have a lot more money in their pockets? (Simplification, I know.)

 

Also, think about the following -- the roughnecks on these rigs are getting paid $100K+ which bumps them up into a pretty high tax bracket. The vast majority of the remaining 94% of the country are in a lower tax bracket than the roughnecks -- so not only do you think about the 94%/6% cash in pockets dynamic, you also have to consider the after-tax amounts being higher in the 94% as a whole than in the 6%.

 

All this is to say that I have a theory that insanely high oil prices actually choke off productive growth in the non-oil parts of the economy by siphoning money away (through COGS and lowered consumer spending) to the oil parts of the economy.

 

I would generally agree with you, but I could also pose the situation of diffuse cost and concentrated benefit. Let's assume I add a $0.01 tax to all transactions in the economy. Every person is going to pay an additional penny for everything and it all goes me. That would put me in an extremely high tax bracket, my after tax portion would be lower than the rest of the country's, and the benefit would be entirely concentrated on me, my neighborhood, and my local area where I'm blowing all that cash. The cost is diffuse so it doesn't impact other areas much, but the benefit is concentrated on what surrounds me without impacting the surrounding economies that much.

 

Now consider the exact reverse situation. Those flows reverse and everyone in the country get's a penny back on every transaction and all of that money flows out of my community. People who were looking to buy houses no longer do either because income is less secure or because they can't get a loan or because property values are falling. Some people lose their jobs, default on owed debt, and become a drag on the tax system through lower revenue as well as increased expenditures. Eventually, prices will equalize again and the area recovers with a different base to build upon, but it takes years. Also, that additional penny on each transaction doesn't really improve the surrounding economies that much.

 

 

So my question is this: Does the current situation in reflect more of your premise where the additional money is spent throughout the rest of the American economy OR is it my premise which suggests the amounts saved are small and diffuse where the cost is concentrated and large.

 

Oil prices have cratered - gasoline prices have fallen less so. http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=EMM_EPM0U_PTE_NUS_DPG&f=M

 

Gasline prices have fallen about 25%. The average American spends about $2000 a year on gas. That means that the average American is currently putting an extra $40 month in their wallet. That is likely to be the cap as many oil experts agree that current prices are unsustainable and that mid-term equilibrium is around $60-$65/barrel (from the current $40ish). So, the real question is, do American's who have an extra $40 to spend every 30 days really more than make up for concentrated loss of credit availability, stable jobs, consumer purchases, declining home values, etc. etc. etc. I don't know, but I tend to lean towards no.

 

If we were talking $100-$200 extra each month, I think it'd be a big deal. But $40 per month, max, doesn't seem to me to really do much for most people. It's not a car payment, it's not enough to take your family of 4 to the movies, it's barely enough to buy a family of 4 dinner at most restaurants, etc. I just don't see $40 changing consumer spending habits for all but the lowest tier of incomes.

 

 

[ERICOPOLY]

Oil prices have cratered - gasoline prices have fallen less so.

 

I found this a moment ago -- I don't know if it takes more time for gasoline prices to catch up with oil prices or not:

 

Implied spot prices for some major gasoline markets in November and December are already trading at around $1.25 a gallon, according to Tom Kloza, global head of energy analysis at Oil Price Information Service.

 

http://www.cnbc.com/2015/08/11/6-reasons-gas-prices-could-fall-below-2-a-gallon.html

[merkhet]

I would quibble a bit with your assumptions here.

 

(1) I think you're assuming that you're blowing mad stacks of cash in your example, but my guess is that you're not blowing all of the $0.01 tax. First, a bunch of it is going to taxes. Second, unless you made a concerted effort to do so, you're not likely to spend all that cash. A lot of that is going into a bank account or an investment account somewhere.

 

(2) Thus, your concentrated effect is likely significantly lower than you think it is. And the combined aggregate effect of the $40 of after-tax spend is likely higher than you think it is.

 

(3) Also, you calculated $40 per person and then for some reason talked about how $40 is not enough to take a family of four to dinner. Except a family of four would save $160, so unless you're going to a really nice restaurant, I suspect you can get a few dinners and/or movies out of that.

 

And, remember, you're just talking about consumers right now. We haven't even broached the subject of companies that have oil as a large part of their COGS (transport, plastics, etc.) and the effect of consumer demand + additional profits that can either go into the pockets of investors or into rising wages for workers -- that's what I mean by multiplier effects. (If each incremental unit of oil price increase hires 1 roughneck @ $100k and removes 5 workers from other industries each earning $40k, then that's not a good thing for the economy.)

[ERICOPOLY]

(3) Also, you calculated $40 per person and then for some reason talked about how $40 is not enough to take a family of four to dinner. Except a family of four would save $160, so unless you're going to a really nice restaurant, I suspect you can get a few dinners and/or movies out of that.

 

Compare $160 to what gets spent eating out:

 

The average American family spends $225 a month eating away from home – dinners eaten out, quick snacks grabbed, and coffees ordered and consumed on the run.

 

http://www.thesimpledollar.com/trimming-the-average-budget-eating-out/