The Inflation Squeeze Is On

If you want to see the front page tomorrow, start looking at page seven today.

These were valuable words of advice I once received from a seasoned journalist.

Stories can often start out as a ‘slow burn’. Some die out.

Others, fanned and fuelled by facts, eventually become headline news.

The constricting forces on the global economy are a trend I identified a number of years ago. At that stage, very few people seriously considered a future without inflation.

This is an extract from the April 2014 edition of Gowdie Family Wealth (emphasis mine):

Underpinning the Gowdie Family Wealth portfolio is The Great Credit Contraction theory. Here’s a brief recap on the theory.

The three decades immediately following WWII generated genuine economic growth through productive activity: manufacturing, agriculture etc. Wages and savings grew.

Whereas the economic “growth” of the past 30-plus years has largely been due to the private sector spending money they had not yet earned. The global dominance of the financial sector (locally, our four largest banks dominate the ASX industrial sector) is a direct result of the Western world’s 30-year credit-dependent habit. Coming down from this “credit high” is the last thing financial institutions, central banks and governments want. These institutions don’t mind seeing a slight temporary downturn, however, the prospect of a sustained and lasting change in society’s attitude towards debt is abhorrent to them.

The whole system (tax revenues, welfare promises, health funding, corporate profitability, share prices, property values, retirement incomes, award wages, etc.) has been built on the tenet of people continuing to spend more than they earn. The financial structures supporting Western society have been developed from 30 years of conditioning — this is how it has been and will continue to be. What happens if these “bedrock” foundations morph into deflationary quicksand?

It’s taken longer than I thought — due to the relentless, unprecedented and coordinated stimulus efforts — for the squeeze to work its way into mainstream consciousness. But it’s now making regular headlines.

‘CPI figures suggest no rate rise yet as inflation disappoints’ [CPI: consumer price index]

The Sydney Morning Herald, 26 July 2017

‘U.S. Inflation Remains Low, and That’s a Problem’

The New York Times, 24 July 2017

The absence of inflation doesn’t mean that all household costs are falling. Some, like power costs and health insurance, are rising far faster than the CPI.

However, what it does mean is that wages growth is much harder to come by…especially in the private sector.

Discretionary spending — and that includes the ability to take on more debt — is under pressure.

The Australian Financial Review published this headline on 27 July 2017:

‘Coles reveals the rising pressure on household’

Here’s an extract (emphasis mine):

“There is a sizeable proportion of consumers who are being forced to devote time and effort each week to work out how they can afford to buy the essential groceries they need to feed their families,” Durkan said.

“At Coles we are seeing shifts in consumption from premium to mid-tier products, and, for many, shifts to our value range of products.”

Durkan said that over the past six years, childcare costs have risen by 58 per cent; household utilities prices by 35 per cent and health and education costs by more than 30 per cent.

If these trends continue, particularly the rise in electricity prices, it could have grave implications for the banking system and other industries heavily reliant on consumer spending.

The last thing the banking system wants is for people to live within their means. The banks want — no, make that need — debt slaves.

The interconnectivity created by globalisation means that what happens in one corner of the world eventually ripples through to our island nation.

Tokyo-based William Pesek (a former columnist for Barron’s and Bloomberg and author of Japanization: What the World Can Learn from Japan’s Lost Decades) wrote an op-ed piece on 21 July 2017 for LiveMint titled (emphasis mine): ‘Is deflation bearing down on Asia? China is at the crossroads where the ideologies of Keynes and Friedman meet: aggressive stimulus over time loses potency, requiring ever bigger doses’.

In his article, Pesek cites recent research from Nomura Securities that states ‘The world’s second largest economy [China], to which the rest of Asia is very exposed, is flashing several signs of vulnerability…Should things unravel, they say, “contagion to the rest of Asia could be substantial.”

Excessive and aggressive use of monetary steroids can do wonders in the short term for an economy, making it appear bigger and stronger than it really is. When, not if, China eases up on the ‘debt juice’, the deflationary effects will not just ripple — they’ll flood into all corners of the world.

And then, last week, I read this from US-based Saeculum Research:

Expect Amazon and Walmart to continue to play hardball with suppliers. All of these discounts come at a price — to vendors. Walmart recently told suppliers that it wants to offer the lowest price on 80 percent of the products that it sells — a feat that would require some suppliers to shave 15 percent off of their rates. Amazon is equally notorious for its tough negotiations. The company often threatens to boot unprofitable products (known as “CRaP,” short for “can’t realize a profit”) from its virtual store shelves if the vendor won’t budge on prices. Insiders suspect that this is why all Pampers products mysteriously disappeared from earlier this year.

This is how the cycle goes.

Income constrained and debt-burdened consumers want lower prices.

Behemoth retailers squeeze suppliers to deliver on consumer demand.

Suppliers in turn look to trim margins…reduce wages, lower hours and automate more of the production. Workers (who are also consumers) face wage pressures.

Central banks reduce interest rates to make debt cheaper (hoping to rekindle the debt-dependent economic growth model), but lower rates also reduce the income of conservative retirees (consumers).

Income-constrained and debt-burdened consumers….

We are caught in a vicious bind of our own making.

Decades of living beyond our means has sown the seeds of our economic demise.

The world built excess capacity to supply a consumption model that was not sustainable.

Suppliers, retailers and consumers are in the process of cannibalising each other.

And as we’re witnessing, the effort of governments and central bankers to reverse this trend is meeting stiff resistance. Leaving them scratching their heads over why the usual ‘incentives’ no longer stir consumer ‘animal spirits’.

Their flawed economic theories are now doing more harm than good.

The trend we identified several years ago is now making its way to the front pages.

As the pressure continues to build, here’s what I think future headlines are going to look like:

‘Dow collapses’

‘Bankruptcies on the rise’

‘Property markets crash’

‘Homes lost’

‘Unemployment numbers worse than expected’

‘Social unrest on the increase’

The world has too much debt, too much capacity, too many entitlements, too many people moving into retirement, and too many people who think the world owes them a living.

Reality is going to hit — and hit hard.

The squeeze is on.


Vern Gowdie,
Editor, Markets & Money

Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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