Inflation : A New Normal
The perception of inflation is all messed up. The constant barrage on the tragedies of persistently low inflation is fatiguing and completely misguided. A recent Bloomberg article highlighted that the Central Banks of New Zealand, along with the US, UK, EU, and Australia were having issues of low inflation. This got me curious, so I got investigating, and despite the complex structural changes, there’s a simple error. The current perspective is wrong.
Low inflation is not an issue or a problem but a new reality.
Now, economists and people in general love to rely on what happened yesterday as a guide for what will happen today. Yet as we all know, the weatherman is often wrong. The higher inflation targets of yesterday are simply wrong for the conditions and environment of today, and here’s why.
Inflationary Challenges
A series of technological and sociological developments have wreaked havoc on markets, industries and shareholders since 2000 and more notably 2007. It has become clear that the internet has changed how businesses compete for the customer dollar. At the same time, the heart of economics is supply, demand and competition. The internet and the rise of smartphones such as the iPhone (Launched in 2007) are core forces giving free market economics palpitations.
I would argue that circumstances that change the competitive environment for customer dollars is sure to have an impact on price, and consequently inflation.
People are actually quite clever. So much so that economics has underestimated us for decades. With the rise of the internet people have been able to shop around more easily, compare products and prices and discover the best value. We are no longer restricted to the prices set by the stores in our local mall. If we want to buy an item on sale, we no longer have to wait until Black Friday or Boxing Day or Mid-Season sales. We can go sales hunting on Google. This is one of the first notable factors in the subdued inflation rate.
The internet has broadened competition, provided access to additional market places, and reduced asymmetries of information. All of which will impact on the buying behaviour and perceived purchasing power of a dollar.
As Central Banks wind back easier monetary policy and regulators around the world tighten lending practices, the supply of credit and consequently money supply is reducing.
Now I have to clearly state that this is not to say that deflation, or even disinflation are likely to occur. It is more that, low inflation is to be expected for a prolonged period while markets and firms adjust to the new consumer demand paradigm and business conditions.
Internet & Competition
The internet … a capitalists dream and nightmare rolled into one gigantic tangled web. Let’s consider, when you last went clothes shopping or even went shopping for that new TV, what did you do? Research it online, read some reviews, check some prices and eventually go to store to see what you preferred and if you could maybe even find a better price?
It’s this behaviour that has an impact on inflation. It’s obvious when we look at the huge retail failures occurring around the world. Toys R Us, Myer, or House of Fraser have all demonstrated the challenges of getting us to get out our wallets. It isn’t necessarily that our purchase is made online, but we seek the best quality for the best price and the internet enables this decision.
The traditional retail cycle has blown up. Sales appear to be never ending, and there’s so many markets to tap into. Geographic locations are only limited by the cost of shipping, which is rapidly falling.
The impact of the internet on prices should be as obvious as looking at Amazon. A colossal retailer that has thrived on lower prices and economies of scale. Then there’s eBay, Etsy, Gumtree, ASOS, Iconic, Boohoo and the list is almost endless.
So the internet has essentially three key impacts:
- Increased supplier competition
- Reduced asymmetries of information : reviews, product descriptions etc.
- Enabled price “shopping” : searching for the current sale, lowest price etc.
There are several more impacts but these are the three I would like to highlight. These three attributes have broad repercussions that have kicked businesses into overdrive. Business is embracing technology like never before, banks are closing branches and going online, retailers run out of warehouses, and all the rest. Customer dollars have shaped business investment.
Inflation is as simple as following the money and watching it’s behaviour. The internet has changed the behaviour and due its enormous scale it’s making a colossal impact. The GFC may have masked or distracted markets from the underlying impacts of this shifting landscape, but that veil is lifting now.
Businesses and consumer behaviour will continue to adjust to the changed and changing landscape which I suspect will eventually cause inflation to rise. Although it may never reach previous highs without extreme circumstances, there is the distinct possibility that as the dust settles, inflation will climb.
Central Banks & Credit Regulation
It’s no secret that as you print more money and increase credit supply prices rise. Hyperinflation is a very real and scary thing. The current Central Bank policy is reducing the money supply which obviously has the opposite effect to printing more money. It causes prices to be subdued.
This is happening in tangent with a generally tighter credit supply and in certain countries, and ever tightening credit supply. This dual reduction in broad money will have counter inflationary effects that also must be considered.
I don’t feel the need to expand on this hugely as sources such as Investopedia and even Wikipedia can provide detailed explanations as to how this occurs. The crux of the argument is that these factors are often overlooked and sometimes ignored in the commentary, yet they are very real, and should be acknowledged.
Other Indicators
I have found traditional measures of inflation and GDP inadequate for the age of data and the internet. Adobe and Yelp have developed their own metrics that leverage their online data to provide economic indicators that are immensely valuable.
Yelp produces the Yelp Economic Average (YEA) which uses millions of customer data points to paint a picture of economic activity. Over the past quarter the YEA declined due to weakness in professional services and retail. The overall fall in the YEA points to early signs of an economic downturn or at leasts indicates that consumers are feeling less optimistic about the future.
Adobe produce the Digital Price Index which similarly to YEA uses millions of data points to paint a picture of economic activity. The fascinating thing with the Digital Price Index is its variance to the Consumer Price Index. The two metrics measure inflation but often diverge due to price perceptions of online retailing and whether or not a segment has an established digital presence. The most recent DPI reflected accelerating disinflation which may point to further rate cutes by the Fed or even a 50 basis point cut if seen on the CPI as well.
Welcome To The New Normal
A new normal with lower inflation is to be expected. As markets and consumers settle into the competition of the world wide market place and supply of money there will be rises in prices.
However, we must respect that we live in a world of increased competition and information. These new factors, generously created by technology are going to result in lower prices. As a consumer, we should embrace them.
As a business, we should find a way to exploit the current environment. Bring back a reason for a customer to be loyal. As my sister often reminds me, quality is making a comeback in retail.
Please note this are is not financial advice, or views of any organisation, it is only the opinion of the writer. If you have any questions, or would like to see analysis on any particular topic please contact me.
Thank you for reading.
Yours,
Chris Leeson
