Inflation ripples?

I must admit Its taken me a while to get some sort of a handle on  last week’s surprising drop in securities and commodities prices.

First, I strongly recommend reading  Mission Impossible by Bill Gross. I think he summarizes quite clearly the overbearing economic markers of the past few years.

He draws the following picture:

The
thought was this: the center of global production was drifting towards
a high savings rate region – Asia. The resultant “savings glut,” to use
Bernanke’s term, would be recirculated into U.S. and Euroland bond
markets to build up “insurance” reserves but also to place a ceiling on
domestic currency appreciation. China was seen as the main culprit but
even Japan was involved in this game of competitive “real” devaluation.
The deal was a win-win for all parties. Asia got to grow their domestic
economies, Japan got to emerge from years of deflation, and the U.S.
got to import cheap goods and cheap money in order to stoke their
housing/asset markets. Euroland prospered as well.

Although
the “stability” produced many inherent disequilibriums including the
U.S. consuming 80% of the world’s excess savings reflected in an $800
billion current account deficit, there seemed nothing impossible about this
mission, I suppose. And there’s nothing improbable about its continuing
either until China/Japan are in closer proximity to their destinations
– China to eventually have a self-sustaining, internally demand
balanced economy and Japan to have permanently exorcised the D word
from its lexicon.

So, what has changed in this cozy arrangement, although deficit laden, to precipitate the markets; and will this deterioration continue?

I think not, and my arguments follow.

I feel exuberant commodity prices are the main culprits responsible of the recent market downturn; in particular, oil and copper.

Of course, we could start a step earlier and say that historically high commodity prices are the consequence of the liquidity glut provoked by low rate lending from CBs of emerging countries and the BoJ, coupled with the investment bottleneck in China –the preferred destination of these funds.

As a result and as we all can attest, commodities also attracted speculative investing pushing their prices to record highs, which eventually had to inevitably show into the core US inflation CPI index.

And, I guess the markets said enough is enough, something had to give… the commodity bubble burst, prices plunged, and carried equities in sympathy…

Gasoline prices were already making inroads into the costs of producing goods, higher Fed mandated interest rates were further weighing in on costs –not to mention, the additional dent on discounted cash flows– but the inflation cost was the straw that broke the camel’s back… at least, for the spiraling out of control commodity prices.

And I want to clarify, inflation finally bore into China’s prices, and China’s higher prices along with the unyielding commodity prices had a global ripple effect, materializing inflation in the US as well.

The good news is that the commodity price bubble had a major correction, which should veer the world economy into a more sustainable path of growth.

Although, I see commodity prices inevitably picking up their previous upward trend –once the flat tire has been changed, I see the car resuming its previous speed.

Under the present rosy conditions –with an unshaken strong demand, BRIC manufacturing and lending at low rates, the world should continue its sustained growth –till the next unforeseen fracture in the road.

One final comment, I see a bumpy road ahead…

Inflation coupled with a lower USD will tend to be more persistent in the coming future; the legacy of the erosion of US manufacturing and the corresponding US worker’s journey to lower wages or purchasing power –from the disparity of Chinese wages, 3 to 4 % of their US counterparts.