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Analysis: At the moment the inflation issue is still pretty distant as few economists see much of a break out
occurring this year but the conditions are setting up for some trouble in the future – depending on how
swiftly the economy makes a comeback. Thus far the recovery has been slow and methodical and the longer
it takes to rebound the better the chances of an escape from inflation’s worst ravages. The distressing
scenario is one in which the demand factors start to ramp up as consumers feel a bit better about the
economy while global growth starts to catch fire. This would put pressure on the factory sector to catch up
and that is when the reduce capacity issue becomes a major problem. At first, the companies will be able to
meet demand as there is still a lot of slack in the system but like a dog that runs to the end of the leash –
there is an abrupt and rude awakening in store.
As the industrial sector faces these shortages there will be an inevitable price reaction and this could well
be coupled with reactions to higher commodity prices as well. There will still be factors that mitigate against
rising inflation – such as high rates of unemployment but there is also the matter of an abundant supply of
liquidity that could be released at some point in this period. All of this could add up to a serious shot of
inflation and that will force the Fed to raise rates in an effort to hold it at bay.
(Continued)
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Analysis: There are four threats emerging as far as inflation is concerned. It bears repeating that none of these situations have
developed fully at this point and there is a chance that not all of them will. Much depends on the pace of the recovery. If the economy
rebounds in a hurry – achieving growth above 4% or 5% by the second quarter, there will be a much greater chance of this inflationary
trend. A more modest 3% growth for the bulk of the year will reduce the threat but not eliminate it altogether.
The most important condition for an inflationary outbreak is the supply of money in the system and right now the financial world is
potentially awash with this cash. The world’s governments and central banks have done everything in their power to flood the system
with liquidity and the numbers are staggering. The interest rates that have been set by the major banks are as close to zero as they can
be. The US Fed has invested billions in mortgage backed securities and has opened its lending windows to corporations as well as banks.
The whole focus has been on the loosest monetary policy that can be conceived of. The impact of all this liquidity has been blunted by
the fact that most banks have hoarded more of this money than would be the case in better times. They are still contending with toxic
debt and the potential for new and more radical regulation that would require them to hold more cash in reserve. At some point the
banks get comfortable with the new rules and they will be in a position to lend more. If that cash comes cascading out into the system
there will be a glut in the money supply sufficient to feed inflation. Some of this cash has already started to leak out and that is why
many have concluded that the markets are overvalued and headed for another bubble burst and correction.
The second most common inflation creator is a run up in the price of commodities. This has been a trigger many times in the past and
was one of the key issues in the recessions of the 1970s and 1980s. Oil has often been at the center of the problem and most remember
the summer of 2007 when the price of oil soared to $150 a barrel and over $4 per gallon at the pump. Today oil is near $80 and has
mostly bounced around between $60 and $85 for the last several months – about half what it was in 2007. The other key commodities
have also been volatile – steel prices rising due to Chinese demand, capper reacting in similar ways. If these commodity prices continue
to rise, the pressure will start to build as every sector will be forced to react to the higher priced inputs. It has been soaring oil prices
that have affected the auto industry, air travel and transportation in general. Right now these commodity prices seem to be pretty
adequately balanced but the potential for bottleneck remains a concern. The good news is that oil producers have not reduced their
output as much as might have been expected and that should mean that they can keep up with demand when it starts to manifest
again. The problem is that refineries have been at reduced capacity for over a year and will be hard pressed to get back to 95%
efficiency in the short term.
Motivation number three is what prompted the first piece in today’s issue. The industrial sector is at a low point in terms of capacity
and output. It will take some time to get back to old levels of output and there are issues looming on the horizon that will further
complicate matters. It has been pointed out that there are shortages of skilled labor in many industries and that will start to drive up
wages in these sectors. The industrial sector will also have to react to the higher priced inputs at the same time that they ramp up their
production capabilities.
The fourth major motivation for inflation is often the deadliest but the good news is that there is almost no sign of this at the
moment. Wage driven inflation is very hard to stop. As wages go up the producers are compelled to raise their prices to keep up with
the increase in labor costs and this is a tactic that works because the workers of the country are getting paid more and have the
capacity to accept the price hikes – at least for a while. The cycle is vicious however. Wages go up and prices respond, causing wage
demands to hike again in reaction. Wage driven inflation is unlikely as long as jobless totals are in the 10% range. It would take
unemployment rates back down to 5% for the wage inflation issue to grow significantly.
There are other factors that can drive inflation but these are generally the most salient. One additional concern exists and that is the
psychological motivation. Inflation is often a matter of self-fulfilling prophecy. If the consumer thinks that inflation is right around the
corner they tend to react by buying what they want and need as fast as they can – trying to get the items while prices are low. This goes
for the business community as well. That very act tends to invite inflation as it stimulates shortages and gives producers an excuse to
hike their prices.
Analysis: The yen has risen as well but not for anything Japan has done. The sense among some investors is that China is on the verge of
overdoing it as far as slowing the economy and that is favoring the yen for now. Other analysts have pointed out that there is no
evidence that China has slowed despite the efforts of the government and they do not expect to see a slowdown at all.
Business Intelligence Brief is an online information service, published electronically by Armada Corporate Intelligence. It is prepared by
Armada CI. The publisher has taken all reasonable steps to verify the accuracy of the content of this information. Armada Corporate
Intelligence shall not be responsible for any errors or omissions.
2
STRATEGIC GLOBAL INTELLIGENCE
January 19, 2010
Analysis: This situation is going to create a dynamic that will either go very badly or provide a slim hope for the nation’s recovery. The
government of Rene Preval has been missing in action. The devastation crippled an already weak state and there is little sign that the
Haitian government is in a position to resume its authority. As more and more security troops pour in, the country looks more and more
like a protectorate. The question will whether the world can bite the bullet and just accept that it will have to take over the running of
Haiti. The power is now in the hands of the global community but there is no coordination. At some point it will fall to some kind of
governing force to impose order and direct the reconstruction. The US has a long and complex relationship with Haiti and many expect
the US to play that role. This is something that the Obama administration has shown no desire to do. France is another nation with a
connection to Haiti but they have also shown no inclination to take control. The other states in the region do not have the resources to
monitor progress in Haiti and that seems to leave the UN. Thus far Secretary General Ban Ki-Moon has been reluctant to make long term
promises but the addition of more UN troops has started to push the UN in that direction. The country could be declared a disaster and a
failed state and this could clear the way for the UN to establish a mandate here. Anything short of a takeover will leave Haiti in a
desperate state.
Analysis: The estimate of Eurozone growth is pretty modest for the year but this may be a good thing in the long run. The European
Central bank is just itching to get back in the mode of raising interest rates. The hawks never left the scene; they just went into
hibernation while the issue was recession relief. If they see price hikes they will pounce and a slow recovery may be the best way to avoid
that scenario.
3
Cabin Fever and Creative Responses
This is a miserable time of the year. The sky is grey and the days are cold. The Christmas season is over and with it has gone the festive
lights that brightened the nights. Now we are left with piles of dirty snow and grimy cars that will not see improvement until the roads
finally get cleared. We are stuck inside and wait for the spring thaw. This is when cabin fever sets in and people start to get creative about
how to get through the winter months. Every year there are some innovations to note. My favorites include the guy who bought several
tons of sand to pour into his garage – along with big lights and umbrellas to simulate the beach. Needless to say he is not married. Then
there is the guy who decided that cold is only a state of mind and elected to hang out in his yard in shorts and a t-shirt in 10 degree weather
(he is being treated for frostbite).
Analysis: My own solution to this time of year arrives in the mail. Seed catalogs. I am not the master Gardener in the family but I am the
Assistant in Charge of Holes – the ACH. I look forward to the spring ritual as much as the MG in the family and in the winter I make
suggestions like “can we plant kiwi fruit trees?” or “how about sixteen types of tomato this year”. The catalog is a great place to escape –
dozens of carrot varieties, eggplants of all description, cucumbers that could be used as a weapon and melons as big as a Prius. The
flowers are even more captivating – filling my head with visions of color and aroma. I have no memory of last year when the humidity
was enough to kill and my desire to dig into that good ol’ Kansas clay was nonexistent. In the dead of winter all things are possible and
spring is only a few weeks away.
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Business Intelligence Brief is an online information service, published electronically by Armada Corporate Intelligence. It is prepared by
Armada CI. The publisher has taken all reasonable steps to verify the accuracy of the content of this information. Armada Corporate
Intelligence shall not be responsible for any errors or omissions.