- “Cotton costs have fallen back to the ground.” – (September 30, 2022)
- “"Timber rates have fallen to their lowest level in more than two years, returning to pre-pandemic levels." (September 27, 2022)
- “Copper spending has fallen to its lowest level in just two years” (July 7, 2022)
- “Oil prices are falling… US crude oil has lost about US$ 35 per barrel in three months.” (September 13, 2022)
- “"Rents fall for the first time in two years" (September 26, 2022)
- “Household expenses persist. First monthly decline in years.” (September 27, 2022)
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Something essential is happening. It's known as... Deflation.
Supply-side shocks
The pandemic and the conflict in Ukraine – two once-in-a-century shocks – squeezed around a stimulus of US$9 trillion (by the IMF's count) have put the global economic climate in a huge whiplash.
- Huge changes in buyer behavior have occurred, generally decreasing spending on functions and increasing spending on physical items (specifically long-lasting items) – as described in the outdated column. The price of trillions of dollars in demand has been diverted in unexpected directions, flooding unprepared suppliers with unfulfilled orders (and raising rates).
- Forecasting errors by producers rippled throughout the supply chain, exacerbating shortages everywhere from supermarket cupboards to car buyers, as logistics managers struggled to cope with business as was no longer commonplace.
- The shortages, sanctions, and sabotage caused by the war in Ukraine have further shifted the global economic climate, particularly in the fiscal and energy sectors.
- Covid lockdowns, quarantines, and travel bans have paralyzed vital segments of the construction cycle, especially in China.
All of this has generated immense stress on the gigantic and complicated supply chains upon which the contemporary world depends to produce and bring in these items.
It also affected the psychology of the general public, damaging buyer self-confidence and terrifying hedge fund makers. “Inflation” became the fifth horseman of the apocalypse, looming over the financial system. In the media today, it even overshadows the common scourges of war (Ukraine) and disease (Covid). The avid players at the Federal Reserve, who resisted for a substantial time, have now succumbed to popular panic. Hundreds of thousands of workers, ironically, are to be sacrificed (unemployed) – perhaps another 10 to 12 million jobs will be destroyed, in the vein of Larry Summers (the former Treasury Secretary, a thoughtful intellect, known for 10% of unemployment). Property will be lost, wallets devastated, pensions overburdened, families destroyed… it doesn’t matter – this hedge has to prevail, we are told, to “tame inflation”. And this will persist – the new facets of the Fed officials' speakme include a warning about how it could be a terrible mistake to relax "too soon." The harsh regime will have to end unless the Bureau of Labor figures determine that its market basket (the basis of the ever-dubious consumer rate index) is no longer on fire and All Clear warns.
The self-healing nature of the supply chain
All this distress is tragic because it is not sensible. The bottlenecks that exacerbated cost inflation over the past 12-18 months are now dissolving. The significant supply constraints that fueled price increases are beginning to ease decisively.
It is fortunate for us that the dominant cause of the current “inflation” is being pushed aside. Supply constraints are painful in the latter case, but they are self-healing.
We've all seen this in action. In the early days of the pandemic, the shortages were glaring. Empty supermarket shelves were commonplace. Remember the frantic search so many people undertook to locate, say… hand sanitizer, considered essential at the time. It became scarce and expensive. Or remember how elaborate it became again in 2020 to find a way to obtain a Covid check and how expensive it was if you could even figure it out.
However, it didn't take long for everyone to start noticing that the supermarket aisles – now generally full of ordinary goods once again – were occasionally physically obstructed by… hand sanitizer – barrels of the stuff! And sometimes now free-for-all. Pallets of toilet paper – once stored away – were being piled to the ceiling in empty corners of the fortress. And if you go to a CVS these days, you also have to cautiously maneuver around the mountains of homemade Covid multi-kits, for $9.99 each.
Covid testing at CVS
image by means of writer
A more consequential and larger “strategic” illustration: consider how the narrative of the war in Europe versus the energy crisis in Ukraine has evolved over the last 8 months. When Russia attacked, it gave the unthinkable first impression that Europe could do without Russian gasoline and oil. It could take years, it was said, to move away from this dependence. Currently, German gas reserves are at 91% of capacity. The valuable German clientele has reduced its energy consumption to an exceptional degree in a very short period of time:
- “"Germany saw a decrease in its consumption of plant-based gasoline in the first five months of this 12-month period, with the decline deepening in May as well. Part of the drop was attributed to milder frosts. Consumption fell by 351 TP3T compared to the same month last year. Adjusted for temperature effects, the drop was 111 TP3T last month."”
There is now confidence that Europe will survive this disaster without a power outage, and Putin's attempt to rig gasoline deliveries is doomed to failure. Even this bottleneck is being resolved.
Here is the simple strength and lesson of the Market. When an imbalance develops, actually because of an external shock, markets respond – meaning that suppliers respond, customers adapt, and before equilibrium is restored. Show me a shortage, and in 3 months, or a year (depending on the product category), I will show you deflation and, in all likelihood, a surplus.
This system is now taking hold in many markets, impacting numerous commodities.
Some examples: Copper, Cotton, Wood, Iron Ore, Crude Oil.
“"Doctor Copper" is an excellent region to start with:
- “The term Doctor Copper is market jargon for this basic steel, which has a reputation for having a 'Ph.D.' in economics, due to its ability to predict turning points in the international economy.‘ – Investopedia
An employee filters the 8 mm diameter copper cable that is coiled before passing through a … [+] rolling mill to become cable at the Nexans factory in Lens, northern France, also on May 11, 2022. – The French cable company is the only one in its sector to have its own copper smelter in Lens. This plant represents a competitive advantage for Nexans at the dawn of a widespread boom for electrical cables. (image by Denis Charlet/AFP) (photo by DENIS CHARLET/AFP via Getty Photographs)
AFP for the use of Getty photographs.
At the start of the pandemic, the cost of copper fell and then rose. For some, the increase became an inflation alarm. The rate doubled between April 2020 and April 2021. It became essentially 50% above the long-term regular rate. This circulation rate was generally predicted to become a vital inflation driver across a wide range of end-user functions.
- “Copper costs have risen to listing highs for the first time in more than a decade… one explanation for why some buyers are preparing for higher inflation.” (WSJ May 12, 2021)
Price of copper per metric ton
Graphic by means of the writer
But after stabilizing in 2021, the cost of copper has been falling for several months and is back within 13% of that pre-pandemic regular. If we calculate the trend of copper spending the way the CPI does – measuring the monthly percentage change relative to the same month of the previous year – copper “inflation” has been falling for 14 months and is now deeply poor. In other words, the copper market is experiencing massive deflation.
Change in copper rate (month-on-month % year-on-year)
Graphic by writer Cotton
The trend in spending on cotton is similar.
CLARKSDALE, MS – OCTOBER 19: A cotton boll awaits harvest at the BTC farm October 19, 2003 near Clarksdale, Mississippi. BTC grows 1,000 acres of cotton, 80% of which is genetically modified (GM) Bt, Roundup cotton. The executive mandates that at least 2% of the crop be planted with known cotton to help prevent insects from building immunity to GM items. BTC plans to plant 1% of its cotton acreage in conventional cotton next year to gain first-class experience paid for with the help of mills. (Photograph using photos by Scott Olson/Getty)
Getty photos
Cotton expenses from October 2021 to September 2022
Char using the author
The increases in cotton prices were driven primarily by supply constraints. As reported this summer.
- “Cotton producers in the Southwest are abandoning tens of millions of acres of parched fields they planted in the spring, leading to forecasts for the weakest U.S. harvest in more than a decade and sending much higher rates of decline.”
But the concerns are diminishing and may have been unfounded.
- “Cotton spending has fallen back to the ground… Futures have fallen 25% considering the end of the remaining month, simply eliminating the positive aspects fueled by a US agricultural agency predicting that more than forty percent of US hectares planted with cotton this year will not be harvested because of the drought.”
Lumber
- “"The hottest commodity in the U.S. today is lumber." (WSJ July 9, 2020)
CHICAGO, ILLINOIS – APRIL 5: Stacks of lumber are delivered to a home in mid-April 5, 2021 in Chicago, Illinois. Lumber expenses more than tripled due to the April shutdowns caused in part by COVID-19 restrictions that hamper sawmills and the low cost of personal home loans that fuel new home development, causing a welcome increase. (Image via Scott Olson/Getty Photos)
Getty Photos
For many years in 2020 and 2021, timber expenses were a prime example of what some perceived as incipient inflation – although it has not yet been proven, experts were convinced that it had arrived there.
Prices of sawn timber from October 2017 to September 2022
Graphic via author
This year the timber rate has fallen back to its pre-pandemic level.
Fluctuations in the timber market reveal how forecasting errors create failures on the delivery side.
- “Many factories closed their shops and switched to maintenance and repairs, figuring that demand would fall as individuals lost their jobs and watched their spending. What happened was the opposite,' said one industry insider. ‘Lumber and plywood started flying out of closets. 'Americans didn’t go on vacation,“ said another insider. ”They stayed home and built decks, built fences, built pergolas. The whole shebang and every little thing. Harvard’s carefully adopted forecast of home renovation spending predicted a slowdown… however, the model couldn’t have anticipated a virulent disease that kept Americans at home for months. Orders for mills were backed up.”
The scarcity fueled an additional problem – hoarding by customers, which is a natural response to the breakdown in forecast certainty. (Hoarding has played a significant role in increasing supply constraints in many different industries, comparable to semiconductors.) In other words, certainty became a factor in increasing demand, but the main problem was the mismatch with the restricted supply.
Iron ore
Iron Ore Mine, Vale Mining (Northern Equipment), Minas Gerais State, Brazil. (Photograph by Giles Barnard/Development Images/Avalon Images/Getty)
Getty Images
The economic climate is much less dependent on iron and metal than it was fifty or 100 years ago, but it is still an important commodity. Iron ore costs increased after the pandemic, but have now also recovered. The global iron ore rate is almost back to pre-pandemic levels. Measured in the same fashion as the CPI (year over 12 months percentage change per month), iron ore is now in a deeply deflationary style.
Exchange rate in the cost of Iron Ore (% month by month 12 months a year)
Chart via creator Crude Oil
Crude oil is the mother of all commodities. It is declared to be one of the main drivers of inflation within the economic system.
City of CULVER, CA – APRIL 25: Oil rigs extract oil as crude oil expense rises nearly… [+] $ 120 per barrel, leading oil companies to reopen many wells across the country that were deemed exploited and unprofitable decades ago when oil sold for a fifth of the cost or much less, on April 25, 2008 at the Los Angeles environmental group in the city of Culver, California. Most of the old unprofitable wells, called “stripper wells,” can be found in areas of the city where homeowners are sometimes outraged by the noise, smell, and potential environmental hazards linked to living so close to renewed oil drilling. Considering that homeowners consistently do not have mineral rights beneath their land, oil companies can drill at an angle to move under homes, regardless of the residents’ wishes. Using expensive new knowledge and drilling recommendations, California producers reversed a prolonged decline of about 5% per year with improved oil circulation of about 2.5 million barrels in 2007 for the first time in years. (Image assisted by photographs by David McNew/Getty)
Getty photos
Oil expenditure was severely distorted through a succession of external macro-shocks – even going badly with the pandemic displacement factor and then increasing when the fighting in Ukraine began.
Crude oil expenditure 2020-2022
Chart using the creator
but the remaining quarter showed a deflationary trend.
Crude Oil Deflation in the 3rd Quarter of 2022
Graphic by creator
Today's news (October 3rd) is that OPEC is considering production cuts to support prices, and this has lifted oil futures by 5%. Oil is a special case, in fact – its expenditures are not absolutely “market-driven”. So, again, a production cut is a donation restriction, therefore, if it creates “inflation”, it will be part of the typical donation picture.
Summary: Deflation… Get used to it.
We can continue. The pattern is identical in virtually all commodity markets. Costs are still, in many cases, above pre-pandemic levels, and food prices are rising due to the Russian blockade of Ukrainian agricultural shipments (again, this is clearly a supply-side constraint), but even these costs are falling and shifting back towards pre-pandemic levels.
There is a new argument on offer that these cost declines are caused by weakening demand. This is largely false, at least for now. A recession may be underway, due to flawed primary banking policies and perhaps Xi Jinping's continued missteps, but it is not here today in the US and does not explain the deflationary trend across our economy over the last two quarters. The labor market is still very strong, and retail income is in good shape. The cost declines are not demand-driven. They are largely a reflection of improvements in supply.
Shocks create bottlenecks. Bottlenecks put pressure on costs, briefly. Markets are now working with their natural technique to eliminate these bottlenecks. Additional external shocks could also disrupt this method, but trends are now deflationary across the entire commodity spectrum.
