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There should be some inflation! So many factors that have historically created inflation are present:
- Despite the concerted efforts of the Federal Reserve for over a decade (efforts mirrored by central banks around the world) to grow the money supply at a rate in excess of the rate of economic growth while keeping inter-bank lending interest rates as low as possible.
- Despite continued sizable deficit spending and carrying ever-growing debt by the U.S. government.
- Despite the U.S. running a trade deficit and the size of that deficit continuing to expand.
- Despite an extremely low unemployment rate and a very tight labor market.
- Even after a period of economic growth that pushed many parts of the U.S. economic infrastructure to its limits.
And yet, there are still no meaningful amounts of inflation.
The most recent (July 30) release by the U.S. Bureau of Economic Analysis (BEA), which estimates the changes in the prices of goods and services purchased by consumers in the United States, the price of living went up a mere 1.4 percent on a year-over-year basis, and 0.1 percent sequentially. Don’t trust the government’s calculation? I understand. I have both confessed and elaborated for many paragraphs about my concerns regarding government data and calculations in previous commentaries. That said, the yield on the 10-year Treasury bond is currently 2.06 percent, which is the global debt market’s way of saying “Inflation? What Inflation?”
So, if the conditions are conducive for inflation, and arguably have been for many years, why is inflation so low?
I blame technology. What if the true lasting effect of technology is to deflate pricing power and kill inflation?
Moore’s law has stayed on course. In 1965, one of the founders of Intel (Gordon Moore) predicted that the power of the microprocessor would double – and its cost would be cut in half – every two years. At the time he only made the prediction for “at least another decade” and then went on to update it as “still a reasonable expectation” in the years and decades that followed. It is easy to see why the continuation of Moore’s Law is deflationary for technology hardware, but it is also deflationary for technology software. Unless programmers are constantly writing thousands of lines of addition code that takes advantage of/utilizes all that ever-growing processing power, their software becomes outdated. Most of today’s software will be passé within five years – or less. As a result, Moore’s Law is deflationary for both hardware and software, but I think that is just the beginning of the story.
The ever-increasing power of the hardware and software has provided full price transparency and complete quality disclosure for marketplaces around the globe. Especially in the Business-to-Consumer (B2C) markets, the middlemen or wholesalers have been nearly eliminated. Massive disintermediation has occurred in insurance, banking, investing, travel, music, consumer goods, education and appliances, just to name a few. The costs associated with that part of the economy have been eliminated as well. Almost all those goods and services are made to order, eliminating the cost of producing excess. Goods and services of similar quality are unable to get a price increase, as technology and the price transparency it provides makes it easy to find the cheapest price. Any vendors that can command higher pricing quickly draw competition from others seeking any pricing power they can find. Vendors that try to sell lower quality in order to generate more profit are quickly exposed as well, by customer reviews and ratings. All of this is not only deflationary, but it constantly thwarts inflation.
The conversion of ever-increasing amounts of the goods economy to e-commerce may increase the cost of physical delivery, but it eliminates the cost of real estate and utilities (for the stores), the cost of employees who work in those stores, lowers inventory carrying costs and eliminates shoplifting (although some fraud still exists), and permits marketing to be both precisely targeted and infinitely scalable for no, or almost no, additional cost. All of which is deflationary.
Technology has steadily increased inventory visibility and tightened supply chain management so effectively that inventory sales ratios have fallen and the inventory which remains is precisely what the consumer wants/needs or has been predicted to want/need through predictive analytics, which are made possible by technology. All of which is deflationary.
Low unemployment and tight labor markets no longer drive inflation as they once did. Technology has driven productivity increases faster than demand for labor has grown in many areas. In many other areas, it is systematically eliminating labor completely. We not only pump our own gas, we scan and bag our own groceries, and pay without needing someone to count out the change. We schedule our coffee when we are at the stoplight four minutes from the Starbucks so that we can walk-in, grab our customized order and walk out, maximizing our time but more importantly dramatically increasing the velocity of order flow that Starbucks can produce at each location.
We can work from home (eliminating the cost of office space and commuting) or anywhere (on the beach or in India) as long as we can stay connected via technology. Not only are qualifications and activity closely monitored by technology, but most modern workers are never really “off work.” Especially in white collar jobs and most professional services – including the technology industry itself – first through the Blackberry and now the smart phone, we are always ‘on call.’ All of which is deflationary.
Agriculture is yet another example of the deflationary power of technology. After remaining flat for almost a century, bushels per acre of all crops began to improve in the 1950s. But those yields have skyrocketed over the last 50 years.
As an example, U.S. corn production varied between 20 and 35 bushels an acre from the Civil War (1860s) until 1940. By 1960, bushels per acre of corn had improved to 35 to 40. Then low-till planting, custom fertilizing, more efficient irrigation and seed genetics that increased yield, resisted pests and tolerated herbicide took root (pun intended) and began to take over. By 2000, bushels per acre were triple the levels of the 1960s, routinely exceeding 120. Yields today exceed 160 bushels per acre and farmers have quit speculating about whether 200 bushels is possible and started debating what it will take to produce 300 bushels per acre.
Farmers in the U.S. use tractors and combines (harvest equipment) that costs hundreds of thousands of dollars (but are capable of tending to thousands of acres with very little labor), to grow crops in land that costs thousands, often tens of thousands, of dollars per acre, yet they still produce most of those crops cheaper than anyone anywhere else on the planet. It is the epitome of the modern U.S. economy – apply generous amounts of capital, even more generous amounts of technology and produce volumes and quality that is so excessive, it dwarfs the capital and technology costs in the denominator of the equation. All of which is deflationary.
Manufacturing is yet another example. Twenty years ago, when I toured a Caterpillar engine production facility, the plant floor was full of members of the United Auto Workers discussing the football game last weekend as they smoked cigarettes and fulfilled their functions on an assembly line.
Today, when touring a Paccar engine production plant, the first thing you notice is the complete absence of workers on the plant floor. Not only are machines making the machines, but they are doing so with an increased level of meticulousness. The cost of the engine does not include labor costs or pensions, or the worker’s compensation and healthcare costs. It also lasts longer because it is made within better precision tolerances. The engine costs less and produces more hours without breaking down or wearing out. All of which is deflationary.
Last but not least, there is the U.S. development of fracking. Using explosions underground to clear wax or tar buildup and rejuvenate oil and gas well productivity is nothing new. That type of fracking has been used for over 80 years.
However, drilling down 10,000 feet into the center of a layer of ‘source rock,’ then turning 90 degrees and continuing to bore horizontally is a relatively new technology. An even newer technology, that was experimented with for years before having an epiphany moment in February 2009 in the Eagle Ford shale, was setting off controlled hydraulic blasts with sand, ceramic proppants, water and a mixture of acids and other emulsifiers. Those hydraulic blasts produce millions of cracks in the source rock, cracks held open by the sand and proppant, and effectively turn that layer of source rock into a giant sponge. A giant sponge that leaks barrels of oil and natural gas as the weight of the 10,000 feet of earth above it squeezes down.
This technology first allowed us to access oil and natural gas resources that were previously unreachable. Since 2009, the productivity of each fracking well has dramatically increased by factors of four to 10. By first gaining access to previously inaccessible resources and then dramatically increasing the amount that was obtained, the U.S. has gone from being the world’s largest importer of oil to a net exporter and the world’s largest producer of oil and natural gas. All of which has effectively lowered the price of natural gas to nearly free (except for the cost of transport) and put a ceiling on the global cost of oil. All of which is deflationary today and should continue to be for many years.
Bottom line – there are many other examples, in addition to those outlined in this commentary, and numerous other intricacies of the examples I did outline. They all add up to a world in which technology has either killed or severely limited inflation for the foreseeable future. Those who are predicting higher interest rates or planning for sustained pricing power are going to be proven wrong by the ongoing march of technological development and its powerfully deflationary forces.
Just saying…
