Why take two price scenarios into the shower, when you can just take one?
Introducing “compartflation” an economic environment in which both inflationary and deflationary forces compete to generate recession or stagnation.
This is not quite stagflation, as not all prices are rising — just a compartmentalised set, namely in this case commodities due to issues of scarcity.
The argument has recently been set forth by Gregor MacDonald. As he writes:
As I was laying out earlier this winter in Recession vs. Collapse, we are experiencing a deflation that appears to trigger both reflationary policy and reflationary responses in the dollar and commodities–which then leads to more deflation.
This is a process that likely began as early as the Summer of 2007. In this deflation-inflation oscillation the metronome ticks first one way, and then the other, causing uproar and loud talk each time among the inflationists, and the deflationists.
As I have been suggesting this year, why the need to choose? We have very likely been in an inflationary recession for nearly two years now, with massive deflation in housing and yet stubbornly higher food, energy and health care costs–the latter well above the price levels of just a few years ago. The risk, in my view, is that both trends now accelerate. And, that we experience next something more akin to an inflationary depression.
The above presumably renders traditional monetary policy focused on measures such as the CPI and RPI somewhat useless as inevitably responses will always be over or under-done.
Price elasticity, meanwhile, also has to be factored in, especially when looking at prices of energy commodities. Gregor looks back at similar peak periods in other commodities like wood and whale oil, noting how increased volatility transpires post the peak; namely before the consumer is able to adjust. As he explains:
When the post-peak phase gets underway the price amplitude increases even further, playing havoc with supply and demand. As demand gets killed, and then finally collapses, it causes confusion about supply. But then, as demand returns, any questions about supply are soon answered as demand once again bumps up against the supply ceiling.
This is exactly what’s happening now with crude prices. And oil’s “dollar-hedge” role ups the volatility even more so.
The issue is that there is no middle ground. In Gregor’s model prices inevitably continue to overshoot and undershoot. The “oil shock” originates not from high prices, but the extreme volatility of prices: too high then too low. To realise the dangers of this you just have to consider the divergent reactions to oil’s fall last October — joy from consumers yet concerned outcries from producers.
This sort of volatility, meanwhile, also hits business productivity as companies fail to keep up with the shifting price environment.
All manner of industries will be affected too: from energy firms and their energy investments to energy dependent firms (so almost all), especially those with major hedging strategies. Basically, anyone who needs to factor in energy or food prices into their daily business models won’t be able to, or the margin of error will be so wide it will severely impact the reliability of profit projections . In essence profit forecasting could become completely unreliable as prices oscillate in an extreme fashion within the band, which looks a little like this according to Gregor:
While prices may eventually plateau, it will only be at the extreme cost of growth and price stability generally. A falling price environment in other goods and services may also very possibly ensue as consumers try to buffer up for the now expected periods of higher energy prices, an enforced type of consumption smoothing on the population.
Related links:
It’s not a liquidity crisis, it’s an energy crisis stupid - FT Alphaville
Niall Ferguson fights back - FT Alphaville
The new art of inflation mongering - FT Alphaville
