When it comes to the inflation versus deflation debate there is basically one distinct caveat that first must be agreed upon before further discussion can commence.
An agreement must be made whether the inflation discussion will revolve around consumer price inflation or producer price inflation, because the difference between the two can cause sizable discrepancies in opinions.
The difference also may mislead one into thinking the macro environment is wrongfully inflationary or deflationary as both the corporate and the consumer worlds affect the macroeconomic environment.
In other words, both are equally important but may not always be suggesting the same reality.
Definitions – Producer versus Consumer
Producer price inflation concerns the price producers pay for raw materials whereas consumer price inflation concerns the price the consumer pays for the finished products that come from the producer.
Producer inflation includes the cost of mining raw materials and delivery costs whereas consumer inflation includes those costs as well as the overhead and labor costs of the business.
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Furthermore, consumer inflation also includes any corporate markup (otherwise known as profits), a significant and often overlooked part of the inflation (NYSEARCA:TIPS) picture.
Producer Prices: Verdict = Deflation
Check out the following charts below that show some of the major input material prices over the last few years.
First let’s look at the commonly followed DB Commodity Index ETF (NYSEARCA:DBC) which shows a clear downtrend in the overall index. Since the top in 2008, raw material prices have fallen over 40% and based on this index are down 25% just the last three years.
This chart suggests producer prices are much cheaper today than they were at recent periods in the past.
Next to it, the price of oil and gasoline are plotted. They too are at lower prices today than they were six years ago and also haven’t risen above 2011’s peak in price. Gasoline and oil remain cheaper for the wholesaler today than they did three, as well as six years ago.
Now let’s move onto agricultural products, the inputs that make up our food. The charts below of corn, soybeans, cocoa (NYSEARCA:NIB), wheat, livestock and hogs show that only livestock has gained in price over the last few years.
Overall, agricultural prices (NYSEARCA:DBA) are much lower today than in the recent past as the charts above and the first chart below of livestock (NYSEARCA:COW) and hogs outline. Beef is the outlier, likely affected much more by the drought and supply constraints than the other commodities. Beef alternates like hogs, however, have seen a significant decline in price, making livestock one of the only major commodity bucking the declining price trend.
Finally, inputs into homebuilding and other industries are also seeing deflation at the producer level. Check out the charts above of lumber and copper that show both of these materials have also not risen in price the last few years. Lumber (NYSEARCA:CUT) peaked in price in early 2013 while copper peaked back in 2011.
Since 2008, only livestock and lumber are higher in price, and lumber prices also were this level back in 2006, at the last peak in the housin market. Compared to 8-10 years, lumber prices have not risen.
These charts show that inflation is not really occurring at the producer level. In fact, the case could be made the producer is actually seeing deflation as revenues of these mined or famed input materials continue to drop.
Really just One Culprit
This brings me to my point. The reason the consumer is seeing certain price inflation has nothing to do with the input materials or inflation in actual commodity prices.
We also know due to the continually falling real wage and median household income growth that increased prices are also not due to rising labor costs. Labor costs are falling, and that is deflationary as well.
This leaves only one culprit.
The reason for the rising consumer prices and smaller packaging sizes is due to corporate profits.
If consumers are feeling any inflation at all it is because corporations are refusing to lower prices, which they could and still be profitable as my final chart below outlines.
Corporate profits today are at an all time high as a percentage of GDP. Whether you measure profits this way or as a percent of revenue (net income %), or most other reasonable means, corporations are making more money today than at most prior periods in American history.
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One of the primary reasons for this extreme in profits is corporations are pocketing the excess profits they are receiving from the falling commodity input costs. They are keeping the deflation and instead of passing that deflation on to the consumer, they are passing on increased prices and smaller packages, having their cake and eating it too.
This is a major reason why profits are at all time highs.
The good news for consumers, however, is the current state is not sustainable and the chart above may be hinting at it as profit growth as a % of GDP has already stalled at the all time high levels.
Corporations such as Target (NYSE:TGT), Caterpillar (NYSE:CAT), and Apple (NASDAQGS:APPL) will eventually need to lower prices to allow those who produce the input commodities they use (farmers, miners, etc) to also maintain some profits. As commodity prices are falling, those companies that produce them are seeing revenues fall, putting pressure on their own margins.
In order for these companies to remain viable eventually they will need to see some price cuts in the products the consumer corporations make that they themselves also need as a cost of doing business. The farmers, miners, etc must eventually see some cost deflation to match their own revenue deflation.
Eventually the circle will complete itself, and everyone will start to see falling consumer prices as corporations will eventually have to drop prices or risk putting their oil, gasoline (NYSEARCA:UGA), wheat, hog, metals, and corn (NYSEARCA:CORN) suppliers out of business.
The ETF Profit Strategy Newsletter keeps subscribers in tune with financial markets so they can stay on the profitable sides of the trade. Deflation remains the primary risk in the current environment as bond yields and commodities are already pricing in that scenario. This has major implications for the U.S. Dollar and other commodities.
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