The Triggers That Will Spark ‘Hot’ Inflation
by Gregor Macdonald, contributing editor
Thursday, April 19, 2012
Executive Summary
- Rising wages in the developing world create upward price pressure everywhere globally
- The paradox of safety: Many traditional “safe” assets (e.g., bonds) are horrible places to store capital during ‘hot’ inflation
- Money velocity drives inflation — and it has only one direction to go these days: up
- Winning and losing assets if ‘hot’ inflation does indeed break out
Part I: Get Ready for ‘Hot’ Inflation
If you have not yet read Part I, available free to all readers, please click here to read it first.
Part II: The Triggers That Will Spark ‘Hot’ Inflation
Arthur Lewis was an economist from the small, Caribbean island of St. Lucia who went on to win a Nobel Prize in 1979. His work identified the process by which very cheap labor is brought from the countryside to urban areas during phases of industrialization in developing countries. At a certain point, this supply of cheap labor went into decline and wage pressures began to mount.
Now referred to as the Lewis Turning Point, such a phase marks the end of a kind of deflationary boom, in which input costs fall during a phase of hyper-strong growth, and the beginning of inflationary restraints, in which profit margins stop growing. This is exactly what’s happening in China today.
The current turn was identified as early as 12-18 months ago. Here is the Wall Street Journal last May, 2011:
Wages are rising in China, heralding the possible end of an era of cheap goods. For the past 30 years, customers would ask William Fung, the managing director of one of the world’s biggest manufacturing-outsourcing companies, to make his products—whether T-shirts, jeans or dishes—cheaper. Thanks to China’s seemingly limitless labor force, he usually could.
Now, the head of Li & Fung Ltd. says the times are changing. Wages for the tens of thousands of workers his Hong Kong-based firm indirectly employs are surging: He predicts overall, China’s wages will increase 80% over the next five years. That means prices for Li & Fung’s goods will have to rise, too.
(Source)
This is precisely why just this past week, China recorded both the slowest GDP in nearly three years, at 8.1%, while at the same time recording a continuation of very painful energy and food inflation. When food
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