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Looking Inside The Market’s Interpretation of Inflation vs. Reflation

We’ve seen a lot of headlines regarding the stock market surging over the past few months (up 11% since the election).

That’s not the only thing jumping: oil prices are up 15% the last few months (and 80% year-over-year).  Steel prices have jumped 325% since last summer.

Headlines are referring to this form of inflation as “reflation”, as if it’s a positive thing.  

Is it though?  Understanding the difference between reflation and inflation will help us with the markets.

The concept behind reflation is that it is ultimately a ‘good’ type of inflation where prices return to ‘normal’.  

Economists talk about reflation as a good thing but only when it comes from an uptick in demand and greater economic activity. For example, gasoline prices were unusually low when they were at $40. But are now reasonably priced at $50.

Whenever someone uses the term ‘reflation’, they mean a return to normalcy. Specifically, economic activity has stimulated a return of demand and a more appropriate higher level of prices.

But reflation – the way headlines are calling it – is not happening here. The term doesn’t fit: global demand and economic activity are both slowing.

In point of fact, we are seeing price hikes because demand is actually missing. In response, suppliers are ratcheting back supplies.  

US Steel (NYSE: X), for example, said on their recent earnings call that its steel volume shipments will be at – or possibly below – last year’s levels.  Yet prices are rising nevertheless thanks to cutbacks in production by global producers.

And that’s my primary concern when I hear most people and economists discuss the “positive” impact of reflation.

  1.      Private sector adjustment: prices have jumped fast and the private sector has to adjust.
  2.     Inflation via supply-constraints not via demand

This is a miniature OPEC oil shock underway.  

Not a shock in the sense of a surprise. Everyone knew it was coming.

But a shock in the sense of an unprepared economy.  

It may be good for the energy and materials sector. But it’s a horrible drag on the rest of the economy.

You can see its effects if you look at the December retail spending data.  

First, retail spending (excluding cars and gasoline) was flat to November.  

Secondly, the higher gasoline costs are squeezing out other spending: gasoline spending rose $700M and spending on Food Services shrank $500M.  

The economic costs are clear: this ‘reflation’ is bad and having a negative – not positive – impact.

When the economy is growing and the outcome is inflation, the rise in prices is easily managed by an offsetting rise in incomes.  

For businesses, greater sales lets them absorb the higher cost of doing business. For households, strong wage growth offsets things like higher prices at the pump.

But when inflation is rising faster than the rate of economic growth, that’s stagflation. This is what we’re seeing today: CPI grew 3.1% last month, and economic growth is barely 2%.

In 2016, falling incomes hit businesses and consumers alike. But thanks to falling prices of gasoline and other commodities, everyone was fine.

Now, we have inflation but no offsetting rise in incomes. It’s not just inflation, but big inflation.

Private Sector Pains: Consumers Blindsided By Inflation

Overnight, U.S. businesses face inflation (Producer Price Index – PPI) that went from 0% to 1.6%… and rising.

Consumer inflation is even worse: Core Price Index (CPI) hit 2.1%.  And, again, it’s the suddenness that makes for the shock. Consumer sentiment metrics showed that households continue to expect a deflationary environment. They are completely unprepared for what is coming.

I called this out back in November in my November report on consumer sentiment as reflected in Google searches.

Businesses Spending: The Big Unknown

At this point, some people might raise other, older data that point to greater business activity. Some might point to when business inventory surged in November.

But that’s against a general trend where they are trying to tame the problem of excessively high Inventory-to-Sales.

Was the fourth quarter of 2016 (Q4) activity a blip (inventory re-stocking) or something with more traction?

If we look at semiconductor activity, we see the same trends: a jump in prices and sales activity.


But dig a bit deeper and you’ll see familiar reasons: supply constraints and short-term inventory restocking.

(We will see an extra boost in December’s figures from the early Chinese New Year – it comes in January – and the race to make and ship product by mid-January.)

KEY TAKEAWAY – Stagflation is rising inflation but sluggish growth.  

We have inflation. Economic activity may be accelerating…Or not.

It’s still too early to know how much is brief re-stocking and how much is sustained economic activity. We won’t know until March.

The big deciding factor is consumer spending. The nominal level has stayed high, but the form is changing fast and not in positive ways.  Add in higher inflation and actual pullback could happen.

That take the wind out of business growth.




Andrew Zatlin

Editor of Moneyball Economics

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