These ISM sub-indices give implicit forecasts of the direction of prices and employment.
Thanks to the Iran War, prices (red line) are heading higher, and employment (blue line) lower.
The shift in just one month (March) is obvious. The longer this continues, the worse it'll get.
This is my calculation of world manufacturing PMI, compared with J.P. Morgan's calculation. I only started keeping the J.P. Morgan data in 2011, which is why I needed to make my own calculation to understand previous cycles. Where I don't have back data for individual countries, I have used manufacturing business confidence, and estimated what each country's PMI would have been if it had been calculated by IHS Markit (which used to publish PMI data before S&P Global took over.) In some cases, I have smoothed the input series (some, such as ABSA's PMI for South Africa, or the AIG PMI for Australia or Canada's Ivey survey, are very "spiky", i.e., have large month-to-month random errors.) In other cases, I have extreme-adjusted the series before I used them to calculate my estimate of world PMI. This mostly, in effect, reduced the down spike from COVID, but had some small effects elsewhere.
Why this chart is interesting is because, hitherto, in all recoveries, from deep recessions or shallower slow-downs, the rebound has been sharp. This cycle, it's been a slow, and not especially steady ascent. Observe that it actually began a steep-ish recovery at the end of 2023, before it fizzled out.
Obviously, Trump's tariff tango has something to do with this, but I suspect there's more to it. Inflation isn't falling like it should be when the economy is so sluggish, and part of the reason for that is the growth of monopoly and oligopoly is the US, and the West's determination to stop China exporting its deflation to the world, particularly in cars, solar panels and batteries, via tariffs and quotas. Why was inflation lower before Covid, when manufacturing was just as concentrated as it is now? Because everybody expected inflation to remain low. But in the Covid rebound, firms found that they could indulge in a bit of "greedflation", and pushed up their margins, and expectations have accordingly shifted. Monopolies and oligopolies now know they can shove up prices every year by more than they used to, and get away with it. To use more technical terms, inflation over the last few years has been more cost-push than demand driven.
Sluggish growth may well continue, even though Europe is clearly (finally) recovering. But higher inflation means that Central Banks will be reluctant (=slow) to cut interest rates. And if the AI bubble pops, the US will go into recession. If that happens, the US dollar will plunge, pushing other economies themselves into slow-downs or recession.
Of course, happy days may be here again. But I hae me doots.
US inflation has started to rise, in consequence of the swingeing jump in tariffs. It took a bit longer than I expected, probably because stocks (inventories) were higher than I thought. But now that businesses have run down their pre-tariff stocks, they have no choice but to pass on their increased costs. No doubt, as inflation gathers momentum, they will also be indulging in a bit of "greedflation", as they did in the post-covid inflation surge.
But it's not just tariffs. The government's campaign against immigrants has meant that food prices are soaring, because immigrants pick and pack the USA's food. (Coffee is rising because of global warming, and because of 50% tariffs on Brazilian coffee imports)
In my judgment, neither of these forces is anywhere near over. Prices will continue to rise until equilibrium is reached, and that will be several months away.
The Fed could "look through" this surge in inflation, on the argument that it will not be a sustained jump in the inflation rate, but a one-off adjustment in price levels. "Cost-push" rather than demand-led inflation. That is what markets (shares, bonds and currencies) think will happen, and the next cut in rates later this month seems baked in.
This rise in inflation will reduce real (inflation-adjusted) incomes, reducing spending, deepening the economic downturn. This might seem to be an argument for further rate cuts, if it happens, but just as the inflation might be transitory, so would the economic downturn caused by that inflation.
Now, it is possible that wages may rise to compensate---which I do not think will happen---but if they do this will heighten Fed fears that higher inflation is becoming embedded in the system, which means they won't cut interest rates any further.
So, the Fed moves depend on data over the next few months. If the economy continues to weaken, and wage inflation doesn't accelerate, the Fed will prolly cut the Fed Funds rate again. If the economy stabilises, then the Fed will have the luxury of waiting for the inflation surge to slow, and it prolly won't cut rates again. If wage inflation starts to pick up, all rate cuts are out of the question.
I'm not at all sure what the inflation rate will peak at, but I wouldn't be surprised if it nears 5% by year-end or early in 2026. This will be a very uncomfortable environment for the Fed to cut rates, as opposed to keeping them stable. It will need to be quite sure that the rise in the inflation rate is transitory. And that its moves are not seen as a response to Trump's pressure, which would destroy its credibility.
Well, at last I have updated all my databases. Almost all!
This chart shows the CPI inflation rate for the Big 8 economies (US, UK, Europe, China, Japan, India, Brazil, Russia) weighted by GDP, alongside the percentage of 43 world economies where the CPI inflation rate is above 6%. The moral of the story is that inflation is falling in the Big 8, and also in the world as a whole.
Inflation is falling because the impact of Russia's invasion of Ukraine is fading (in the sense that it's not making inflation worse, so year-on-year rates are falling); because commodity prices are declining; because growth is slowing; and because China's inflation rate has gone negative (one sign of just how weak China's economy really is). It'll prolly take another year, perhaps longer, for Big 8 inflation to get back to 2%.
I think it quite likely that the longer-term underlying inflation rate has risen, because the key reason it got so low is offshoring and just-in-time manufacturing. Goods were efficiently assembled from parts in different countries. The progress of offshoring has stopped and reversed. The war has shown that relying on other countries for key parts of your own country's manufacturing could be problematic, even disastrous. Even in the absence of war, the lockdowns in China showed just how dependent manufacturing in developed countries was on the free flow of parts. Tesla, which produces all its own chips, was unaffected by supply-chain breakdowns. There is a lesson there for other CEOs.
We will never get back to the two decades of low inflation we have come to regard as the norm. Whereas central banks struggled to raise inflation over these two decades, it is likely that they will now struggle to keep inflation at 2%. Central to this is the realisation by the West that relying on China could be as strategically perilous as our naïve belief that Russia could be trusted and that we could rely on her for all our gas and oil. I remember when Stephen Roach in 1989 (or thereabouts), when he was at Morgan Stanley, pointed out that the fall of the Iron Curtain, and the opening of Eastern Europe and China to world trade would drive the long-term rate of inflation down, and it did. What we are seeing now is the partial reversal of this trend. We no longer trust that politics will not impede trade. Globalisation is no longer fashionable.
Moreover, global warming has pushed up food inflation. Who would have thought that alternating droughts and floods would push up food prices? Amazing. Well, greenhouse gas emissions continue to rise. It will only get worse.
In other words, the fall in world inflation may be slower than in the cycles of the last 30 years, even if we have a deep recession, and underlying inflation will remain stubbornly high. This has important implications for bond yields and PE ratios. The major bull markets in asset prices were driven by a secular downtrend in inflation. If that trend is over, valuation rates for all asset classes will rise, and that will keep their prices from rising.
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| I can't read the signature, and The Age itself doesn't give credit. If you know who created this, let me know in the comments |
We’ve worried a lot about inflation and its causes this year, but in one important respect the economy’s managers have yet to join the dots. The most basic economics tells us that what stops prices rising more than they should is strong competition between firms. If competition has weakened, that will be part of our inflation problem.
But is there evidence that competition is less intense than it was? Yes, lots. It was outlined by Assistant Treasurer Dr Andrew Leigh in a recent speech.
The basic model of how markets work – the one lodged in the head of almost every economist – assumes “perfect competition”.
Markets are supposed to consist of a huge number of consumers and many producers, each of them too small to have any ability to influence the price of the products they’re selling. So the price is determined purely by the interaction of producers’ supply and consumers’ demand.
Competition between these small firms is so intense that, should any one of them be so foolish as to raise their price above what all the other firms are charging, consumers would immediately cease buying their product, and they’d go out backwards.
I doubt if that was ever an accurate description of any real-world market. But even if it approximated the truth at the time economists got it so firmly fixed in their minds – the late 19th century – all the years since then have seen firms getting bigger and bigger.
So much so that many key industries today have just a handful of firms – often no more than four – accounting for well over half the industry’s sales.
This has happened thanks to a century or two of firms using improvements in technology to pursue “economies of scale”. Up to a point, the more widgets you can produce from the same factory, the lower their average cost of production.
Firms do this in the hope of increasing their profits. But the magic of markets – when they’re working properly – is that your competitors also use the new technology to cut their production costs, then undercut your price to pinch some of your share of the market.
This is the competitive process by which the benefits of scale-economies end up mainly in the hands of consumers, in the form of lower prices. This is a big part of the reason we’re all so much richer than our great-grandparents were.
The digital revolution has moved scale-economies to a new stratosphere. It costs a lot to develop a new GPS navigation program, for instance, but once you’ve done it, you can produce a million or two million copies at negligible extra cost.
So, fundamentally, the move to fewer but much bigger firms is a good thing. Except for this: the bigger a firm’s share of the market, the greater its ability to influence the prices it charges. This is a key motivation for big firms to keep taking over smaller firms.
And when markets are dominated by three or four big firms, it’s easy for them to reach an unspoken agreement to use advertising, marketing and superficial product differentiation to compete with their rivals, while avoiding undermining existing prices and profit margins by starting a price war.
Similarly, when all the big firms in an industry are hit by similar big increases the costs of their imported inputs – caused, say, by pandemic or war-related shortages of supply – it’s easy for them to reach an unspoken understanding that they will use this opportunity to fatten their profit margins by raising their prices by more than the rise in input costs justifies.
Which is just what seems to have been contributing to the huge rise in consumer prices this year – though it’s far too soon for economic researchers to have hard evidence this is happening.
What we do have, according to Leigh, is a “growing body of evidence that suggests excessive market concentration can lead to economic problems”.
“Dominant firms in a market may have less incentive to carry out research and development. They may have less incentive to produce new products. And in some cases, they may have less incentive to pay their employees fairly.
“As you can imagine, the drag on the economy only becomes stronger and deeper with each and every concentrated market,” Leigh says.
In the past decade, there has been a huge increase in the number of studies – covering the US and many other countries – confirming that markets have become more concentrated. That is, a higher share of the market held by a few big firms.
But, Leigh says, “mark-ups” – the gap between firms’ costs of production and their selling prices – are one of the most reliable indicators of “market power”. That is, power to raise their prices by more than is justified by their increased costs of production.
Australian research led by Treasury’s Jonathan Hambur finds that industry average mark-ups increased by about 6 percentage points between 2003 and 2016. This fits with figures for the advanced economies estimated in a study by the International Monetary Fund over the same period.
Hambur finds that mark-ups for the most digitally intensive firms increased by 12 percentage points, compared with 4 percentage points for all other firms.
And also that industries experiencing greater annual increase in concentration had greater annual increases in their mark-ups.
Of course, none of this should come as a great surprise to those few economists who specialise in the study of IO – industrial organisation – the way the real-world behaviour of monopolies and oligopolies differs from the way simple textbook models of perfect competition would lead us to expect.
Institutionally, the responsibility for seeking to ensure “effective competition” in our highly oligopolised economy rests with the Australian Competition and Consumer Commission. But its efforts to tighten scrutiny of company takeovers and other ways of increasing a firm’s market power have met stiff resistance from the big business lobby.
This new evidence of increasing mark-ups suggests the econocrats responsible for limiting inflation should be giving the ACCC more support.
