Why You Shouldn’t Rule Out Inflation

Dear Reader,

‘If Spain wins everything, you win everything.’

That was the marketing campaign Media Markt, a consumer electronics retailer in Spain, ran during the football (soccer) World Cup in 2010.

What was the ‘everything’ you could win? A new TV…computer…iPhone…The company promised to reimburse anything you bought at the store during certain dates if Spain ‘won everything’.

With so many retailers struggling in the aftermath of the 2008 crisis, other companies followed the same strategy to boost sales.

Toshiba and Intel promised free TVs and laptops if Spain won the World Cup.

Supermarket chain Carrefour launched their ‘Crazy about the World Cup’ campaign. Any client that spent 15 euros at the store got a 100-euros-off coupon to spend if Spain got the title.

Banesto promised a 4% interest rate to anyone who opened a savings account, an extra 1% from the 3% they were offering.

When you looked at Spain’s World Cup history, their chances of winning were slim. Some even thought the team was cursed.

In their 12 World Cup appearances Spain had never won the World Cup. And it had been 50 years since they had even gone past quarter finals. They didn’t even get that far when they hosted the event in 1982.

But fans were hopeful Spain had a chance. They had watched the team get stronger over time…and they were right.

In 2010 Spain won the World Cup for the first time in history.

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It was an expensive victory for some. Carrefour lost a million euros. Banesto paid out 10 million.

The only company to not lose money was Media Markt, living up to their company slogan ‘I’m not a fool’. Their campaign stipulated that Spain had to win the World Cup, but also every single game. The team had lost their first game against Switzerland.

They hadn’t been so lucky (or clever) two years before, though.

In 2008 they had run a similar campaign for the UEFA European Football Championship, where they promised to return 25% of the price of every TV purchased if Spain went through to the semi-finals. They ended up losing around 1.7 million euros back then.

Spain winning the World Cup was a shock. A bout of inflation may produce a similar shock.

While there’s not much expectation of inflation showing up out there, I still wouldn’t rule it out. Inflation could truly be a shock many don’t expect.

I mean, people are stuck at home. Money velocity, which has been dropping since the 90s, has collapsed during the pandemic. People aren’t spending money.

But I’ve written before that we can’t really trust our indicators at this time.

Harvard published an interesting study recently on inflation. In it they argue that people’s spending habits have changed during the pandemic but our way to measure inflation has not.

You see, we measure inflation through a basket of everyday things like transport that have different percentages. Most statistical offices update their CPI expenditure weights once a year. The last time the US Bureau of Labor of Statistics did this was pre-pandemic in December last year.

During the pandemic, they found people are spending more on food and less on things like transport, hotel and recreation. If you have inflation showing up in food but then price drops in things like transport, it could balance inflation out even though the item you spend the most has increased.

Inflation isn’t looking likely

The study created their own ‘COVID CPI’ and gave more weight to items like food and less to things like transportation and recreation.

They found that compared to the official CPI, COVID CPI showed the same inflation for January and February 2020, but then diverged from March.

By May 2020 their COVID CPI was marking 0.95% while the official was 0.13%. Quite a difference there.

Even when using core CPI, that is excluding food and fuel, the study found a similar bias.

By May, the core COVID annual inflation rate was 1.59% compared to the 1.20% in the official core index.

As they said:

These findings imply that the cost of living for consumers is rising faster during the Covid crisis.[…]

Furthermore, my results could help explain the sudden increase in consumer inflation expectations in April and May, as reported in the Michigan Survey of Consumers. This behavior is consistent with a growing literate that suggests that consumers use their own purchasing experiences to form expectations about future inflation.

The study suggests there’s higher inflation than we think.

Anyway, my point is don’t rule out inflation just yet.

So far it looks unlikely with weak demand. There is also a lot of debt in the system so consumers may choose to pay down that debt at the cost of spending. And a rise in unemployment would also affect spending.

Demand is one side of the equation. My doubt here is on the supply side. There can be price increases when costs of production increase.

One of the big factors of decreasing inflation has been globalisation and the shift to manufacturing in China.

Now we are starting to see a reversal.

Nations are looking at diversifying and moving away from China. Rum Rebellion’s Editor, Greg Canavan says Australia could be in for a long and painful ‘divorce’ from China. You can read his research here.

Electronic manufacturer Foxconn, said this week China’s ‘days as the world’s factory are done.’

China is realising this too and shifting to a ‘dual circulation’ strategy to boost domestic demand.

As Bloomberg reported:

There are few details on the new approach. President Xi Jinping oversaw the July 30 Politburo meeting where the “dual circulation” strategy was emphasized. That was days after Xi said at a gathering with business leaders that “we must give full play to the advantages of the domestic super-large market” amid rising protectionism and the global economic downturn. The strategy is to effectively reduce reliance on the West — just as other nations seek to become less dependent on China for economic growth amid rising U.S.-China tensions.

For now, inflation isn’t looking likely, but that could change.

As I said, don’t rule it out just yet.


Selva Freigedo Signature

Selva Freigedo,
For The Rum Rebellion

Selva Freigedo is a research analyst for The Rum Rebellion.

Born in Argentina, her passion for economic analysis started at a young age. Her father was an economist for the Argentinean governments and the family used to discuss politics and economics at the dinner table.

Argentina is a country with an unusual economic history. Growing up there gave Selva first-hand experience on different economic phenomena such as hyperinflation, devaluation and debt default.

Selva has also lived in Brazil, Spain and the USA.

Back in 2000 she was living in the US as the dot com bubble popped…
And in 2008 she was in Spain as the property market exploded and then collapsed…

She has seen first-hand what happens when bubbles burst.

Selva joined Fat Tail Investment Research’s team in 2016, as an analyst. She now writes from her vantage point in Australia, where she settled in 2015.

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