The Bubble In Inflation Fears

It was famously repeated during the housing bubble that when your hairdresser / shoe-shine guy / [insert-low-skilled-low-paying job here] was buying houses to rent them out, you knew you were in a bubble.  Set aside the condescending nature of these remarks (because let's be honest, on an hourly basis, plumbers are so well paid, I thinking of encouraging my kids to skip college) and apply that to inflation.

Las week, I got a lecture from my car service driver (thank you San Francisco bureaucrats for making taxi trips from SFO to Woodside Meter-And-Half, making it insanely expensively just to go to the curb at the airport and hail a cab) on how he'd put all his savings into silver coins because the Obama administration is going to cause hyperinflation.

In fact, short of a real bout of hyper-inflation, the forces that keep prices down now are much more powerful than they used to be.  I think there are three forces that are making it extremely hard for companies to raise prices:

1. Low Cost Imports.

Free trade has always been a big driver of growing economic wealth, but the speed and power with which it operates has accelerated in the last decade.  China is a big part of that, but I actually think it is not China but rather Wal-Mart and other US companies that have really driven this process.  The Economist has a great blog entry on recent research showing how Chinese imports have saved US consumers about $800 billion in the last decade alone.  Link.

2. The Internet.

The Internet facilitates two things that drive down prices in a very big way: one obvious and the other not so obvious.  Most obviously and directly, price comparisons keep cost down on commodities and push retailers to be aggressive.  It only takes a few people to switch their purchasing behavior to drive companies to cut prices and win them back.

The second, less obvious effect is in feature and product comparison.  Companies have spent a lot of time and effort trying to differentiate their products.  Internet sites spend a lot of time comparing them.  The Internet has made it harder for companies to charge a premium for differentiation that doesn't create a lot of value.  This pushes good products into "higher" categories and caps the price that brands can earn as a premium just for the name.

From China With Low Costs (Picture Cliff1066)

3. Shifting Consumption Towards Electronics.

For retailers and consumers alike, electronics are the gift that keeps on giving.  Over the last 40 years, the electronics content of a consumer shopping basket keeps increasing.  In 1980, the average shopper did not buy many electronics, today they buy a lot of electronics and related services.  All of those keep dropping in price so even as their share of the inflation-calculating basket goes up, their big annual price declines contribute to lower inflation.


Combine all three and it's hard to see how inflation can get a grip again without a very concerted effort by the Fed.