The Financial Times on the 9th September 1993, almost 15-years ago, published an article by Kevin Done, headlined 'Lopez preaches gospel of third industrial revolution'. Jose Ignacio Lopez de Arriortua at that time had recently left General Motors and joined Volkswagen. In the article, Keith Done described him as Volkswagen's beleaguered but charismatic production and purchasing director. Lopez recognised that the world was embarked upon a new era of disinflation/deflation and that the economic implications of this would transform business conditions. He said, in his presentation, 'Those that fail to grasp that the industrial revolution is underway are condemned to fall by the wayside as surely as those that ignored the first two, namely the introduction of steam-powered loom in Britain in 1750 and the production of cars on a moving assembly line in the US in 1913'Beyond that sentiment and central to his view, he said this:
'In the old world of dominant downwards values (inflation - our words), manufacturers started with costs, added a profit margin and arrived at a price. Now in the brave new world of ascendant values (deflation - our words), the customer dictates. You start with a market price, work backwards to add in a profit and you are left with what can be the cost. Now you must develop functions that can achieve that cost.....'
'Not to do this is like making clothes by hand or cars one by one. You will not survive. There are only two ways to go. Look for intelligent excuses - and lose. Or put creativity into action - and win.'
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In the Economist of 9th July 2005, they reported that Chrysler, over the coming weeks, will be giving customers cash, but in addition to that, unbelievably, will sell vehicles to the public at the same deeply discounted price as they sell to company employees. Chrysler are hardly breaking new ground because a month ago, GM with its 'employee discounts for everyone offer' added approximately $450 on average to GM's typical incentive package which, the Financial Times comment, it is a lot of money for a business that lost $l.lbn in the first quarter 2005. How they wish that fifteen years ago they had listened more carefully to what Lopez said!
Martin Barnes of the Bank Credit Analysts publication in the US, recently wrote: 'A perfect breeding ground for inflation has been in place in the past few years: large fiscal deficits and a weak dollar. It speaks volumes that core inflation has remained close to 1.5% (based on the Personal Consumption Index) in that environment. Powerful structural forces are keeping a lid on inflation: intense global and technological advances are boosting productivity......
To the extent that inflation is always, and everywhere, a monetary phenomenon, the Fed's easy stance has had an important impact. It has shown up in rising house prices, rather than conventional consumer price indexes ... The housing bubble is likely to get bigger before it inevitably bursts. However, when the housing bubble does burst, it will represent a huge deflationary shock to the economy.
Looking ahead the risks facing the US and global economy will remain more deflationary than inflationary. Other than burst housing bubbles, there is also the lingering concern that global investors will, at some point, be unwilling to finance US profligacy, forcing a major retrenchment in demand.' (That's how bad deflation is made -our words.)
Martin Bames words reflect, very succinctly, our view which is that the natural deflationary force is winning its battle against Central Bank's loose monetary policies.
For evidence that the deflationary force continues to rule, just look at the relationship since 1990 of bonds to other asset classes. As a class, bonds have been one of the most successful investments to hold for all of that period, that would not have happened if the risk was inflation. The continuing long-term decline in interest rates associated with that deflationary force has caused the ongoing bull market for bonds.
The FT recently reported that UK manufacturers' input prices for the year to June rose 12.1%. 50% of that rise was attributed to crude oil prices. Output prices, for the same period, rose only 2.4%. That difference is a profit squeeze of nearly 10% and illustrates bad deflation. In the past, when inflation ruled, those input prices would have transferred quickly to higher output prices. Higher retail prices and higher wages would have followed, causing inflation to sharply rise. Examples such as this are much more than straws in the wind, they are indicative of the deflationary nature of the economy. Deflation, good or bad, will cause the price of just about everything, except bonds, to fall.
By RH Asset ManagementFor more, visit: www.rhasset.co.uk
