Monday 14 August 2017 by Opinion

Global inflation at lowest level since 2009

G20 inflation has reached its lowest point since the 2009 June quarter.  Economists are “puzzled” by this and it is causing many central banks to delay plans to remove post crisis stimulus measures.  Readers of The Wire won’t be puzzled though as we continue our notes on the Amazon Inflation Index


In 2016, a convoy of trucks travelled more than 2,000km across Europe.  What was unique about this convoy was that only the front truck was driven by a human.  The other trucks were operated by autonomous vehicle technology, a combination of radar, robotics and analytical software.  The trucks still had drivers, but 90% of the time they were not driving the vehicles, as shown in the attached video.

This is the first stage to fully automate vehicles, a transition which will transform every part of our lives, the global economy and investment returns on everything from retailers to car parks.  The transition will take 15 years at least, mostly due to the safety issues in the transition period while there will be a mix of human and autonomous vehicles sharing roads.  But the impact from semi autonomous vehicles and autonomous drones, where safety is of less concern, is here and accelerating.

How does this tie into CPI?  Simple - think about the impact on the cost of logistics and thus every product in the CPI basket.  

Earlier in 2017, central banks in the US, EU and the UK all flagged that they plan to end quantitative easing and other monetary stimulus measures.  This sent bond yields sharply higher and had the usual media and equities commentators flagging the end of the bond rally and a return to more “normal” interest rates.  

But, once again, they were wrong to look backwards to forecast forwards.  The global economy has fundamentally changed in recent years.  If it was just the GFC that caused the changes, it could be reasonable to expect a return to pre-GFC normal conditions.  

But the GFC masked a more fundamental change to the global economy - a period of much lower inflation caused by the combination of the massive increase in global labour availability, particularly from China and India, and the cost-efficiencies of the digital economy. 

While the market expects inflation to return to historic ’normal’ levels, it won’t.

The misperception will result in markets constantly mispricing.

Last week’s US inflation data coming in under expectations is just another example in recent months.  

Recap on the Amazon Inflation Index - why lower global inflation should not be puzzling

In June, we first raised the concept of the Amazon Inflation Index (see the link to the previous article below), an index of the price changes for those goods and services that are bought and sold online more than they are offline.  In 2001, this represented less than 1% of the “basket” consumers buy in any given year.  By 2008, when the GFC struck, it had reached 4% of the basket.  Now it is 17% of the basket and heading for a forecasted 30% in the next few years. 

Source: Amazon, Bloomberg, FIIG Securities

Those products and services have experienced falling inflation and now are deflating (See Figure 1 below).  The greater the share of the overall CPI basket they make up, the more they pull down CPI.  As the digital economy is a global phenomenon, it impacts global prices, thus  global inflation is falling.  This should not be a surprise or puzzling to anyone, unless of course you look backwards where the digital economy didn’t exist.

How will the digital economy impact inflation in future?

Digital technology is creating an economic revolution only preceded by the industrial revolution of the mid 1800s.  The impact on costs is far reaching, far more than the minor impacts seen prior to the GFC as people bought books and music online.  This is a massive area to explain in detail but for purposes of understanding the impact on future inflation, consider the following examples of how costs will be reduced dramatically:

1. Amazon Inflation was just the first step

Amazon is just one example, but the world’s leader of course, disrupting traditional retail and wholesale industries.  Amazon started by selling books online cheaper than they could be bought from retail stores simply because they cut steps from the value chain (less mouths to feed) and saved on retail store costs.  Now they are the world’s largest retailer and causing severe pain for the previous leaders such as Walmart, Sears, CostCo and soon, Woolworths Australia.

2. “Google Deflation” - empowering the consumer with instant price discover

As consumers have shifted their buying habits, one of the biggest changes has been to use the internet for price discovery.  This was firstly just about where to buy the cheapest DVD player, displacing the old catalogue businesses, but then when online price discovery become the norm, it became the consumers preferred way to select service providers.  If you want to engage a roof tiler, plumber, mechanic or any other traditional service provider, you go to the internet first to search for the best combination of quality (reviews) and price.  This has put pressure on providers to keep prices down or they miss out on getting new customers.  This in turn flows on to how much they can pay in wages, pushing down wage growth and therefore reinforcing low inflation.

3. Uber Deflation - lowering the cost of repetitive services into the hands of the client

With the invention of the smartphone and “apps” came a major deflationary impact on professional services and other low value add services like bank tellers, taxi drivers, travel agents.  As artificial intelligence gains traction, this will eat into more and more professional higher value adding services such as accounting and legal services.  Wage growth in professional services in Australia, for example, is already at its lowest level on record and both the US and UK have similar trends.

4. Autonomous vehicles (“Tesla Deflation?”)  -2020s-2040s deflator

This is typically thought of in the context of autonomous passenger vehicles, but that will actually be the last transport mode impacted by autonomous vehicles due to the enormous transition challenge of having autonomous vehicles and humans driving on the same roads.  But far before that, larger autonomous transportation technologies will be implemented, reducing logistics costs by up to 70%.

The EU, Singapore and Japan are already trialling autonomous truck convoys in which the first truck is driven by a human operator but up to 12 trucks behind automatically follow that leader.  Because the braking and other signals from the lead vehicle are known to the convoy vehicles faster than the brakes of the lead vehicle can respond, they can follow at a distance of just a few feet, reducing petrol costs due to the lower drag from air resistance.  These convoy trucks still have human operators standing by in the driver’s seat, but within ten years they won’t, and in the meantime the costs due to less human error, greater fuel efficiency and less driver fatigue mean logistics costs will start falling.  Combined with autonomous drones for delivering goods from trucks, trains and even ships, the cost of home delivery will be slashed.  Amazon’s Prime service currently offers same day delivery in some US locations for $7.99.  They are proposing a $1.00 delivery charge and 30 minutes delivery time once they move to full autonomous drone delivery.  There are some significant air safety issues to overcome, but this is expected to be a reality by 2019.

When fully autonomous vehicle technology becomes reality in the 2020s, costs will fall even faster and have a dramatic impact on inflation.  For many products, logistics costs represent 20-30% of overall costs, so this represents 15-20% reduction in costs for these products, or deflation of say 1.5-2%pa over ten years. 

When autonomous vehicles comes into full service somewhere between 2030 and 2050, it will release billions of hours of labour supply that is currently wasted in commuting time, particularly in the service industry.  Current estimates are that this release of the 250 billion hours of commuting time will add around $5.6 trillion (around 6%) to global GDP.  A lot of research has looked at the impact of the baby boomers retiring and the lack of available labour pushing up wages and therefore inflation, but this technology will create more additional labour supply than the baby boomers retirement takes away.    

These examples don’t include artificial intelligence nor the array of endless possibilities when some of these technologies start to combine and reduce costs even further.  It is impossible to imagine at this stage what the impact will be, but it should be fairly intuitive that the digital economy will reduce costs far more often than it increases them.

The only questions for today’s investor are by how much and by when will inflation start to be materially impacted?  I believe that this has already started, and while it is just early days, the “puzzling” global inflation results coming out in recent months will become the new norm.  This will have lasting impacts on interest rates, company earnings, property yields and most other investment markets for decades to come. 

Inflation will no doubt have a few surprises for us yet and can never be assumed to be dead, but there are significant opportunities for informed investors to buy when markets make the mistake of expecting it to rise to historic norms.