Thursday, September 27, 2007

Real Inflation

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Its been announced today that the price of eggs are going to rise 50c a carton, milk up 10c per litre, in addition to other foods. The rationale for the increase in prices is said to be the drought, but there are two factors which suggest this is not true:
1. Farmers have said that they will not benefit from the price increase - which suggests its either to cover higher input costs or retailers are in fact getting all the benefit
2. Products which are unlikely affected by drought are facing price increases - eggs and milk being some examples.

The reality is that retailers are pricing products on the basis of people's capacity to pay. Australians have benefited from a huge wealth explosion over the last 15 years as a result of credit expansion. These price increases largely reflect an attempt by business to claw back some of the gains. It thus becomes apparent that any future wage rises were not precipitated by greedy wage earners, but by business trying to claw back earnings at a tim when they are finding it hard to sustain profit growth. The fall off in profit growth is a direct result of a slow down in credit growth, as households worry about falling housing prices and higher inflation.

In these circumstances there are only 2 ways that businesses can build earnings:
1. Higher prices > increasing the prospect of inflation
2. Consolidation of productive capacity > normally results in greater pricing power so higher prices

Clearly in this type of environment if business cannot expand unit capacity then they have to make more profit margin to earn the same profit. From this point forward we are looking at an acceleration of inflation.

In recent years the CPI has been the market measure of inflation. At some point over the next few years people will come to realise that was nothing more than a political tool for facilitating a shift of wealth from households to governments (through tax bracket creep) and business (through higher prices). At some point farmers and unions are going to see the fraudulent nature of this workers start to loose their jobs and farmers are forced off their farms by higher input prices, low farm gate prices and drought.
Reason is the standard for debate.

- Andrew Sheldon
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