The surprising precursor to the downfall of values of overinflated assets worldwide is something so many of us depend on, yet at the same time completely ignore; the price tag on a gallon of gas. There is absolutely no more emotional purchase that Americans are forced to make and as the biggest set of consumers as a percentage of GDP of any developed nation, they have the most to lose as the price of this commodity reaches record highs.
Rising gas prices are a catch-22 problem for the US Federal Reserve. In reaction to frozen markets, the Fed eased monetary policy to encourage confidence and borrowing following the 2008 sub-prime crisis that nearly took down world markets. A necessary evil that developed in response to their unprecedented easing of money was the debasement of the US Dollar compared to other currencies. In the shift from the strong dollar, the price of all dollar denominated commodities have what’s now becoming the last leg of a marathon run towards high prices not witnessed in history.
At the same time, geopolitical events haven’t cooperated. Iran, Iraq, Nigeria, and Libya are all in a state of upheaval. As major producers of the light sweet crude necessary to make the gasoline consumed by the US and also other demanding buyers, the losses to production in these volatile times has been a leading cause for the rise in prices. At the same time, the closure a number of refineries and the shortage of refinery capacity has touched off a speculative rush in gasoline, which threatens to push the cost over $4 per gallon. Once this happens, a chain of events will unfold which can give rise to unprecedented revaluations connected with all asset classes.
Inflation that produces Deflation
Absolutely nothing more destructive than inflation, when considering the purchasing power of consumers. Nothing, that is, except for major deflation, like that which took place within the Great Depression of the 1930s. As the US Central Bank and central bankers internationally have done everything in their power to stimulate the expansion of loan demand and thus inflate their currencies, the unintended consequence of their actions have been crushing the purchasing power of commodities. Since these commodities have risen compared to the purchasing power of the consumers who demand them, there is a cost, and beyond this aspect, consumers start to demand less gasoline and their consumption behavior for all goods changes likewise.
American consumers have witnessed high prices at the pump before. In 2008, at the peak ahead of the sub-prime crisis, the cost of gasoline caused many individuals to have to make important choices, one of them was if they should pay for a tank of gas, or come up with a ballooning mortgage payment as their adjustable rate loans climbed with monetary tightening by the Fed, concerned with overheating inflation. While following it’s dual mandate of promoting full employment tweaking inflation at a target rate, the Fed continues to be given the job of a conundrum. As monetary conditions are eased to allow for expansion in the money supply, the relative valuation of the dollar has weakened, causing inflation in commodities, which results in stronger inflation, which in 2008 was growing faster than employment.
As a consequence of rising gasoline costs, consumers typically cut back on non-essential expenditures. These discretionary costs makeup nearly 2/3 of GDP in America alone so when they decline, also do the revenues on the businesses employing them. The negative feedback loop that occurred when this happened in 2008 forced employers to trim down their payrolls and laid off as many people as they could. This in turn exacerbated the shrinking demand for discretionary goods and caused more companies to lay off much more people. Behind the scenes of layoffs and inflation, US consumers are aging into retirement en mass, nearly 80 million baby boomers are one step nearer to retirement, and in a natural progression, are in the process of deleveraging and buying less products or services.
Gas prices are the fulcrum for the start of deflation mainly because they destroy disposable income, the lifeblood of the US consumer. Despite it’s best efforts, the central bank cannot fight this process by lowering interest rates to recreate additional improvement in demand because once higher gas prices wind up in the system, they impact the costs of countless numbers of other products or services that inflation turns into chief concern; not unemployment. In a situation where the prices of food, transportation, shipping, and anything else which has a petroleum product input in its production becomes just slightly inflated in value, the demand for that good or service will fall incrementally. This incremental reducing of demand has a cascading result on the demand for all the other products or services consumed and suddenly this process has a mind of it’s own and cannot be turned around.
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