The surprising precursor to the downfall of values of overinflated assets worldwide will likely be something a lot of us rely upon, 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 required to make and as the biggest group of consumers as a percentage of GDP from a developed nation, they’ve got 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 answer to frozen markets, the Fed eased monetary policy to encourage confidence and borrowing following the 2008 sub-prime crisis that nearly took down world financial markets. A necessary evil that developed in a reaction 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 is now becoming the very 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 generally in a state of upheaval. As major producers of the light sweet crude needed to make the gasoline consumed by the US as well as other demanding buyers, the losses to production of these volatile times has been an essential cause for the increase in prices. At the same time, the closure for many refineries and the shortage of refinery capacity has touched off a speculative rush in gasoline, which threatens to push the retail price above $4 per gallon. Once this happens, a chain of events will unfold that will promote unprecedented revaluations connected with all asset classes.
Inflation Causing Deflation
There is 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. Even though the US Central Bank and central bankers around the world have done everything in their power to stimulate the expansion of loan demand thereby inflate their currencies, the unintended results of their actions has become crushing the purchasing power of commodities. Since commodities have risen compared to the purchasing power of the consumers who demand them, there is a price point, and beyond this point, consumers begin to demand less gasoline and their consumption behavior for all goods changes additionally.
Americans have seen high prices at the pump before. In 2008, at the peak before the sub-prime crisis, the price of gasoline caused many people to have to make important choices, one of them was whether to pay for a tank of gas, or to come up with a ballooning mortgage payment as their adjustable rate loans climbed with monetary tightening by the Fed, concerned about overheating inflation. While following it’s dual mandate of promoting full employment and maintaining inflation at a target rate, the Fed has been given the job of a conundrum. As monetary conditions are eased to allow expansion in the money supply, the relative value of the dollar has weakened, causing inflation in commodities, causing stronger inflation, which in 2008 was growing faster than employment.
As a result of rising gasoline costs, consumers typically reduce 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 once 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 even more people. Behind the scenes of layoffs and inflation, US consumers are aging into retirement en mass, nearly 80 million forty somethings and beyond is one step closer to retirement, and in a natural progression, are in the process of deleveraging and getting 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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