What's On Tap..

Inflation is NOT on the Horizon

As the September Federal Open Market Committee (FOMC) meeting approaches, we expect policy to remain unchanged yet again.  While this anticipated outcome has set off a wave of rhetoric surrounding the low rate environment, weak economic data has likely been the impetus for continuing the status quo.

Critics warn of potential inflation should the Fed continue its policy of maintaining low rates. (It should be noted that the recent record low yields were achieved after the December 2015 rate increase). Some notable numbers from the July CPI are in the table below and hardly point to inflationary pressure. Shelter and Health Care appear to be among the few categories bucking the deflationary trend:

Source: bls.gov 

Source: bls.gov 

Yet, contrarians are discounting a major factor—the degree to which technology has changed the traditional rules of economics. The “textbook” relationship between interest rates and inflations reads something like this:

“As interest rates fall, more consumers are able to borrow money with which they will consume more goods and services. As interest rates rise, borrowing becomes more difficult and saving becomes more attractive—thereby causing consumption to slow and inflation to falter.”

This explanation only addresses the consumer side of the equation. For the better part of the last century, there aren’t any obvious reasons why the supply side would have any more than a negligible effect on supply due to a change in interest rates.

Technology has changed that.

The entrepreneurs of the modern era are able to spread their ideas around the world — instantaneously. It is possible to hire employees remotely, to organize a business entity, and distribute a product —digitally. Contrast this with the reality of business just 20 years ago— barriers to entry are falling fast.

But it isn’t just technology that has disrupted the supply side of the equation in today’s marketplace. All of the next great ideas and the associated heavy machinery requires funding, and it is here that the current rate environment has the potential to have its most profound effect. As rates remain extremely low, lenders/investors can take on more risk in the hope of achieving higher returns. This implies that more start-ups will be able to secure funding, and larger, well-established companies will be able to reduce borrowing costs while making capital investments for and investing in technology.

Critics will point to the valuations placed on recent startups as evidence of the “moral hazard” that ensues during these low rate periods, but they are failing to see the forest for the trees. Ten years ago, it would cost a consumer $100 to purchase 16 MB of portable storage — now 16 GB of the same portable storage is a “tchotchke” given away at industry conferences. The scale of improvement within technology itself was necessary to allow for economies of scale at the mega-conglomerate level.

For technology, a low rate environment has the most impact potential. A few developing examples include:

        GMOs (Genetically Modified Organisms): Humans have bred food crops since populations moved from being hunter-gatherers to farmers. Technology now introduces precision that wasn’t possible before. In 2014, 93% of corn grown in the U.S. was genetically modified.[i]

        Energy: With electric cars finally common pace, and directly a result of technological advances in battery power (storage), it may be a wake-up call for some that 66% of petroleum consumption falls in the transportation category. We quickly approach a day when most forms of transportation are powered by batteries.

        Housing: News that a 3D printer was able to build 10 template homes in 24 hours could be a game changer for this space.[ii] Building a home would become significantly less expensive. Customization of these homes as well as improved structural integrity are other attractive characteristics.

Imagine if you will…

How long before perfectly optimized farm crops can be grown with zero human interaction, with optimal nutritional values, creating limitless supply? How long before extraction of energy at the atomic level effectively creates a safe, clean, global power source out of a tiny supply of hydrogen? How long before a fully customized home can be printed and habitable within a few weeks? The answer is invariably: not nearly as long as we imagine. Technology can and will evolve quickly to the point of ubiquitous supply of everything – at a cost of almost nothing – ushering in an era of prosperity that is simply unimaginable.

This means Inflation expectations are likely still too high – propped up by reliance on the old, pre-technological, consumer-oriented version of inflationary economic theory. The low rate environment now only serves to force businesses down the path of adopting technology to remain competitive.

The fact remains that inflation is still well below the Fed’s 2% target, and technology has only just begun to push prices lower.


William Royer, Portfolio Manager / Associate Vice President

William Royer, Portfolio Manager / Associate Vice President


[i] http://www.ers.usda.gov/data-products/adoption-of-genetically-engineered-crops-in-the-us.aspx

[ii] http://www.huffingtonpost.com/2014/09/08/3d-printed-houses_n_5773408.html

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