Saturday, May 14, 2016

Deflation — the elephant on your smartphone



Should you be worried about deflation? For investors, the problem is so big (and yet rarely talked about) it has come to be described as “the elephant in the room”. But for consumers, it is the elephant on our smartphones.
An increasing proportion of the money I spend these days is via an app. Who needs a shop when you’ve got a smartphone? A busy life means Amazon and eBay apps are my go-to retail destinations, open 24/7 and exceedingly keenly priced. 

And if I do find myself in a conventional shop, I can sneakily hover the Amazon app’s barcode scanner over the packaging to see if I can buy it cheaper online. I would balk at doing this in an independent bookshop. But I have no such qualms in Boots (if you try it, be warned — the shifty look on your face as you pull off this manoeuvre could give you the air of a shoplifter).
Then there’s the Uber app, allowing you electronically to hail a very cheap taxi, and Airbnb, through which I’ve successfully booked some very reasonably priced weekend breaks in other people’s empty homes.
Technology is driving down prices. But the true cost of this disruption goes much further. How many high streets have been hollowed out by Amazon? How many mini cab companies or bed and breakfasts have gone bust, thanks to Uber and Airbnb undercutting them on price?
Too bad for the legacy businesses. Most consumers aren’t worried about the long-term effects on the labour market, or whether these newfangled tech disrupters are paying enough corporation tax. They just want cheaper prices — and that’s what they’re getting. So price deflation rules OK. Or does it?
Let’s turn our attention to China (which after all is the source of many of the cheaply produced goods filling our high streets and online shopping baskets). China currently has a 13 per cent share of global export trade, according to Michael Power, strategist at Investec Asset Management. I recently heard him speak about what is arguably China’s biggest export — deflation — and what he had to say will make most investors feel rather “deflated” about the future.  
Nevertheless, it was a fascinating presentation. Mr Power asked the room of (mostly) besuited City gents if they had ever heard of Qiaotou. If they hadn’t, their trousers probably had. Known as “Zipper City”, Qiaotou is where 80 per cent of the world’s zips are produced (not to mention 60 per cent of the world’s buttons).
Then there’s Suzhou, otherwise known as “Wedding Dress City”, which is home to over 700 factories producing guess what? And Datang, or “Sock City”, which produces one-third of the world’s socks.
The statistics are mind boggling. But while Brits might enjoy buying cheap packs of socks online, we certainly don’t like it when a flood of cheap Chinese exports threatens the future of our steel industry.
As potential buyers circle Tata Steel’s ailing UK operations, its Indian owners have claimed that the UK business is losing as much as £1m a day. But that’s not the biggest obstacle to a sale — it is the colossal £15bn British Steel pension scheme (with 130,000 members and a £485m deficit), which could now be ringfenced by the government to get a deal done and save 11,000 jobs.
How much industrial workers are paid is key to understanding the deflation threat. Mr Power cited data from UBS showing that the annual salary of a female industrial worker in Chicago could pay the wages of about 20 women doing a similar job in Jakarta.
And Western employees are so much costlier than a base salary alone, with their pension schemes, sick pay and medical insurance.
As the world turns negative — with central bank interest rates, bond yields and even corporate debt all entering minus territory — corporate profits are falling and dividends are being cut. This deflation is a real problem for the managers of pension schemes who are struggling to generate the returns needed to cover their growing liabilities.
You have to wonder how long it will be before so many shipwrecked schemes are crying out for assistance from the Pension Protection Fund that it will be forced to change its own rescue model
Even the financial instruments such as index-linked Gilts that most have traditionally held to hedge against this risk are turning negative.
The retailer BHS is the latest to send up a flare for the pensions lifeboat (another business model that has been buffeted by price deflation from the likes of Primark and nimbler online retailers).
You have to wonder how long it will be before so many shipwrecked schemes are crying out for assistance from the Pension Protection Fund that it will be forced to change its own rescue model.
For now, the consumer groups with the least to fear from the threat of Japanese-style deflation hitting our shores are those with pensions in payment. People on fixed incomes will be insulated from deflationary wage pressure, and additionally, they will benefit from deflationary prices and cheaper goods and services.
Fantastic news if you’re a pensioner with an Amazon habit — so long as your pension scheme doesn’t go bust.

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