Is Inflation Or Deflation Coming? Part 2

So 15% of corporations—if this is the margin, it’s a wide margin—have a return on total capital < interest on the subset of capital that they borrow.

The interest rate drops, which would be good for them. But alas! Each drop has the effect of driving down their return on capital.

Stubbornly Rising Prices

We highlight the difference between monetary and nonmonetary forces to help explain why some prices are sometimes stubbornly rising, despite monetary forces pushing them down. However, even where prices are rising, there is no corresponding rise in per-unit margins nor in return on capital. Quite the opposite, the gas tax, the ethanol mandate, the ADA bathrooms, the supply chain compliance, and many other regulatory assaults on business push profit margins down. A 25-cent hike in gas tax may result in a 23-cent hike in the retail gas price. That means the refiner is making 2 cents less per gallon.

In a rising rates environment, profits and returns are rising. As are profit margins. At least until their plant needs replacement, and then one by one manufacturers close their doors.

In today’s environment, companies must race to get to a bigger and bigger scale, in the hopes of achieving further economies to get per-unit costs down so they can make a penny or two.

It is interesting to compare production of raw commodities to consumer goods, especially consumer goods in single sizes with service attached. In other words, the price of 25,000 pound lots of coffee vs. the price of a mocha latte served in a trendy downtown bakery. This comparison is useful, first because commodity production is usually done by major corporations. And major corporations have the lowest cost of capital. Copper and iron mines, for example, are billion-dollar investments. Also, the impact of regulations is the lowest per unit produced. So commodities show the clearest picture of monetary forces, with the least distortion from regulatory, fiscal, and social policies.

Here is a chart of commodity prices, going back to 1992. The entire graph is within the falling interest rate trend, so does not show the difference from 1947-1981. But it’s as far as the St Louis Fed data series goes back.

commodity prices 1992-2020

There is no doubt that there has been a recent uptick (corresponding to the uptick in Treasury bond yields). There is also no doubt that it’s been a falling trend since the peak prior to the last global financial crisis. Interest rates were a lot higher than, with the 10-year Treasury around 4%. Zooming out to see the big picture helps smooth out the noise of corrections that inevitably occur along the way.

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Disclaimer: The content in this article is provided as general information and for educational purposes only and should not be taken as investment advice. We do not guarantee the accuracy ...

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