America’s #1 Import: Deflation

It seems that everyone these days is exporting deflation to the US.

The drop in commodity prices and the US dollar rally versus a broad basket of currencies in recent years had a big impact of course, but the magnitude of the decline of US import prices has been very significant indeed. And this matters for many reasons.

Competition for the all-important US consumer remains fierce, as exporting countries devalue their currency and/or further reduce their costs to maintain market share. While imports represent a relatively small percentage of US GDP (typically <17%), the technocrats at the Federal Reserve will now have to work harder to fan the flames of inflation across the economy (hint: not by continuing to raise interest rates…). Moreover, these price patterns suggest that all is certainly not well in the global economy.

The graph above shows the evolution of selected US import price indices by country of origin since January 2009 (=100), when the world was in the throes of the great recession, as provided by the US Bureau of Labor Statistics.

The dotted line shows total import prices excluding oil, to isolate the direct impact of the recent collapse in crude oil prices. After staging a post-crisis rally, prices of overall imports pretty much remained in a range between mid-2011 and mid-2014. But then something happened: the US dollar started to rally hard and that price index quickly went the other way.

How the major industrial exporters have responded is where things get really interesting.

The price index of the three majors peaked at different times: Chinese import prices peaked in early 2012, the Japanese later that year and the Europeans kept raising their US dollar prices until mid-2014. While the composition of the imports varies from country to country, it were the diverging policy responses that largely dictated what followed.

The graph above shows the 12-month change (in %) of each of those indices, providing a better sense of the magnitude of the price change. As a result of Abenomics and the crushing of the Yen, Japanese exporters have been the most aggressive in reducing their US dollar prices since 2013. The Chinese had started that process a few months earlier, but that has been more subdued until now. And the Europeans eventually jumped in the bandwagon, substantially cutting their prices throughout 2015.

With Japan joining the negative interest rate club last week, any subsequent Yen weakness will further tighten the screws on its competitors. And as the US dollar price of a Lexus becomes cheaper compared to a Mercedes, probably the Europeans will have to follow suit.

While the Chinese may not compete directly in the same high-end segments, with these dynamics it looks likely that they will have to further reduce their US dollar prices at some point. And if they do so in a meaningful way the impact on their competitors – from all over the world – could be quite dramatic.

Meanwhile American companies will have a much harder time competing domestically and abroad, certainly if the US dollar remains elevated.

The graph above shows the 12-month change (in %) for the EU import price index only, this time extended to the start of the data series in September 1993. When it goes negative it is usually associated with a major financial crisis, a global recession or both. So the recent price move suggests that there is trouble out there indeed.

American consumers will be delighted with everyone sending cheaper goods their way. However, what this may do to their income and employment prospects is a whole different matter.