Tuesday, May 27, 2008

Inflation set to rise in beginning in the next few years spurring rising interest rates

Hi All,

The good economic news cannot last forever. The article below discusses something I've been thinking about a lot lately - how high energy prices (over $150/barrel) could begin to push up inflation by making imports from low wage countries expensive. Increased inflation will force The Bank of Canada to raise rates, which would have a downward effect on the Vancouver Real Estate Market. That said, if you already own and have a large fixed rate mortgage at a good low rate, inflation will be good for you because it will erode the value of the mortgage and will your interest costs will remain the steady.

I'd love to your thoughts!

High energy costs will bring dramatic changes in trade: CIBC World Markets

Globe and Mail Update

OTTAWA — The rising price of oil is making international trade of heavy cargo prohibitively expensive, and acting as an incentive for importers to find products such as steel closer to home, new research by CIBC World Markets shows.

For heavy products, rising shipping costs are eroding the low-wage advantage of China over North America, say chief economist Jeff Rubin and senior economist Benjamin Tal.

If oil prices continue to rise, the soaring cost of global transport will act like a major tariff barrier and lead to a substantial slow down in international trade, they argue.

“Globalization is reversible,” they state.

These days, the cost of oil is the equivalent of imposing a tariff rate of about nine per cent on goods coming into the United States. At $150 a barrel, transport costs act like a tariff of 11 per cent. And at $200, all the trade liberalization efforts of the past 30 years are reversed, Mr. Rubin said.

Oil prices now account for about half of total freight costs, and for the past three years, for every $1 increase in world oil, there has been a corresponding one per cent increase in transport costs.

“Unless that container is chock full of diamonds, its shipping costs have suddenly inflated the cost of whatever is inside,” Mr. Rubin said. “And those inflated costs get passed onto the Consumer Price Index when you buy that good at your local retailer. As oil prices keep rising, pretty soon those transport costs start cancelling out the East Asian wage advantage.”

Persistently high oil prices will also cause many commuters to consider moving to the city, reversing the allure of the suburbs, he said. And it could also force a change in eating habits, as foreign food becomes too expensive to ship.

“It means forget about that 50-mile commute from Cooksville to Toronto, and also forget about that avocado salad in January.”

More fundamentally, the soaring oil price will prompt a major rethinking of how production is organized, Mr. Rubin argues, and could even lead to a revival of North American manufacturing.

Already, U.S. imports of Chinese steel are declining dramatically, while domestic production is rising at rates not seen for years, they say.

China's steel exports to the United States are falling at a 20-per-cent annual pace, while U.S. domestic production has risen by 10 per cent in the past year. That makes sense, the economists say, because Chinese steel producers need to import iron ore from the likes of Australia and Brazil, then turn it into steel and then pay huge and rising freight costs to send the hot-rolled steel to the United States.

Regional trade looks much cheaper in comparison, they say.

As oil prices continue to climb, shipments of furniture, footwear and machinery and equipment are likely to meet the same fate, the economists say.

“In a world of triple-digit oil prices, distance costs money,” they say in a paper released Tuesday. “And while trade liberalization and technology may have flattened the world, rising transport prices will once again make it rounder.”

At first glance, such developments may seem to favour a renaissance of the moribund steel mills and boarded up furniture plants of Canada. But high oil prices won't eliminate importers' search for cheap labour. Instead, they're eyeing Mexico.

“Instead of finding cheap labour half-way around the world, the key will be to find the cheapest labour force within reasonable shipping distance to your market,” CIBC says.

“In that type of world, look for Mexico's maquiladora plants to get another chance at bat when it comes to supplying the North American market. In a world where oil will soon cost over $200 per barrel, Mexico's proximity to the rest of North America gives its costs a huge advantage.”

While high oil prices will require major reorganization of global supply chains, the bigger danger comes in the form of inflationary pressure, Mr. Rubin warns.

“If you're a steel buyer, your costs are going up regardless of whether you are sourcing it from China or Pittsburgh,” he says, saying the same dynamic applies to Hamilton.

Soon, the United Steelworkers of America will want a piece of that higher price, and wages that have been kept flat for years because of labour competition from Asia will begin to rise.

He doesn't necessarily see a return to the double-digit inflation of the early 1980s, but figures the central banks in the United States and eventually Canada will have to begin raising rates dramatically in order to confront inflation running at around 3.5 or 4 per cent annual pace. Canada's target is two per cent a year.

No comments: