The Hamburger Inflation Fallacy: Cost Push vs Demand Pull
An excellent equity analyst and friend of mine forwarded me the following headline from Bloomberg this morning (originally printed in the Nikkei Newspaper):
“McDonald’s Japan to Raise 100 Yen Hamburger to 120 Yen”
Is this how the beginning (of the beginning) of reflation is going to look? After all, this is inflation, right? Yes, it most certainly is. Technically speaking this will indeed mean an increase in prices (inflation) for the hamburger market. To the extent that the price increase is a result of Bank of Japan’s monetary expansion policy (which in a way it is – more on that later), then on the face of it the policy is working.
However, the BoJ’s goal is not to create inflation per se, but to create economic growth through inflation. This in turn is meant to happen through higher consumption – the idea being that is that people will spend their money now if they think prices are going to rise in the future. But why would a more expensive hamburger cause Japanese consumers to consume more hamburgers? Yes, nominally sales at McDonald’s will go up 20% (assuming people don’t lower their consumption of hamburgers by at least 20%), but even then – if salaries are not also going up then the net effect could actually be negative.
At any rate, what is certain is that if the number of hamburgers sold remains unchanged, then McDonald’s Japan’s hamburger sales will increase by 20% and this in turn will have a direct positive impact on GDP figures. But the important point here is that even if rising prices lead to rising sales, and even if that ends up having a positive impact on GDP growth, the whole effect is a purely nominal. It is simply an accounting effect, which does not reflect an increase in real economic growth, value creation or indeed wealth creation for the Japanese economy. It does not reflect a higher level of taxable economic activity in real terms, which is the only thing that will ultimately enable the government to balance its books and begin to reduce the debt mountain it has created.
In addition, McDonald’s Japan are raising it hamburger prices, not in the expectations of increased consumption or higher demand in general, but because the yen has been weakening for months so their cost are going up. Everything that goes into a hamburger (and certainly the meat, which is by far the largest cost component) has to be imported to Japan and the same goes for energy, and so McDonald’s Japan’s costs have been rising in tandem with the Yen weakening. In other words, what McDonald’s Japan is experiencing is pure cost push inflation, as opposed to demand pull inflation, the latter being what the BoJ is really hoping for. Below is included the 5 year weekly chart of the Yen vs USD.
As we have pointed out here before, the causality argument that the BoJ is putting forward as justification for its aggressive monetary expansion simple doesn’t stand up to close scrutiny. This is not to say that the future of the Japanese economy can be predicted by looking at hamburger prices, but it does provide a good opportunity to examine the causality between demand and price inflation, and the impact it has on the real economy. Without real growth (as opposed to just nominal growth), Japan has no chance of pulling itself out from under the debt mountain, because the future of the demographics of that country is so challenging for government finances.
The BoJ will almost certainly be able to achieve some level of inflation through its monetary expansion, but that is not automatically a cause for celebration, even in an economy suffering from deflation. If all it does is create inflation without real growth on top of it (partly through devaluation of the Yen), then the only thing it will achieve is to debase the currency and impoverish the average Japanese citizen and tax payer who is left ever deeper in debt-by-proxy, i.e. government debt.
Anecdotally, it seems that most companies (especially smaller manufacturing companies) have so far only felt the effects of the weaker yen on their costs base which is rising, since Japan has virtually no natural resources and so has to import everything it needs. One of the problems with devaluing one’s currency in order to achieve a competitive advantage over other countries, is that there is an asymmetrical time lag between the positive and the negative effects of the devaluation. Increased competitiveness and thus higher overseas sales, leading to higher income for the exporting company and hopefully higher salary/bonus payouts to its employees and eventually higher consumption (assuming they spend more and don’t save) is a protracted effect that may not show up in the real economy for a while. However, the increased costs of materials that have to be imported and used in manufacturing is felt immediately, so the cost base for both the exporting companies and the domestic demand orientated companies rises more or less as soon as the currency weakens. In a situation where the global economy appears to weakening again, this asymmetrical lag is a decidedly negative factor for corporate Japan and for the Japanese economy as a whole.