Ore and More

At some point, inflation is going to hurt everyone, but it hurts people differently. This is because inflation is in essence measured alongside a basket of goods and services. From country to country, people spend different proportions of their income on raw materials, processed goods, and services. The question I want to look at is, what is the cost of raw materials as a percent of GDP, and how does that impact the consumer?

In America, people complain if gas prices go up $2 per gallon, and I understand their pain. I am feeling it every time I fly. My wife feels it every time she fills up our van’s gas tank. Putting aside the flight costs for the moment, let’s look at the math of how gas prices are affecting people like my wife who drive a lot. She drives a van that gets 20 miles per gallon about 20,000 miles per year. So my wife uses 1,000 gallons of gas a year driving around the kid-hauler. She buys regular gas, and she is now paying on average $4.30 a gallon. Assuming gas prices stay at $4.30, she’ll spend about $4,300 this year on gas. Last year, gas prices were a high $2.40 per gallon, so she would have spent $2,400 on gas if we had not lived in Israel at the time. So this year she is spending an additional $1,900 for the privilege of not staying home and going stir crazy.

Now let’s apply that cost increase to a family with an income slightly above the American average, say $60,000. On a take-home basis, that family is losing an additional $158 a month to gas costs against a gross income of $5,000 a month. On net income, it is probably a bit worse. That family is losing 3-4% of their net income to gas.

Now let’s flip commodities and countries. In China, they consume probably 275 kg of steel per capita per year. That translates to 440 kg of iron ore. Now the price of ore went up around $40 per tonne in China. So that mythical Chinese person is losing $16 in purchasing power to get the same steel. It takes 250 kg of coking coal for a tonne of steel, and the price of such coal went up $200 per tonne, for another $50 in lost purchasing power.

Now you might say, so they lost $66 per person, that does not matter, but that is 9% inflation on steel raw materials alone. And that is without freight or fuel. When you add in the freight jump it is worse, and with the fuel jump it is even scarier. The total inflation gets to be a bad burden when you figure that it affects everything a person consumes: raw materials, fuel, food, and everything else.

I do not notice when rice doubles in price. Not that much of my caloric intake comes from rice. And not that much of my income goes toward food, relative to my other expenses. If food goes up in cost by 30% on a macro sense, and as an average American I am spending 6% of my budget on food, the percent of my income I spend on food only will go to 7.8%.

However, if you were in Asia and spending 30% of your budget on food, an increase of 30% in food prices would be a much bigger problem. Suddenly, you would be looking at your food bill taking up 39% of your budget, a significant increase.

As I said before, inflation is in essence measured by a basket of goods and services. The American basket, with 6% of our money going to food, and x for fuel is completely different from those of people in the rest of the world. The reason, of course, is simple. People in other parts of the world spend a lot less on finished goods and a much higher percentage of their money on the basic raw materials that form a life. We in America do not, on the whole, buy rice. We buy rice mix. We also make a whole lot more than most other people in the world, so rice mix costs us a lot less, relative to our income, than rice costs the poor guy working in Shanghai with a wheelbarrow to make a living.

So what is the issue that I see here? At some point, inflation is going to bite the emerging market expansions in the rear and cause people to curtail basic spending. If we’re lucky, a feedback loop will take care of the problem: People buying fewer items will be enough to just slow down inflation and growth. But if we’re not lucky, spending will decrease so much that growth will nearly grind to a halt. That would be a hard landing.

I think my wife at this point can afford the gas she spends to drive. I worry a lot more about the rice bowl in China and if is it staying full. And I worry even more about the bowl of food in Africa, where a lack of food can cause political instability and war. If you cannot afford to feed your kids and they go hungry, you probably will do anything to put food in their mouths.

People will not riot for lack of gas for the car, but they will kill others to feed their own kids. Let’s hope that the feedback loops will avert that from happening. In the long term this is not a zero sum game, but it can sure feel like one in the short term.