The free lunch is over

Inflation seems to be rearing its ugly head once again. With the next repo rate announcement from the Central Bank due on April 27, investors should be keeping a close eye on the inflation numbers that are released with that announcement.
In March the numbers released for February pointed to a headline inflation rate of 9.2 per cent while the core inflation rate has remained steady at 1.8 per cent. The current inflation levels leave us just shy of double digit inflation, a level that was once described as being on a “slippery slope.” Over the past few years inflation has been my pet peeve not only because it is so misunderstood, but because it has been a reflection of misguided policy initiatives which have negatively impacted the people of T&T.

I am on record as being a strong critic of some of the economic policies of the past administration in that  it pushed the economy beyond its normal absorptive capacity and fuelled an unnecessary level of inflation which negatively impacted the working-class—defined as salaried workers. Inflation during that period got as high as 15 per cent and people in this country lost as much as 40 per cent of their purchasing power in a four-or five-year span. Inflation eventually fell to low single digits during the course of last year. I am also on record as pointing out that the low inflation levels of the recent past was not the result of any explicit initiative by the current administration, but rather due to the flagging, sagging local economy.

Inflection
 We now stand on what is effectively an inflection point. Interest rates in this country are at record lows and were brought down, in part, because the inflation dynamic became much more accommodating. The theory goes that lower interest rates would reduce the cost of borrowing, which would make it easier for persons to access credit. The expansion of credit would be expected to fuel economic growth and so the cycle moves from negative to positive.  Inflation is back on the rise and the economy has not yet picked up speed. In fact, the strike action at Trinidad Cement Ltd (TCL) is sure to negatively impact the economic prospects as construction activity slows. Having seen a slowdown because of a global financial crisis, followed by our own version in the form of the CL Financial collapse, then to a transition in government, followed by a state of emergency, the economy is now faced with headwinds to the construction sector which is a major employer. These consistent headwinds have at varying times impaired the momentum in the economy leading to stagnation. The higher inflation levels reduces the wiggle room as were it to persist with a low interest rate policy and would leave the Central bank with a tough choice in terms of whether to remain accommodative or tighten policy by raising interest rates.

 
Labour power
Based on past experience, it is likely that the Central Bank will lean on the side of being accommodative, even at the expense of higher inflation levels. The argument is that headline inflation is transitory and that policy should be aligned more towards core inflation as it is considered to be much more stable. For the record, headline inflation takes into account increases in the price of items such as food and energy. In T&T food price inflation is very fickle, causing the headline inflation to bob and weave, depending on the prices of imported food items and local rainfall patterns that may result in flooding and lost crops. Core inflation strips out these volatile elements and is seen as a better gauge through which to define monetary policy. I consider this approach to be simplistic, especially when food price increases have been persistent over a number of years. We all eat food and regardless of the price volatility on hand, food represents a fundamental element of the basket of goods that a consumer purchases. More importantly, a lower- to middle-income person is likely to spend a higher percentage of their income on food items than a wealthier person who has more income for discretionary purposes.

 A rise in food prices will therefore have a disproportionate impact on the average consumer, the same consumer to whom credit is being extended to woo them to purchase items such as cars and homes, which positively impacts economic growth. Ignoring headline inflation and setting policy based on core inflation create the potential for deep-rooted inequities, which, over time, will have social implications. A big factor in determining the extent to which headline inflation should influence policy is the strength of the labour movement in a particular country. Examine the reason as to the reason why the United States Federal Reserve cut interest rates so aggressively while the European Central Bank (ECB) were not as aggressive, despite a worsening European debt crisis, deep austerity measures and pending recession.
The reason the ECB acted in the way that they have is because it was critical to the European social and political framework that inflation is kept in check. With a very strong labour union movement across much of Europe and very labour-friendly employment regulation, the erosion of personal spending power through inflation would not be tolerated.
The ECB understanding the consequences of higher inflation levels managed monetary policy in a manner that provided a check against the fiscal authorities (respective European governments), so the fiscal authorities were forced to adopt policies to manage their fiscal issues.

 
Trade unions’ failure
In T&T, it is my view that the working-class in this country were largely let down by the trade union movement which is only now trying to play catch up. The harsh reality is that when they were required to act they were either asleep at the wheel or enamored by the politics and so failed in their duty. Had the labour movement acted on the high levels of inflation with the appropriate vigour either the Government of the day would have had to adopt more measured policies or the Central Bank would have had to be less accommodating. Recognise that for the better part of ten years, the inflation rate has been higher than the bank deposit rate, which means that for this period, savers (in particular, the working-class) have had an additional hidden tax on their savings. Some may argue that the aggressive fiscal policies of the past and the accommodative monetary policies have resulted in a high level of employment that was embraced by the labour movement as opposed to being challenged. The counter to this is that a progressive and forward thinking labour unit would and should have recognised the short-term nature of such policies. Their failure to provide the necessary check and balance in the system is a big part of the problem we now face.

There is a view in investing that “there is no such thing as a free lunch.” Put another way: there is always a price to pay somewhere down the line. Today, we are paying that price and the collective failure of the system is there for all to see.
It was the construction sector that benefited most from the fiscal spending of the last decade. That sector was overheated to the point where it was difficult to get skilled labour. Building materials became scarce. Today, the trade union movement belatedly seeking the interest of workers, is in support of salary increases at TCL in order to provide for a “living wage” that has been ravaged by inflation. TCL is having difficulties meeting their financial obligations. The ensuing stand off has resulted in strike action, leading to a shortage of cement. In the process, this is affecting the same construction sector that was the boom during the days of fiscal excess with negative consequences for employment.

It seems we have now come full circle. In the end, it is important to step back and reflect. The crucial question is: have we as a country accomplished what we should have with our natural gas windfall? From the perspective of social stability and an overall improved standard of living for the average consumer, the answer is probably no. That is a shame.
Hopefully, we will recognise that with no free lunch on offer there is always a price to pay for poor policy. Going forward, there is no room for expediency either at the fiscal, monetary or productive level of our economy.

Ian Narine is a broker registered with the Securities and  Exchange Commission.