Just when the central bankers of the world were getting ready to cross "conquer inflation" off their collective to-do lists, it seems those pesky price indices have some life left in them yet. The high cost of food and energy is pushing global prices up at a 5.5% clip, while the major emerging economies of China and India are closer to 8% (...and Russia is at 14%). But wait just a minute, didn't Alan Greenspan and Co. bring inflation to its knees in the late 80s and 90s (we can remember quizzing a well-known bank economist back in early 2002 about the specter of Japan-like DEFLATION in the western world) and usher in a golden era of sustained economic growth? Well not exactly... there was a bit more to the decade-long inflation decline than simply monetary policy, including:

• Globalization - goods producers (and increasingly service providers) reaped the benefits of manufacturing in low-cost geographies, paring their cost bases considerably (New York Times columnist Thomas Friedman's book The Lexus and the Olive Tree does a nice job of laying out the new "rules" of globalization, along with its pluses and minuses)
• Supply Chain Management - retailers (led of course by Wal*Mart) took advantage of advancements in information technology and new ideas in merchandising and inventory management (among other areas) to squeeze costs of out their supply chains
• Low/stable Commodity Prices - in the wake of the recession of the early 90s raw material supplies were generally plentiful and commodity prices were largely flat or falling. Crude oil actually DECLINED 26% over the twelve year period following its Gulf War spike in late 1990 (seems like a lifetime ago doesn't it... see chart below)

Although these three cost structure phenomena are significant, the bulk of their benefits have already been realized. So what does this rebirth of inflation mean for investors? Well in the good old days a slowing US economy would mean slower global growth and declining demand (i.e. a reduction in inflationary pressures). These days, demand for commodities from the emerging world keeps those prices elevated (not to mention the impact of misguided government trade policies and enormous subsidies for food and fuel... but we'll save that for another post), and seeing as things like gasoline and food fall into the category of inelastic demand, this leaves consumers with less disposable income to purchase everything else they need/want. One study we came across sees energy expenditures by US consumers in 2008 hitting 18% of disposal income (the highest level since 1982) versus a mere 8% in 2002. The situation is most acute in the US, where consumer spending constitutes 70% of GDP, but this dynamic is also at play in Europe, Japan, etc. In short, we would expect global growth to decelerate in the coming months, with the consumption component of GDP bearing the brunt of the slowdown. Conversely, as long as commodity prices remain elevated (which to us makes sense given the supply/demand picture), producers of food, energy and metals will remain well positioned.

In other news...

We found this interesting article about the mistakes made by individual investors as identified in the field of behavioral finance. Apparently, thinking too much leads to overconfidence, loss aversion and "anchoring". Fortunately, professional money managers do not suffer from such difficulties (wink, wink).