Jeff Snyder Explains Crisis‑Led Deflation Behind Recent CPI Drop

Jeff Snyder of Euro Dollar University provides a detailed breakdown of recent CPI (Consumer Price Index) data, suggesting that while inflation appears to be coming down, the underlying reasons are cause for concern rather than celebration. He distinguishes between two types of deflation: crisis-led and innovation-led.

Crisis-Led vs. Innovation-Led Deflation

Deflation, often perceived negatively, can be beneficial if driven by innovation, leading to cheaper goods over time. However, crisis-led deflation, like that experienced by Japan, is problematic. In Japan's case, an overinflated property market bubble burst, leading to widespread debt and a reluctance to spend, even with currency inflation. This resulted in economic stagnation, as people prioritized debt repayment and fiscal conservatism. Prices fell due to lack of demand, making it difficult for the economy to grow and fostering a sense of pessimism.

Snyder argues that the current deflationary trend is crisis-driven, not a positive development. Central bankers, in their efforts to hike rates, are primarily concerned with core inflation, specifically services prices, fearing that rising oil prices could spill over into other sectors.

Understanding CPI and Core Inflation

The CPI is often sliced and diced in various ways, which can be confusing. Core CPI attempts to remove volatile energy and food prices to get a clearer picture of underlying inflation trends. While these categories are crucial for the average consumer, their fluctuations tend to "wash out" over time for traders.

The CPI for June showed a surprisingly weak performance, with a significant monthly decline, the largest since April 2020. This decline was not solely due to motor fuel, indicating broader issues.

The "Phase Shift" and Elevated Prices

Snyder highlights a "phase shift" that occurred during COVID-19. Prices surged massively during the pandemic and have not returned to pre-COVID levels. While the rate of increase has slowed, prices remain elevated from that initial spike. This means that even with declining inflation rates, the overall cost of goods and services is still significantly higher than before the pandemic.

The speaker expresses frustration at not fully grasping the long-term economic consequences during COVID-19, particularly the impact of money printing and increased credit card spending. These actions, combined with policies that systematically disempowered workers, have made everything more expensive.

Demand Destruction: The Real Story

The recent CPI decline is attributed to "demand destruction." This occurs when consumers can no longer afford goods and services, leading to a reduction in spending. While some initially resort to credit card spending or depleting savings, this is unsustainable. This phenomenon is a precursor to what happens when governments reach the end of their debt capacity, forcing austerity measures.

The annual inflation rate has fallen below expectations, but for the wrong reasons. The Federal Reserve's focus on core inflation, particularly services, is based on the theory that rising energy costs lead to businesses raising prices, creating a spiral of "second-round effects." However, Snyder argues this theory is flawed.

Businesses, facing increased input costs, are finding it difficult to pass these costs on to consumers because consumers simply cannot afford them. This leads to two outcomes:

1. Reduced Sales Volumes: Businesses raise prices, but sales fall, as seen with retailers like Walmart, which opted to cut prices instead.
2. Absorbing Costs: Businesses absorb higher input costs, leading to squeezed profit margins. To compensate, they cut their own costs, often by reducing worker hours, converting full-time positions to part-time, or even layoffs. This is consistent with recent labor data.

The Consequences of COVID-19 Policies

The speaker asserts that the draconian lockdown policies during COVID-19, driven by a "psychotic desire for power" by governments, have had staggering and long-lasting economic consequences. These policies made everything more expensive and are now contributing to the struggles of the middle class. The economic impact is complex and difficult to unwind, much like a cancerous tumor.

Market Signals: TIPS and Oil Futures

Snyder emphasizes the importance of looking at market signals, particularly Treasury Inflation-Protected Securities (TIPS) break-even rates and oil futures curves, to understand true economic conditions.

TIPS Market Insights

The TIPS market provides a relative measure of demand for inflation protection. A rise in break-even rates indicates increased demand for inflation protection, while a fall suggests less demand. The TIPS market has consistently signaled that there is no significant additional inflation risk, even when mainstream narratives suggested otherwise (e.g., tariff inflation, sticky inflation, Iran conflict).

For instance, during the Iran conflict, while break-even rates rose slightly, they did not soar, indicating the market did not price in substantial inflation risk. More recently, break-even rates have been plummeting, signaling a significant shift in inflation expectations.

Comparing 5-year and 10-year break-even rates further reveals that any CPI effect from oil prices is expected to be short-lived, with demand destruction being the more likely outcome. Longer-term inflation expectations, as indicated by the 5-year, 5-year forward rate, have consistently shown that the current situation is not a repeat of the 1970s inflation but rather a supply shock and phase shift.

Oil Futures Curve

The oil futures curve also points to demand destruction. While near-term oil contracts (e.g., August delivery) have seen price increases due to supply disruptions from the Middle East, longer-term contracts (e.g., November delivery and beyond) are being sold off. This indicates that the market expects oil prices to become cheaper in the future as demand continues to fall globally, driven by macroeconomic weakness in major economies like the US, Europe, and Asia.

Global Economic Weakness

The two largest economies, the US and China, are both struggling. The US is experiencing the lingering effects of COVID-19 policies, while China is grappling with a housing crisis. China's ability to maintain its oil reserves, even amidst supply disruptions, suggests a massive downturn in demand for both diesel and regular gasoline, indicating a significant weakening of its economy. The fact that energy demand, traditionally considered inelastic, is being destroyed, highlights the severity of the global economic situation.

Conclusion: A Different Narrative

Snyder concludes that the prevailing narrative about the economy is often inaccurate. The signals from the TIPS market and oil futures, combined with consumer surveys showing pessimism about job and income prospects, all point to weak demand and demand destruction, not inflation. This is a crisis-led deflation, where people are not feeling flush with cash and are cutting back on spending, leading to a cascade of negative economic effects, including job losses.

He hypothesizes that unlike the 1970s, when real wage growth provided a buffer against economic shocks, decades of stagnant real wages have left consumers with little financial resilience, making them more susceptible to demand destruction during current disruptions.

The speaker encourages individuals to seek out reliable economic signals and data to make informed decisions about their finances, emphasizing the importance of humility in interpreting complex economic systems.