How to cope with cost-put inflation and stagflation?

Currently, the environment of cost-put inflation or stagflation has been seen clearly. Every people realize that the increase of food price and oil price affects the daily life. On the other hand, what is the action of the government when they face this peculiar situation?

The government tends to carry out the monetary policy in order to improve the output of the economy. Although this can facilitate the consumption demand and investment demand in the short-term, the decrease of the interest rate and the increase of the money supply exacerbate the increase of the price level. Economists always say that there is no free lunch. The output (or employment) is the kind of lunch that you need to pay (by inflation)!

The main crux of the cost-put inflation and the stagflation is the source of supply. For example, extreme natural environment such as bad weather and pollution curbs the productivity of the crops and the raw material. Slow-down of the technological progress in the production of raw materials or agricultural products is also the concern. The basic solution must be on the supply side such that the incentives should be given to the producers of the raw materials and agricultural products. The frequency to recycle the product should be increased. Nevertheless, this is not an easy process to ignite the supply again.

The market determines the temporary difficulty we currently face. This also produces the link of feedback (reflexivity) to the producers to research the production of agricultural products or various resources. Another swing can be produced through this process, i.e. from under-investment to over-investment and from over-consumption to under-consumption. This is the main logic proposed by Jim Rogers.

Figures as references

Attached please find two figures, where I regard this to be utmost important. Aggregate market becomes volatile, while "relativity", trend and contrary during extreme moments always exist in the aggregate economy.

First figure is the time series for the equity index and the commodity index.

Second figure is various currencies against Japanese Yen.

In addition, it is vital to look at the volatility index, posted in my previous essay.

Demand and Supply

Demand and supply may be the simplest jargon used in the economics and the application in finance and investment, but in reality, how many people can truly realize the implication of demand and supply (especially for the analysis through the Price-Quantity coordinate) acting in our economy and every market that we involve?


The above demonstration is a kind of usual mechanism of microeconomy. This is a kind of mismatch or time lag, appearing in both good, labor and financial market from microscopic point of view. Try to repeat the above mechanism to perceive what happens.

As for the macroeconomy, price belongs to the price level and quantity becomes the output level, while the demand and supply become aggregate demand and aggregate supply. It should not be that similar to the above demonstration, but the thought through this kind of coordinate should be indispensable. In turn, the final macroeconomic dynamics should be tractable.

Volatility and financial market

Currently I am a bit busy on my work and moreover, there is not much special viewpoints that I cannot spend much time to write the essay. I have created a question mark on the Hong Kong economy in my last essay, but it is nothing special. To simplify this, it can be the mixture of Chinese and US economy with more weight on Chinese side. On the other hand, I would like to share some alternative points.

Attached please find two figures of the VIX, which is the implied volatility for the S&P 500 index options. The first one is in 1-year span, while the last one is in maximum time span (Source of figures: finance.yahoo.com).

The VIX has some indication, i.e. the fear index such that if it is high, the market is at the most terrific moment such that some investors rely on this index as contrarian indicator to trade. In terms of the shorter time span, we can see that there is a mere double top (or even triple top) developed in the VIX. One can feel confident to buy the US stock again, at least for the rebound.

What I want to emphasize is the second figure, where it has the significant implication on the stock market. It seems that when the VIX is high, the US stock market is at the moment from 3rd stage of bullish trend to 2nd stage of bearish trend. When the VIX is low, the US stock market is at the moment from 3rd stage of bearish trend to 2nd stage of bullish trend. Is there any explanation? It is not only the excessive fear, but also the enormous greed fuelling the second moment of the stock price.

Regarding the overseas financial market, many are arguing whether the decoupling exists or not*. Regardless of the validity of the decoupling of the economy or stock market, the volatility of the financial market, even among stocks, commodity and foreign exchange, should hardly be decoupled, as we have already observed in these years. If you are the writers of the options, notice this.

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* Personally, I do not agree that there is significant decoupling when there is international trade and with some additional notes that there should be time-lag for the decline, combining some points in view in 2008 I. Despite this, I am discreetly optimistic about Chinese economy in long-term.

View in 2008 I

(Please notice the disclaimer before reading the analyses below. The window is one-year period and it can be subject to change if there are shocks or structural changes occurring in the period.)

Merry Christmas and Happy New Year! The skin of my blog has been changed to welcome the new year. First of all, I would like to carry out some macroeconomic analyses. Next I will continue to talk more about other thoughts related to economy and investment. One can apply the IS-LM and AS-AD to the analyses below such that one can get clearer picture, while I get the equation proposed by Kostolany for your concrete reference on the abstract economy.

- Macroeconomy in US

US is trivially going to the stagflation environment although the inflation is not significant now. Stagflation is not the usual phenomenon since it is triggered by the supply shock, such as oil and food. On the other hand, people's confidence on the credit market is another side to contribute to the decline. In the stagflation environment, even though there is inflation or even decreasing interest rate, this cannot induce money flowing to the capital such as stocks and corporate bonds because the cash flow of the company becomes more uncertain during the decline (One may refer to Mr Law's comments where he mentioned that the stock price may not increase during inflation or even negative interest rate). The Fed increases the money supply, but bears the risk that the people do not have confidence to carry out the credit market transaction and the inflation can be further increased.

In Kostolany's syntax, strong money (?) + weak confidence
=> Pro-weak environment
=> Needs some moment to recover.

- Macroeconomy in China

Growth still proceeds, but due to the changing economic environment, three aspects have to be considered.

- How is the structural inflation on the supply side?
- Can decoupling succeed, i.e. unaffected by US?
- What is the significance in the contractionary monetary policy announced in late 2007?

In Kostolany's syntax, weaker money + strong confidence (?)
=> Pro-weak environment
=> Needs some moment to decline. Note that growth still proceeds but the growth rate will be slower.

- Macroeconomy in Hong Kong

Hong Kong is the special location. There is increase in money base due to US expansionary monetary policy and linked exchange rate. However, Hong Kong is not the same as US to face severe threat in credit market, while mainland China is facing the above uncertainty. How can the investor do in order to survive in such kind of environment?

(Continue)