Amazon’s headline grabbing June 16th takeover of Whole Foods has been seen by many commentators as a sure sign that grocery prices will be lowered when the economies of scale efficiencies that Amazon brings with online shopping and distribution start to kick in.

Moreover, the supermarket company Kroger cut its earnings forecasts on June 15th, citing lower grocery price trends as the main reason, and its shares dropped by 32% over two days. Kroger Chief Financial Officer Mike Schlotman told CNBC:

In the quarter, we had about 20 basis points of deflation, excluding fuel. That was a little bit less deflation than the prior year and the prior quarter. But keep in mind that’s deflation on top of deflation.

Clearly, food prices in the USA are under pressure at the moment – but should we see this as a general trend towards deflation? First of all, let’s remind ourselves what deflation is and isn’t.

Deflation is a contraction in the total supply of money and credit in an economy. Inflation is an expansion in the total supply of money and credit in an economy. In other words, neither has anything to do with prices! Prices of goods and services move up and down for many different reasons at different stages of the economic cycle and whilst this price deflation/inflation can be related to the (properly defined) monetary deflation/inflation, it doesn’t have to be.

As you can see in the chart below, food prices in the USA have gone through a number of deflationary occurrences since the 1940s, most recently from September 2016 to January 2017. Food prices are affected by a lot of different variables, not least by the wholesale prices of soft commodities like cocoa, coffee and sugar, and grain commodities like wheat, corn and rice. The S&P GSCI Softs index is down 62% from 2011 and the Grains index is down 50% since 2012. No wonder that retail food prices are also under pressure.

Food prices may move back into a falling phase (certainly the highlighted lower peaks on this chart in 2011 and 2014 are signs of rising prices losing momentum) but even if they do, it still can’t be categorized as general deflation. Falling food prices would be the correct way to describe it.

For real deflation to occur, that is, monetary deflation, we need to see components of money supply starting to contract. In the USA, money supply is measured in two ways, denoted as M1 and M2.

M1 is made up of:

  1. Currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions.
  2. Traveler’s checks of nonbank issuers.
  3. Demand deposits at commercial banks (excluding those amounts held by depository institutions, the U.S. government, and foreign banks and official institutions) less cash items in the process of collection and Federal Reserve float.
  4. Other checkable deposits (OCDs), consisting of negotiable order of withdrawal (NOW) and automatic transfer service (ATS) accounts at depository institutions, credit union share draft accounts, and demand deposits at thrift institutions.

M2 is made up of M1 plus:

  1. Savings deposits (including money market deposit accounts).
  2. Small-denomination time deposits (time deposits in amounts of less than $100,000), less individual retirement account (IRA) and Keogh (tax-deferred pension plans) balances at depository institutions.
  3. Balances in retail money market mutual funds, less IRA and Keogh balances at money market mutual funds.

The Federal Reserve releases the money supply reports each Thursday. The latest data shows that there is still year-on-year growth occurring, i.e., inflation. However, the chart below shows that since its October 2016 peak at 7.57% annualized growth, M2 readings have been lower. This can rightly be described as the money supply disinflating (inflation is becoming slower). For pure deflationists, even though money supply data can appear to be as dry as the desert, this is actually quite exciting.

In summary then, at the moment we have food prices under continued downward pressure, and we have a money supply that is showing signs of disinflation. Evidence is mounting that a slump may lie ahead.

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