The downside of innovation: deflation and job losses

What happened to the siren’s song of rising inflation due to low interest rates? I have been hearing those warnings for five years and I fully expect to continue to wait for a noticeable rise in inflation for another 5 years or more.

In my last note I touched on the 30% decline in money velocity over the past 5 years, and its deflationary effect. However, there is another dramatic deflationary factor which is just as hard to predict and harder to measure, and that is innovation.

Innovation affects almost everything in our daily lives; it creates new jobs, but don’t forget it also causes deflation and eliminates jobs. The first iPhone was introduced in 2007, the same year as the financial markets and the economy began to unravel.

The iPhone was certainly not the cause of those problems of course, but it is a good data point that illustrates the rapid change in communications that have also occurred in the past five years. While the combination of the internet and smartphones changed consumer behavior, they  also had negative impact on industry and employment.

Advertising, commercial construction, computers, financial services, movies, music retailing, printing, paper (to name a few) have all shed employees because of disruptive technologies that reduced revenues and profits.

The upshot is that while these new technologies lowered the unit costs of many of the things we consume, the new businesses do not immediately create enough positions to replace those lost. Unfortunately, the negative impact of disruptive technologies is real and obscures the benefit of those technologies in the short-term.

These are the real headwinds our economy is facing – not fiscal policy discussions and government inaction. For that reason, unemployment and the monthly jobs report are what the Federal Reserve and many of us will remain fixated on.

DISCLAIMER:  All opinions included in this material are as of November 1, 2013 and are subject to change. The opinions and views expressed herein are of the portfolio manager and may differ from other managers, or the firm as a whole. Past performance is no guarantee of future results.