What goes up (down), must come down (up)
“What goes up must come down” is a familiar phrase that means that any object that goes up because of the law of gravity must come down. For example, any bullet shot up in the air by the law of gravity eventually shoots down. Apart from the law of gravity, the law of averages can be seen to be another reason for the saying. That is, any spike from the normal value of a variable tends to be corrected by a subsequent abnormal low so that the two values even out to equal the average.
In the past 10 years, inflation has normalized and averaged at 3 percent. When in 2018 the government failed to import rice, the price of rice spiked. So, in September 2018, inflation peaked to 6.7 percent. That is more than twice the double of the average. What goes up must come down. Thanks to the eventual importation of rice, what went up in September 2018 went down in September 2019 to 0.9 percent. The two eventually averaged out to 3.8 percent. Not exactly 3 percent, but close enough.
The correction has to do with the jargon that is the “base effect.” If the normal inflation is 3 percent, a commodity that is worth P100 today is expected to be worth P103 next year and P106 the following year, thus an average annual inflation of 3 percent. However, suppose the price of the P100 commodity increases to P105 next year resulting in an abnormal high of 5 percent inflation. In the following year, the same is then expected to increase to P106 resulting in an abnormal low of 1 percent inflation. Because the increase to P106 is relatively a small increase from a high base of P105, what goes up at 5 percent must go down at 1 percent resulting in an average inflation of 3 percent.
In recent months, mainly because of the failure to protect the hog industry from the African swine fever, inflation in meat shoot up to an abnormal over 20 percent. The result is that overall inflation in February shot up to 4.7 percent, which is the highest since 2018. As the ASF continues to hurt the hog industry, inflation in meat is expected to pressure the overall inflation to increase even higher. Yes, what goes up must come down, but inflation in meat is expected to go up and remain up for awhile before it will go down.
As for the application of the law of averages on inflation and commodity prices, “what goes down must come up” is also true. Suppose the price of the P100 commodity increases to P101 next year resulting in an abnormal low of 1 percent inflation. In the following year, the same is then expected to increase to P106 resulting in an abnormal high of 5 percent inflation. Because the increase to P106 is a relatively big increase from a low base of P101, what goes down to 1 percent must go up to 5 percent resulting in an average inflation of 3 percent.
Because of the Covid-19, countries in different levels suffered supply chain disruptions and economic shutdowns in 2020. With the peak of disruptions and economic shutdowns in April 2020, the global price of oil troughed. For example, Dubai crude troughed to $23 per barrel. This is equivalent to over 60 percent drop from its approximate normal of $60 per barrel the past five years. It is no coincidence that inflation in May 2020 dropped to 2.1 percent, which is the lowest it had been since December 2019. Inflation has since increase from then on.
What goes down must come up. The global price of oil has slowly normalized. As of March 5, 2021, Dubai crude stood at $67 per barrel. If the price remains the same to April, the price will increase from $23 to $67 per barrel or an annual increase of over 190 percent. Incidentally, this author approximates that inflation tends to increase by 1.5 percent per 100 percent increase in the price of Dubai crude. This translates to additional pressure for inflation to increase by 2.9 percent. Counting for oil only, the inflation of 2.1 percent in April 2020 can shoot up to 5 percent in April 2021.
Counting for oil and ASF together, what goes up will come down, but not after inflation goes up even higher in the coming months.
Luis F. Dumlao, PhD is the Dean of the John Gokongwei School of Management, Ateneo de Manila University.