A recent Wall Street Journal article talked about inflation and the following article excerpts illustrate something interesting: Inflation isn’t a given.
- “U.S. consumer prices continued to rise • at a moderate pace in December 2009 from the previous month, indicating that a soft economic recovery is keeping inflation contained.”
- “The most severe recession in decades • has led the jobless rate to rise to double digits. In December, unemployment remained unchanged at a lofty 10% as employers cut more jobs than expected.”
- “The U.S. central bank has spelled out • that as long as core inflation and inflation expectations remain low and unemployment stays high, the fed funds rate won’t be raised from a record low.”
With all the spending involvement we have seen from Washington D.C., there arises the frequent question: ‘Aren’t we going to have massive inflation with all this money they are printing?’ We could agree that maybe this is a potential risk, although not an imminent one. Let’s first look at the definition of inflation.
in·fla·tion
A persistent increase in the level of consumer prices or a persistent decline in the purchasing
power of money, caused by an increase in available currency and credit beyond the proportion
of available goods and services. This means we need to be in a period of economic expansion combined with/caused by the massive availability of money. This contrasts with the opposite situation:
de·fla·tion
A fall in the general price level or a contraction
of credit and available money.
Where do we sit now? We would argue that we are still in a period of deleveraging and deflation.
Even though the economy has stopped declining and collapsing, there are still many deflationary forces that can cause prices to decline and thereby keep inflation at bay for some time. Some examples:
- Foreclosures wave that is still coming
- Likely 2010 termination of the Government spending that has been supporting this economy so far
- The sustaining of artificially low interest rates by the Fed illustrates that they aren’t inflation driven yet
- Falling commercial real estate prices
The Fed
The Fed knows that they need to keep short term interest rates low for some time because if they raise them too soon, they run the risk of stalling the economy and forcing us into the dreaded “double dip recession”. Being that 2010 is an election year, this would be political suicide.
Banks
Also, as most have assumed, we will eventually find ourselves in an environment of higher long term interest rates on mortgages. From this standpoint, the real estate market will be a very telling sign of whether deflation is at work or not. Ever wonder why the banks are not negotiating with homeowners about restructuring their debt and adjusting the mortgages down to current appraisal levels? If you were a bank, would you want to lock in low rates on what are perceived as risky assets with billions and billions of dollars? The banks have realized that they don’t know what to do with all the foreclosures and therefore are letting houses go to auction for cents on the dollar rather than working with homeowners. This process is going to take a while to work through and government intervention
is only going to extend the recovery time. And it is deflationary.
So, while we may worry about inflation at some point; this is not the immediate problem.
Therefore, to plan for inflation with a large portion of investment assets at this point would increase, not reduce risk.
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