Inflation, Deflation, Stagflation?
Yes I realize that the above title is misspelled but I wanted to prove a point. As I stated in my last newsletter, we are in the midst of a deflationary spiral now, are facing the potential for stagflation (inflation with muted economic growth) and may face hyperinflation. While we are the first one's to admit that one of the unintended consequences arising out of this credit crisis and subsequent unprecedented Federal Reserve actions is the chance of inflation. We feel that the inflation risk is a distant (but very real) worry; however, the depth of deflation now could very well increase the long-term risk of hyperinflation. The cycle could force the Fed to continue to pump the system with money and continue to engage in quantitative easing, but the Fed will have to be Harry Houdini in order to escape the throws of inflation. It remains to be seen how well the Fed can pull the string to avoid dramatic inflation.
It can be argued that a modicum of deflation is good, but only if you have excess disposable income to purchase these products at lower prices. Based on the jobs numbers today, the lack of wage increases and the fact that we are furiously deleveraging, excess disposable income is being saved (the savings rate rose to 6.9%), not spent today. Of particular concern to us in the US is that we may feel the double whammy of deflation effects on assets we own (think US dollars and real estate) and subsequently feel the inflationary effects of the things we need (think raw materials and oil). In a cash based economy, easy Fed policy has historically led to inflation. However, in an asset heavy economy built on credit, what will happen when too much debt chases too little income - deflation. Or asked another way, what happens when the Fed's printing of money can't keep up with the destruction of credit - deflation.
There are a few signposts to be cognizant of in the lookout for inflation (or the end of the deflation scare):
It can be argued that a modicum of deflation is good, but only if you have excess disposable income to purchase these products at lower prices. Based on the jobs numbers today, the lack of wage increases and the fact that we are furiously deleveraging, excess disposable income is being saved (the savings rate rose to 6.9%), not spent today. Of particular concern to us in the US is that we may feel the double whammy of deflation effects on assets we own (think US dollars and real estate) and subsequently feel the inflationary effects of the things we need (think raw materials and oil). In a cash based economy, easy Fed policy has historically led to inflation. However, in an asset heavy economy built on credit, what will happen when too much debt chases too little income - deflation. Or asked another way, what happens when the Fed's printing of money can't keep up with the destruction of credit - deflation.
There are a few signposts to be cognizant of in the lookout for inflation (or the end of the deflation scare):
- Capacity Utilization => otherwise know as the output gap or the slack in the economy with factories idles and workers furloughed
- Growth in Wages => with employees more fearful of losing work or hours, stagnate wages will keep prices low
- Total Hours Worked => this would be a sign that demand is picking up and those who have jobs need to work more hours
- U-6 => this is known as the 'underemployment rate' of unemployment + discouraged workers - currently at 16.5%
