Inflation Or Deflation Or ?
by
Stanley C. Clayton, Ph. D.
February 13, 2010
Economic Tea Leaves
Decisions, decisions - investing is full of them. So is governing especially in today's environment of many governments around the world trying desperately to cope with not enough money and too much debt coupled with struggling economies. As we watch this play out, many of us are trying to anticipate whether there will be inflation or deflation or are we even asking the right question? Science long ago developed The Scientific Method for answering questions of science. Once in a while scientists come up with an answer of substantive value. Wait! Why are not all the answers of value? Because most scientifically derived answers are to the wrong questions. This is not unique to science as humans spend most of their time answering the wrong questions - that is just life. Answers easily roll off the tongue while finding the right question is a tough slog.
Today, we have clear deflation in home prices in many U.S. geographic areas - serious and continuing deflation. Recently, commercial property has been added to the declining mix. Meanwhile, if you do much grocery shopping, you can not miss the fact that food prices continue to relentlessly inflate. We currently have both inflation and deflation at the same time. There is nothing unusual about this as having some of each is the norm. So, which will it be? The answer that is always correct is: both. That answer tells us there is something wrong with the question as its answer is of no value.
A substantially better (but surly not the "right") question is to ask how important elements of inflation and deflation are working out for the dominant part of the economy - the consumer? Usually at about 70% of sales, understanding their condition and outlook is instrumental for most investors.
As we all know, a great many consumers are in tough shape, and the rest are worried they may follow suite. Life on the float, as it has been known, no longer is the much sought after condition. Many have been leaning the hard lesson that as your debts increase so do your risks. Risk seemed like a foreign concept that had no place in the modern world. House prices had risen for so long that it was obvious to most that their prices would rise forever. Everything was coming up roses - until it did not. House prices started to decline, and decline some more, and the decline continues through today and beyond. That was the major risk few people factored in.
In desperation, many started trying to sell assets such as an extra car, boats, RVs and anything else they thought they could get along without. Then only to find out the market for these things suddenly was thin, and the occasional buyer was not willing to pay much (a little talked about sector of deflation). The economy was tanking, and many became worried about their job, or finding themselves under employed or unemployed. This level of deflation in such important parts of their lives weighted very heavy on them: most of their important financial assets were deflating.
As if this were not enough of a burden, inflation is alive and well. Many of the essentials the consumer must buy like food, electricity, fuel, clothes and such continue to rise in price. This inflation is making it worse for the consumer. What little wealth they have left from deflation of their assets is being eaten up faster and faster by the inflation of the essentials they have to buy. They are being hammered by deflation and hammered by inflation all at the same time.
While this was going on, the government continued to compute its usual figures on inflation. Lo and behold, net net we have a stable economy - inflation and deflation cancel each other out. As a statistician from a sociological perspective, I know full well how averages can sometimes be very misleading. The above example of the consumer attests to this. In this case, it hides the horrific plight of the consumer. It makes things appear fine when they are not.
Stock Market Tea Leaves
OK, but how does all this play out in investment markets? First, we should recognize that many consumers are not homeowners, nor do they have to worry about selling that extra car, boat or RV they do not have. While these people are an important part of our society and they are severely impacted by inflation of everyday essentials, in terms of dollars spent by consumers, they represent a smaller percentage. However this is changing as their ranks are rapidly swelling from an influx of former homeowners, and from new entrants into the job market who are unable to find work or become under employed. The spending of the wealthy does not total much as there are relatively few of them. The conclusion seems obvious: the consumer is in a position of substantially reduced capacity to spend, especially on non-essentials. They also seem to be gaining a better understanding of the risks of "life on the float". The folly of buying consumer items on credit is a lesson being learned the hard way by many. This further reduces their capacity to spend.
This analysis adds to the argument that the investor may be looking down the wrong end of a double barrel shotgun: a double dip recession - or is recession the right word?
