Inflation/Deflation

The big topic at a lot of investment/business websites is the ongoing debate of our future wrt inflation and deflation.  Peter Boockvar at The Big Picture writes a good post today on the subject.  It is worth repeating here in full.

With Treasury bond yields at or near historically low levels on one hand but with commodity prices near 8 month highs, and with the personal feeling that outside of a home, a computer and a flat screen tv, the cost of living seems to only go higher on the other hand, here is another perspective on the inflation/deflation debate. Since June 1981 when Volker started to lower interest rates from 20% as high inflation rates started to fall, the absolute level of CPI rose 142% to the high in July ‘08 (90.5 to 217). Deflation is defined as a decrease in the general price level of goods and services but to quantify the current fall in prices, the CPI has fallen just 1% from its all time high. This tiny price move, notwithstanding we are still near an all time high in the daily cost of living, has led to talk that the Fed needs to do more to avoid deflation at all costs and thus create inflation via more QE. An example, oil goes from $50 to $85 in one year and the next year falls 1% to $84.15 and we’re told there is deflation and deflation is bad.

The view is that with excess capacity and a lack of demand combining for softer prices, we must have even lower interest rates to spur more borrowing and thus more economic activity to increase demand and thus reduce the large output gap. Think about this, policy makers think we should raise the cost of goods and services in order to cure a lack of demand. The law of supply and demand says lower demand must be met by lower prices in order to get to the proper equilibrium. What the Fed really wants to do is create inflation in order to not deal with an overleveraged economy in the most responsible way, either paying debt off or writing it down. They want us to pay off the debts with inflation. Inflation is a hidden tax on every single one of us and thus the corollary is deflation is a tax cut. Inflation is good for those who are highly indebted as those debts get paid back with inflated money while deflation or flat prices are good for those who save and have little debt and vice versa.

In the state of deleveraging the US is in where the low cost of money doesn’t matter much to an individual or a business in making spending and investment decisions, artificially low rates mostly spurs just refinancing and higher commodity prices. While maybe or maybe not higher commodity prices makes there way into government consumer price statistics, the commodity inflation is still there and has to be eaten by someone. Food for thought.

I put one part in bold because I just refinanced my house.  I have a fifteen year mortgage with about 9 left on it, and the rate went from 4.875% down to 4%, with very little closing fees.  My bank was even nice enough to let me fold the fees into the mortgage.  I saved $3800 by doing nothing more than signing some papers.  Not having a large amount of debt and being a fanatical saver I am staunchly in the deflation camp on a personal level.  Cash is already king and will be even a bigger king in the future.

But I am afraid the books are cooked.  The Fed is going to gerrymander this game until we get inflation whether we like it or not, which is good for those who are in debt up to their ears since future dollars are going to be worth less, and they get what amounts to a big tax break.  It makes me feel like a sucker at times for doing things right, and beating down my personal debt to zero within a few years.  Think of it like this – why am I paying for things now like my mortgage when I could pay the mortgage in the future with cheaper dollars?  It makes me mad.

But I was always taught that it was right to own things and get out from under the debt trap, so that is what I do, in a fanatical way.  And if we get deflation like we are supposed to, I will be the king of the mountain.

On an unrelated note, pork bellies are soaring and are around all time highs.  This means bacon lovers will be paying more in the future.  I am lucky that I contract with a local farmer for a whole pig a year and have a large stock of wonderful bacon in my freezer.  The theory is that a lot of the large producers cut their herds of pigs in the economic downturn and the lack of supply/inventory is pushing the price up.

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