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Several people on this list have recently mentioned the threat of deflation
to the economy and to the stock market. Rest easy folks, it's a non-issue.
First of all, it's important to understand two very different terms which
the mainstream media tends to use interchangeably. When prices in the
economy as a whole are actually falling from one month to the next, that is
a deflationary environment. Certain individual sectors of our economy are
definitely experiencing deflationary cycles right now- oil and other
commodities come to mind. However, in an 8 trillion dollar economy, this is
really nothing to worry about. It's what's happening to prices in the
economy as a whole that is important.
In the overall economy, prices are still increasing, but they're rising at a
slower rate. This is not a deflationary cycle, but rather a DISINFLATIONARY
cycle. Deflationary cycles are almost always bad, disinflationary cycles
are almost always good. However, as with anything else in the economy,
momentum can be a very powerful force. If the rate of inflation is rapidly
falling towards zero, it certainly stands to reason that a deflationary
cycle is almost inevitable, right? Yes, but the good news is the
disinflation rate isn't nearly as great as the mainstream media would lead
you to believe.
Over the past several quarters, the Bureau of Labor Statistics has been
implementing changes in how both the CPI and the PPI are calculated, because
a consensus opinion formed that the CPI and PPI were overstating the rate of
inflation. As investors, we should all applaud these changes, because for
any market to perform at its peak efficiency, the most timely and accurate
information possible is needed.
Unfortunately, what has been completely overlooked is the fact that the BLS
has been making these changes WITHOUT BACK-ADJUSTING THE DATA. In other
words, when you hear the CPI fell from 2.0 to 1.8 from one month to the
next, it's entirely possible that some or all of the decrease was due to the
fact that the method of calculation was changed from one month to the next.
When the complexity of doing the back-adjustment is considered, it makes
sense not to do so, but the media could at least mention this fact to you
when reporting the numbers! For those of you who feel compelled to check on
my claim, I've already saved you the trouble. I have a message from an
economist named Sharon Gibson at the BLS that verifies my statements. I'll
forward it upon request.
Don't misunderstand me, the rate of inflation is clearly dropping, I'm not
disputing that. However, the rate at which it is falling is much less than
the "official" numbers indicate, and therefore the threat of a free-fall
into a deflationary cycle is significantly exaggerated. The rate of
inflation has simply been falling over a longer period of time.
Still pessimistic? Don't be, because there's even more good news. Even if
deflation were to slowly appear in prices as a whole, I absolutely guarantee
you it won't be around long enough to even worry about. Why, because of all
the potential threats to the US economy, this is by far the easiest problem
to fix.
The simplest definition of inflation is "too many dollars chasing too few
goods." That's pretty self-explanatory. Therefore, deflation is simply
"too many goods chasing too few dollars." Now if that's the case, all the
government has to do to eliminate deflation is PRINT MORE DOLLARS AND SPEND
THEM. Targeting the worst hit sectors would help. The Strategic Oil
Reserve could be re-opened and large purchases could be made from the oil
companies. You get the idea (and remember, this won't cost the taxpayers a
penny because the dollars are being printed, not taken out of their
pockets). Let's face it, if there's one thing that our government is VERY,
VERY good at, it's spending money...
What got us into the deflationary cycle of the 1930's? The government
contracted the money supply at the very time they should have been expanding
it. What got us out of it? A massive expansion of the money supply to pay
for World War II (some things you learn by trial and error...).
Bruce
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