Why the Pessimists Are Wrong About Inflation
by Alexander Green, Investment U’s Chief Investment Strategist
Monday, April 18, 2011: Issue #1493
Everywhere I go these days, investors keep telling me the same thing. They’re adjusting their portfolios for the leap in inflation that lies just ahead.
These investors are probably right about inflation. It’ll almost certainly tick higher in coming months. After all, it was only 1.2 percent in the fourth quarter. But all this investment capital flooding into gold and silver, inflation-adjusted Treasuries and commodities may well prove to be spectacularly ill-timed.
Let me explain why.
I’ll start by making my usual caveat. I don’t know what the future inflation rate will be and neither does anyone else. But, in my experience, when the overwhelming majority of investors are thinking the same thing, they’re usually not thinking at all. Instead they’re simply repeating the conventional wisdom…
A Weak Dollar, High Commodity Prices and Massive Spending
What is that? That a sharp increase in the CPI lies just ahead thanks to a weak dollar, sharply higher commodity prices and budget-busting spending by Uncle Sam. These symptoms are obvious, of course.
- The dollar has spent much of the last decade wilting like last week’s roses.
- Agricultural commodities, energy prices and precious metals have all rocketed higher.
- And Congress – the recent budget compromise notwithstanding – continues to spend our tax receipts like sailors with four hours of shore leave.
So why isn’t hyperinflation dead ahead? Let’s start with Milton Friedman. The Nobel Prize-winning economist famously observed that inflation is always and everywhere a monetary phenomenon. In the inflationary spiral of the 1970′s and 80′s, for instance, the money supply, wages and U.S. gross domestic product all rose at double-digit annual rates.
But today economic growth is tepid. Wages are stagnant. (And will remain so with unemployment high.) And the money-supply gauge known as M2, which includes cash, bank deposits, and money market funds, rose just 3.4 percent in February.
How about higher commodity prices? Chances are good that these are nearing an end. As I’ve often explained, high prices always sew the seeds of their own destruction. Take oil, for example. The higher it goes, the more competition (and therefore supply) it attracts. Properties that aren’t economically feasible (think oil sands) suddenly become so. And consumers and businesses cut back, by conserving or buying more fuel-efficient vehicles.
A Long-Time Commodity Bull Reverses Position
Just this week, Goldman Sachs – a long-time commodity bull – reversed its position on raw materials. The firm expects the hot money going into commodities to cool down. I agree. We’re likely to see lower prices for energy, grains and especially metals in the months ahead.
How about the humongous federal budget deficit? Certainly there’s no way that that isn’t going to be inflationary, the pessimists insist. Hmm. If only we had a modern-day example of a major, developed country that ran a persistently high deficit so we could see what happens.
And, fortunately, we do. Japan’s government has been wasting (excuse me, spending) ridiculous amounts of money for more than two decades now. Its federal debt as a percentage of GDP has now hit 200%. That’s more than double our rate and much more than even bankrupt Greece and Ireland’s.
Has Japan suffered from hyperinflation? No. It has the opposite problem. For more than twenty years, it’s been battling a persistent and debilitating deflation.
That doesn’t mean we’re going to have disinflation here, of course. But it certainly ought make you stop and consider whether we’re in for a head-spinning rise in prices.
Yes, I know. Food prices, gasoline, health insurance costs and college tuition are already rising much faster than the official inflation rate. But consider too that appliances, cell phones, computers, consumer electronics, cars, furniture and (ahem) home prices are coming decidedly down.
The bottom line is this. Inflation may or may not become a problem. You should certainly own oil stocks, precious metals and inflation-adjusted Treasuries, but only as part of a reasonable asset allocation.
In short, don’t overdo it. Because the hyperinflation that everyone keeps crowing about may be late to the party. And it may not show up at all.
Good investing,
Alexander Green
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20 Responses to “Why the Pessimists Are Wrong About Inflation”
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Dear Alexander,
I agree we will not see hyperinflation but inflation is more prevalent than most people will accept. Your article nailed it…..”Food prices, gasoline, health insurance costs and college tuition are already rising much faster than the official inflation rate”……these are essentials. Cell phones, appliances and electronics etc. are non essential to most.
Taking the essentials out of the CPI is playing a game of smoke and mirrors. Inflation is alive and well for the average North American and rising. I believe it will continue to do so until we run full tilt into the global sovereign debt crisis which lies, inevitably, in the future, and which includes the USA.
Sincerely
Ivor
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Regarding gold & silver: Especially silver: Your comments would be more true if the prices where freely traded the last 25+ years. But they have been highly manipulated downward so that silver is in very short supply and paper promises hugely over-blown. Study Ted Butlers writings over the last 12 months for all the facts you’ll ever need. Silver is just getting to the range of what normal prices should be and now the the illegal huge short position, unallocated silver storage programs, ETF fraud & COMEX futures deliveries are on the edge of default! The smart folk are getting delivery now from the tiny silver pile!
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HYPERINFLATION IS IN THE FUNCTION OF THE MONETARY AND FINANCIAL AGGREGATES CURVES AT THE SAME TIME DEFLATION IS IN THE FUNCTION OF THE PHYSICAL ECONOMIC INPUT/OUTPUT.
THE TRUTH IS THIS SYSTEM WORKS ONLY FOR THE ELITES AND THE INSIDERS IN WALL STREET. MAIN STREET IS GOING TO DIE.
http://www.youtube.com/watch?v=QLJGrz6qrOQ
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THIS IS A BETTER TOPIC THAT YOU SHOULD WRITE IN YOUR EMAILS BECAUSE IT IS THE TRUTH.
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That’s a really good article!! It’s good to hear the voice of reason – something we know we can count on from Alex.
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With less than 0.07% of all investment funds going into gold and silver, even less into actual physical gold & silver, most investors are underweight and under-invested in gold and silver. I actually find it unbelievable that gold hits a new nominal high almost daily and it’s treated with a yawn. No doubt they need a rest and a correction would actually be healthy. More people NEED to diversify out of dollar weighted assets and investments. With that said, I don’t believe the statement in the beginning of the article to actually be true among the people I speak to about their portfolio’s (“…all this investment capital flooding into gold and silver, inflation-adjusted Treasuries and commodities may well prove to be spectacularly ill-timed…”). Most investors are not interested in gold, silver, agriculture stocks or other commodities. Most still talk about what tech stocks they ought to be buying! I find that to be more risky and potentially “ill-timed” as the overall market is overdue for a correction!!
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I do not know where the comments made about inflation come from, we have it now. Maybe he should go to the store and shop for food, cat food, meats and restaurants as well as clothing stores…
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I don’t agree with your analysis. You got off on the wrong foot at the start when you said that inflation was only 1.2% in the 4th quarter. WRONG! (that is what the government lies reported…do you believe them?)
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I have a great deal of respect for Mr. Green, however, this time he is way off the mark.
The Federal Government’s spending binge is nowhere near an end, and with monitorization of our debt, the falling value of the dollar, artificially low interest rates, rising cost of health-care, food and fuel cost with an extreme socialistic agenda, we have a potent cocktail that will first produce rampant inflation followed by a severe recession.
The Fed has boxed itself into a corner. Both the Federal Government and many State Governments are on the brink of insolvency and we no longer have access to the quick fix tools because of extremely high debt levels. All this is exacerbated by an administration that has no interest in reversing course. It boils down to the fact that if you continue to spend more that you take in, eventually you go broke.
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“But consider too that appliances, cell phones, computers, consumer electronics, cars, furniture and (ahem) home prices are coming decidedly down.”
Alex
I don’t know where you shop but other than home prices all the other items named are not cheaper. You may get more for your money but the amount charged is higher each year.
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The key is the value of the dollar. Since Qe2 it’s down over 8%. Now this phenomenon can be circumvented if we are somewhat isolated. But we’re not anymore. So any inflation we send overseas will boomerang back upon us. So, yes, I’m looking for serious inflation and if we get a slowdown in the economy which is also highly likely we’ll be back to the 1970′s redux.
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What our author fails to take into consideration is that the dollar’s strength and value are tied directly to its role as the world’s reserve currency. To focus on the price of goods, real estate, college tuition, etc now is to miss the point entirely. As long as our dollar retains this status we have nothing to worry about. Yes, we will see inflation and deflation at times, but as long as the rest of the world needs our dollars we will always be able to recover.
However, with many nations of the world, the IMF, and the UN all calling for a change to the reserve currency it is only a matter of time when the dollar loses its status. When this happens it will become virtually worthless overnight as we continue printing money to sustain our spending. THEN you will see hyperinflation as the world will be flush with dollars and no way to get rid of them.
I guess you could say, I have a different perspective. Keep your portfolio in dollar denominated assets if you wish. It will help keep the cost of the things I invest in down.
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Isn’t there a difference between Japanese debt and US debt. Our debt is owned primarily by foreign entities whereas as I understand it, Japanese debt is primarily owned by the Japanese citizens. We thus rely on others to fund our excess spending. The Japanese do not. How long will others fund our spending 50% more than we take in without a rise in interest rates? Our government already must buy a substantial part of our debt for lack of other buyers.
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The US is often compared to Japan with regard to our national debt, but the comparison is flawed because the citizens of Japan hold most of their debt where as China and Japan hold most of our debt. Certainly, China and Japan will back our debt and overtly express confidence so as not to lose their investment. But, the future issue will be when the Yuan is allowed to float. A weak dollar is great for US exports and US companies with manufacturing overseas, but how will we pay for all the imports we buy everyday? This will be real inflation. Another difference is our economy is mostly consumer spending, how does that work? The GDP measure is flawed.
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Your inflation argument could of course be right on, but then why did Bill Gross sell his treasuries?
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Alex: I hope you are right.I believe we have betrayed the world as holder of the reserve currencyand that will bring the revival of commodities as a standard. We need to produce things of value to exportor I fear we are on slippery ground. Thanks for your work. Its been good for us.
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Inflation is growing steeply at Japan is evident. On the other hand national growth factor (GDP) is the most important to check whether to worry about ongoing – increasing inflation or not. If growth is normal or higher side despite increase in inflation, then inflation factor is subdued. Whereas if growth is less (recession), then growing inflation factor is severe worrying factor, I opine. In light of this, we can judge whether Japan’s hyperinflation is really worrying/dismal factor or not.
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Methinks Mr. Green STILL doesn’t get it. Inflation isn’t “around the corner”, or however he puts it, it’s already here. And anyone who’s buying gasoline, groceries, and paper goods (uh, that would be ALL of us?!?) knows it’s here, and only getting worse.
With massive U.S. debt, and the unwillingness of the powers that be to curb spending, things are going to get a whole lot worse in the very near future. And I’m no Chicken Little, just a pragmatist that can see what’s going on.
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Hi Alex:
I tend to agree with your perspective but would be interested in any comments you may have with a friend that strongly disagrees!
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Thanks for the story. I wholeheartedly disagree.
But that’s how the game works.
We’ve never, ever had policies by Federal reserve banks across the world that have been so conducive for inflation. We’ve never had budget deficits across the world (even relative to GDP) like we’ve seen.
And the bigger issue is that instead of trimming spending, their spending more!!!! (not just here, Europe is much worse and has bigger problems).
The reality is that it just needs to go up relative to what it is now, in order to make good money.
So if now it’s 2.8% or so (which we all know it’s higher), it just needs to go to 5% or so to make money (5% doesn’t imply runaway inflation and is something we can manage).
Keep the articles coming though, i always appreciate other opinions.
Ezri
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Since this article was written and the above comments made, silver has crashed and the brief rise in inflation has moderated somewhat with commodities like oil and gasoline having fallen more than 10%.
And just to correct people who mistakenly believe foreigners own most of our debt, the fact is that the U.S. government, U.S. pensions funds, commercial banks and American citizens own about 65-70% of the U.S. debt. The U.S. household sector is actually the third largest holder of U.S. debt and not Japan as the doom and gloom crowd would have you believe. There is a lot of “misinformation” (propaganda) being spewed out by them. While the economic and financial picture is not that great, the fact is that things are not as bad as the doom and gloom crowd claim. The odds of the dollar becoming worthless and the U.S. entering into a hyperinflation period similar to Zimbabwe or the Weimar Republic is virtually nil. The U.S. is not anything like those two examples, at least not at this time nor for the foreseeable future.
And concerning the bond king Bill Gross, since he sold his U.S. Treasuries, interest rates have fallen and not risen as he believed. If the economy remains weak and inflationary pressures continue to moderate, interest rates should remain low and may be even go lower. I believe the he made a costly mistake, at least in his timing. If the Fed begins QE3 or some equivalent that would be looked at as inflationary and interest rates would rise just like they did for QE1 and QE2. Why he got out of bonds because QE2 was ended and believing that there would not be a QE3 is puzzling. There should be ample buyers of U.S. debt without any QE taking place. We will soon find out.
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