Mike Blake/Reuters
What should an investor do? Prepare for both inflation and deflation and start now.
Earlier this year inflation was all the rage. Oil is up! Grains are up! Metals are up! Now, however, it's deflation that has investors and the Federal Reserve panicked. Oil is down! Grains are down! Metals are down! Which one should we be worried about—rising prices or falling prices—or at least preparing for? The answer may be surprising.
It's worth pointing out that both inflation and deflation can seem much more appealing than the dire headlines suggest. Yes, back in the early 1980s, during our last major bout with inflation, prices were soaring. We had nearly 15 percent inflation, which was driving up the cost of everything in sight, from wages to products and services. But there was a bright side (or two). Higher wages, at least temporarily, made people feel better; and interest rates touched the high teens, even 20 percent, which, in retrospect, seems like a delirium dream. If only we could lock in those sort of returns today, we think. Ah, inflation!
Panic is vastly underrated as a response, so feel free to start there.
The trouble is, we forget that higher interest rates must be put in context. While rates were high, they came at a time when people thought cash was trash, with inflation eating away 10 to 15 percent of the value of a dollar in any given year. Sticking your money in a bank account for a few years, even one earning high interest rates, seemed much more dangerous to people then than it might appear today from our yield-starved perspective.
The funny thing is, deflation has some of the same semi-romantic appeal. In that sort of economic period, prices are falling all around us: Wait a month, or a year, and whatever you want will cost less. Cash is king, etc. All you need to do is hoard money and tomorrow you'll be wealthy. Who needs high interest rates, or equities—just hide what you have from anything risky and tomorrow, or maybe the tomorrow after that, you'll be able to do something with it. What's to complain about?
Plenty. A collective compulsion to hoard money in the face of falling prices creates a dormant economy. The implicit buyers' strike causes all industries to see their revenues go pffffft, except for those delivering the few things that people must buy, like health care, food, and fuel. Deflation is a business and economy killer. Companies struggle to get by as consumers hide away and grow carrots. In the end, we re-enact the Depression.
Neither scenario leaves us much to choose from, and in some sense, it's not our choice anyway. We had inflation earlier this year, and have deflation now. Prices will fall in the current quarter, and will likely fall for at least a few quarters more, for the first time since the Depression.
Knowing the perils of deflation, officials are working to arrest this slide, and the massive Treasury/Federal Reserve cash transfusion into the US economy—more than $7 trillion, at last count—is, in large part, an attempt to do that. The government is trying to convince people that cash isn't king, that money will soon start flowing again, causing prices to stop sliding and thus requiring you to stop hoarding. (Now, we don't want people to stop saving entirely again. We want US savings rates to tick higher from their previously near-zero levels, perhaps to 6 percent or so. We just don't want no spending.)
John P. Avlon is the author of Independent Nation: How Centrists Can Change American Politics. He writes a weekly column for The Daily Beast and is a senior fellow at the Manhattan Institute. Previously, he served as Chief Speechwriter for New York City Mayor Rudy Giuliani and was a columnist and associate editor for The New York Sun.
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Paul Kedrosky is the editor of the business blog Infectious Greed. He's a senior fellow at the Kauffman Foundation, where he is focused on entrepreneurship, innovation, and the future of risk capital. He is also a strategist with Ten Asset Management, a Southern California institutional-money-management firm.
Paul Kedrosky is the editor of the business blog Infectious Greed. He's a senior fellow at the Kauffman Foundation, where he is focused on entrepreneurship, innovation, and the future of risk capital. He is also a strategist with Ten Asset Management, a Southern California institutional-money-management firm.
Paul Kedrosky is the editor of the business blog Infectious Greed. He's a senior fellow at the Kauffman Foundation, where he is focused on entrepreneurship, innovation, and the future of risk capital. He is also a strategist with Ten Asset Management, a Southern California institutional-money-management firm.
Paul Kedrosky is the editor of the business blog Infectious Greed. He's a senior fellow at the Kauffman Foundation, where he is focused on entrepreneurship, innovation, and the future of risk capital. He is also a strategist with Ten Asset Management, a Southern California institutional-money-management firm.
TIPS are a reasonably way to combat inflation in your portfolio. Commodities are stupid and risky. Equities are a far better hedge against inflation for long term investors.
Inflation does not lead to higher wages. During the first of the year when we had inflation, the real wages earned continued to fall. And although some are waiting until prices fall further, most are holding on to their money because they are not sure if they will have a job next year. Their purchases are for less expensive items if they buy at all. You must be talking about the wealthy. You certainly don't know what the rest of us are dealing with.
quick fix to housing market --
Emergency measures are needed to prevent more damage to the economy caused by the Fed raising interest rates 17 times in a row before drastic reductions this past year. The Government should offer mortgages direct to homeowners as follows: extended to 30,40,50 and 60 year terms. Rates should be as low as 1% (like those offered to the banks whose pipes are now clogged with taxpayer billions). For those homeowners that were able to make it thus far, this might be the safety net needed to prevent economic death and undo reversal of equity and drainage of homeowner capital caused by The Fed. The net effect is the Government will make the homeowner whole again and mitigate the damage caused by The Fed. It may even stir the real estate market out its Fed Induced coma.
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