Right now a little inflation is good news
Inflation? Ever heard of it?
It’s back. Or at least investors can smell the faint whiff of it amidst the seasonal tang of freshly cut Christmas trees.
And that’s actually a good thing.
On December 15 the Bureau of Labor Statistics announced that the Producer Price Index (PPI), which measures price increases at the wholesale level, had climbed 1.8% in November driven by rising prices for food and energy. The core PPI, which excludes those two categories on grounds that prices in those sectors are too volatile, rose 0.5%.
The next day the bureau reported that prices at the consumer level (the Consumer Price Index or CPI) had increased by 0.4% in November led by higher prices for energy and healthcare. That increase followed a 0.3% climb in the index in October. The core CPI, which excludes food and energy prices, was unchanged in November
I know that inflation hawks, on the outlook for any signs that the massive increase in government deficit spending as a result of the twin fiscal and economic crises has led to an increase in inflation, reacted negatively to this news. To them the increase in the headline PPI and CPI is a sign of that runaway inflation is just around the corner.
I’m worried about the long-term inflationary trend too. Anyone who looks at the deficits piled up in the United States (and in much of the rest of the developed world) has to worry about the possibility of runaway inflation at some point in the future.
But not yet. As Federal Reserve chairman Ben Bernanke told the U.S. Senate Banking Committee recently, the U.S. economy is operating with so much unused capacity—so many factories are running at 50% of full speed and so many workers are unemployed—that a rapid increase in inflation is unlikely any time soon.
(Of course, the definition of “anytime soon” isn’t very precise. But the term isn’t any more or less vague than the Fed’s promise to keep interest rates low for an “extended period.”)
In the short-term of “anytime soon” a bit of inflation is actually a good thing. It’s a sign that the U.S. economy is growing—prices should rise if the economy is recovering from the Great Recession—and that the United States will escape the prolonged period of deflation that has keep the Japanese economy trapped near zero growth for much of the last decade.
None of this means we—investors, Fed officials, our representatives in government—shouldn’t be worried about runaway inflation in the long run. Just that right now a little inflation is a positive signal of economic recovery.
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It is generally accepted that an inflation rate of consistent 1 to 2% is a sign of healthy economy. Whether 1.8% inflation reading will be consistent remains to be seen.
“The core PPI, which excludes those two categories on grounds that prices in those sectors are too volatile, rose 0.5%.”
I thought food and energy prices are too volatile, not the core PPI.
I agree with Jim right now we don’t have to worry about run away inflation, but I certainly would have liked to see a bit of the deflation/no inflation all these numbers keep talking about. Because except for electronic stuff, everything I pay money for kept going up while they were throwing those negative numbers around.
So even when they talk about deflation I have to worry about making sure my investment keep up with inflation, so that is why I’m here!
Please disregard my previous comment:
I thought food and energy prices are too volatile, not the core PPI.
I apologize.
I agree, anything to avoid deflation is good news.
For now, the worst case scenario is experiencing the lost decade Japan went through. I don’t think the FEDs will say anything different today than last time, especially when options are about to expire. I guess the dollar carry trade still has some legs under it… for now
You know everyone always talks about Japan’s lost decade, but from what I can see they are still not out of their lost “decade” so I make it at about 20 years for them. After all they are still competing to be the currency for the carry trade. And we certainly don’t want that kind of trouble!
Here’s a simple question: Why is deflation a bad thing?
Consider: With deflation, the cost of goods and wages goes down. With inflation, the cost of goods and wages goes up. Either way, the VALUE of goods and wages remains the same. However, under a deflationary situation, your savings actually INCREASE in value, even assuming a zero return on investment. Under an inflationary situation, your investment returns are reduced by the inflation rate (i.e. if inflation is 1% over a period of time, and your investment return is only 1% over the same period, you’ve made nothing).
Deflation is a boogeyman the Fed uses to scare people from the Fed’s inherently inflationary tactics.
One major flaw in your theory, is people’s mortgage payment.They don’t go down, as your wages will in a deflationary cycle. I would rather have increasing wages, and my mortgage would be less and less of a problem.
weaner21 is so right. The eventual fix in the housing market will occur when prices start to rise. This will be just illusion, however, because the gains will just be inflationary due to the massive increase in the money supply and the federal deficits. The fed will need to be brilliant to avoid much higher interest rates, very low growth and/or a much lower dollar. I am not optomistic. I can see a replay of the seventies coming.
thats why economists track inflation adjusted prices….
As for deflation, it may sound good until you realize it seriously stunts economic growth (which is what raises living standards) as it makes our products and services more expensive relative to other countries. People who wants to buy things just says, “lf I wait, I can get this cheaper,” so companies sales drop sharply across the board and are forced to layoff people etc etc. Economy contracts even more.. Its a vicious cycle. Its a very very bad situation.
In inflation your money is worth less, but your house(real estate) is worth more. It takes more dollars to buy it.
In deflation your money is worth more, but your house is worth less. Because money is worth more, it takes fewer dollars to buy.
(I’ve oversimplified that comparison a bit)
I’m more in the deflationary camp. As Ed pointed out savings actually increase, and we need a little more saving in the country. We’re behind in that area.
The relative value of your house is the last thing you’ll be worrying about if there’s prolonged deflation.
I’m with Chris and Ed, deflation is not such a bad situation for the US economy. The real threat is runaway, self-reinforcing, ‘hyper’ deflation. But with so many US pesos sloshing around, I think that threat has been mitigated. We need deflation in housing prices in order to reflect true market values (supply and demand – what people can afford WITHOUT gov’t handouts), because housing prices under the reckless Greenspan and Bernanke Fed are not a reflection of market prices.
One other offshoot of deflation – people would be more encouraged to buy bonds (read: US Treasuries) because bonds GAIN value in periods of deflation. This demand for bonds could help offset some of oncoming avoidance of Treasuries by our foreign investors (China & Japan), which could help stem the interest rate increases in the future that most now fear.
You’re correct in the context of people who are flipping houses will worry about that(or view their home as an investment). I don’t plan on selling anytime in the next decade or so. My house isn’t an investment, it’s a place for me to live(and a place for me to play with my power tools
).
I can tell you deinflation would certainly make my retirement planning easier, I could just sit back with everything in cash and know that each year the same amount would buy me more food and other things.
Nice to read some positive thoughts on deflation, which I totally agree with it. Deflation gets a bad rap…I won’t write an essay on this, but just say that deflation promotes savings, rather than inflation promoting spending. In response to the tired and erroneous argument that inflation drives economic growth, pray tell how the US economy went from an agrarian society at the start of the 19th century to the greatest economic power in the history of the world by 1900? Besides the Civil War blip, that entire century was deflationary. Economies grow via productivity gains and investment, not creating money with the push of a button.
^^where did you get this data from? care to cite some sources?
also I am not sure if anyone argued that inflation drives economic growth, its only proven that slight inflation is best for sustained economic growth, Everyone knows too much inflation is bad, in fact the Feds #1 duty is to keep inflation in check.
Terry is on the money. If we don’t have some inflation we are looking at implosion of banks and more problems that we can even think of.
I don’t argue that housing prices need to come down to reflect true values, but a deflationary cycle in all assets would be ugly
Terry, I would call that the Fed’s #2 duty, since Bernanke seems more intent on fighting deflation at any cost.
Lets not forget that a 0.4% monthly increase in the CPI for November is a monthly, not annual rate of increase in the CPI. This translates into an annual rate of inflation of about 5% if continued for one year at that 0.4% rate. Similarly a 1.8% rise in the non-core PPI is an annual rate of about 24% inflation.
To Ed, and you should be happy that they are doing whatever they can to avoid it. The impact of deflation is a lot more far reaching on a country’s economy and your lifestyle than just the relative value of your savings account.
I understand where you guys are coming from in the current fiscal situation, which has debt at alarming levels. You can make a fair argument that inflation is the least bad option, and then you hope to God it works (I think that plan is doomed, but that’s not relelvant).
My point is, all other things being equal, why or how would increasing the money supply make your economy better than keeping the money supply flat and letting productivity gains decrease prices? Say you were starting a new country with a new fiat currency…how does an inflation policy make things better for the long run? All your doing is devaluing every other currency unit by adding new ones. That’s why the US Dollar has lost something like 97% of its value since 1913, when the Fed came into existence. An inflationary policy is good for one group and that’s bankers. If you know prices are going up, you spend money and take on debt to do it and the policy drives bank profits. If you know prices are gently falling you’ll be induced to save your money. I think most people have heard the inflation propaganda so much they don’t even think about it, they just take it as a given that deflation is bad.
I agree with what you said Purewater, if and only your requirement of ALL OTHER THINGS BEING EQUAL is true. But its a capitalistic economy, and when you change something, everything else changes too to adjust. All other things being equal is a dream scenario, not reality.
If you think 97% inflation since 1913 is bad, Id hate to imagine how many times worse iinflation would have been if the Feds did not exist.
Actually Terry, if the Fed did not exist, and the U.S. had a static money supply, there could only be inflation or deflation if the population increased (deflation) or decreased (inflation). Prices would only be effected by supply and demand.
Terry, Since the Fed causes inflation (along with fractional reserve banking), how would inflation be worse without the Fed (assuming the other alternative was a gold standard like we used to have)?
Ok, lets be realistic,
If the Fed did not exist:
Politicians, we are talking about congress, the president have huge incentive to want the economy to be stimulated as much as possible. Im not saying Greenspan is a saint or anything, but he had to make many unpopular moves against the presidents wishes to raise interest rates to keep inflation under control much to the dismay of Reagon, Clinton and the Bushes during the booming years.
If the Feds did not exist, you think the politicians would ever consider raising interest rates? You would leave it to congress? to the president’s office where they have every incentive to print more money?
I dont think talking about a static money supply or golds tandard is even relevant in this discussion when its just not the way things are set up. These assumptions are not realistic.
I mean in a unrealistic world, If deflation does not cause demand to dry up, and company revenues, earnings, to fall, and my 401k wouldnt crash, and unemployement dosnt increase and economy GDP does not decrease.
If the above is all true, and my money has more and more buying power?! SIGN ME UP! GIVE ME SOME DEFLATION
I’m just saying, in a realistic world, if you want to see what deflation does to our economy or your lifestyle, all you need to do is look at the last time in U.S. history we had a stretch of few years of deflation. Hint: Great Depression, or check out “the lost decade” or 2 in Japan.
Terry, I think you’re missing a key piece of the puzzle. Deflation didn’t cause the Great Depression or mediocre growth in Japan. It was/is a symptom of excessive growth (i.e. bubble) caused by inflationary monetary policies…the bubble eventually bursts. Depressions are the cure, they get rid of all the mal-investment caused by the irresponsible monetary policy of the central bank. They’re brutal but, before the 1930s, they were over quickly. Now, the Fed/Congress/President is simply trying to prop back up a bubble economy via money printing and taking on incredible levels of debt. They’re trying to solve a problem caused by too much debt, with more debt. It’s insane, it won’t work and it will end in tears. A Gold standard restricts the ability of the government to inflate and cause these huge economic problems and that’s why people like myself & Ed are for it.
For those of you who are proponents of deflation, you seem to assume that one of the benefits of deflation is lower prices.
However, considering that the US imports most of its goods, if the US currency is devalued, the cost of these imported goods will rise and therefore deflation will actually lead to higher prices for goods (until the point that US manufacturing starts making most of the goods that are sold in the US)
Respectfully, I understand what you are getting at.
I think you are missing the point that you are making all these unrealistic fundamental assumptions such as gold standard, etc when it just wont happen any time soon in the real world, if ever. I cant think of any modern developed economy thats on the gold standard.
In a fantasy world, where we do have a gold standard, sure maybe your idea could work? But its a fantasy world none the less. Under today’s real world situations and circumstances, aka. reality, deflation will sink us back into recession if not depression.
Deflation makes the buying power of your savings worth more tomorrow than it is today. That’s dangerous because it gives incentives for people to stop buying and only put what they have in savings since they’ll get more from it next year (including large purchases like mortgages). That’s a hard scenario to have economic growth in.
Seen another way, if goods cost less and less (deflation) then companies are forced to reduce costs or squeeze margins in order to stay in business. They might even have to lower production and layoff workers which ends up reducing demand even more.
The problem is that it becomes a downward spiral. When people start to expect deflation, it becomes a self fulfilling prophecy where demand dries up and people wait for better deals and unemployment goes up as companies can’t make profits under these situations and reduce headcount. Unemployment up, spending down, revenue down, reduce expenses, unemployment up… (repeat^∞)
^^exactly
, Jim has said the same thing.
With respect, you guys are living in some fantasy world with a set of fantasy fundamentals thats from another dimension if you believe deflation is good for us right now.
Ok, last one from me and then I’ll have to call it a day…
Deflation is actually a good thing, because in a deflation prices drop and money becomes more valuable, so deflation encourages people to save money. Deflation rewards the prudent saver and punishes the profligate borrower. The way a society, like an individual, becomes wealthy is by producing more than it consumes. In other words, by saving, not borrowing. And during a deflation, when money becomes more valuable, everybody wants money. They want to save. Whereas during an inflation, you want to get rid of the money. You want to consume. You want to spend. But you don’t become wealthy by spending and consuming; you become wealthy by producing and saving.
Inflation encourages people to borrow, because they expect to pay the debt off with cheaper dollars. It encourages people to mortgage their future.
The basic economic fallacy in your argument is that a high level of consumption is good. Well, consumption is neither good or bad. The problem is the emphasis on consumption financed by debt — which leads to the national bankruptcy we’re facing. It’s much healthier to have an emphasis on production, financed by savings.
Terry you seem to imply that in the future the economic problems we’re facing are going to be resolved by some kind of economic miracle. I totally disagree. All that’s happening is we’re kicking the can down the road. The further the can is kicked the worse the resolution is going to be. You’re right that deflation can be avoided by the Fed printing trillions upon trillions of dollars. However, that’s just going to result in an inflationary depression like Zimbabwe. In reality, it doesn’t really matter what I think because we all know what the Fed is going to do: print, print and print some more.
Gusspresso your deflationary spiral claim is simply an erroneous theory. I’m still waiting for an answer to how the US economy grew so incredibly fast from 1800 – 1900 despite a deflationary environment. Let me ask you this: if your refrigerator busted tonight but you knew that prices would be 5% lower a year from now would you wait to buy it? Of course not, you’d still buy the things you need but wouldn’t feel pressed by inflation to spend your money and take on debt to spend even more.
Enjoyed the discussion guys. Have a good night!
have a good night!
I’m not implying anything about any miracle or magical solution lol I have repeatedly said that high inflation is not a good thing either, however right now avoiding Great Depression II is more important than worrying about inflation for now.
If you are rooting for Great Depression II to occur then you probably does not have a realistic idea about just how bad it would hurt everyone.
Your argument of 1800-1900 is wrong
Please see the data below. CPI was flat from 1800-1900 not deflationary.
http://economics-charts.com/cpi/cpi-1800-2005.html
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Fascinating discussion. I must say I’m certainly no expert, but am intrigued by a deflationary economy. I do think that people are bombarded with the notion that deflation is bad and therefore don’t even question inflationary policy.
Thanks for the chart Terry, but I would like to disagree with your assertion CPI was flat. If you look at it closely it spikes 2 times around 1815 and the Civil War, but for two 40 year periods it tracks downward from 40 to 25.
Ultimately, neither inflation or deflation is bad if kept to 1-2% annually, but I guess I lean toward deflation since I’m a saver at heart.
I bed to differ, outside of the spikes from the war, most of the 100 years is spent in the 20s. its relatively flat compared to the 20th century.
ohh and this is just as irrelevant as the 1800-1900 argument. but since we are at it
real per capita GDP in 1800 was roughly $1200, and in 1900 is roughly $4100, ill be generous and say, that it went up 4 times in the 19 century. your so called deflationary century where the US’s growth is supposedly so strong :p
in the next 100 years where your so called inflationary century. In 2000, real per capital gdp was about 40,000, which went up 10 fold from 1900.
By your logic, inflation > deflation.
But the fact of the matter is, there are so many other factors involved. This whole 1800-1900 thing is a very bad argument to try to show that deflation > inflation.
source:
http://www.nationmaster.com/
My point was that you can have strong economic growth in a deflationary environment. You misread the chart you linked to (look at the table format). The price level started at 51 in 1800 and ended at 25 in 1899 = 50% decline in prices.
You don’t realize it but you’re making my point with your 20th century GDP statistics. Yes GDP went up strongly but it was on the back of debt. We now have something like $50 trillion in total debt (federal, state, local, consumer, corporation). That’s what drove the GDP growth so high.
So would you rather have 400% GDP growth with no virtually no debt (from 1820-1900) or 1000% GDP growth (1900-2009) with debt 4X the size of GDP, that’s unserviceable without resorting to hyperinflation or a default? The century you prefer results in a debt that is going to bankrupt the country. I’ll take slightly slower growth that is sustainable.
once again, I already said before. Look at the conditions that needs to be true for deflationary growth? In your fantasy world where we have no debt, and high growth, and on the gold standard. Sure, maybe deflation wont hurt.
I respect your point, and Im not a proponent of inflation lol. But look at all the assumptions you have to make in order for your model to be true lol, Your point applys to conditions that are completely unrealstic to what we face right now. We are not on the gold standard, our government has already ran up the debt for decades, globalization and trade at a complete different level. With weak growth like this, deflation can only lead to a spiral.
please look at the following 2 scenarios where deflation is present.
1) deflation, 1800s, agricultural economy starting to get industrialized. gold standard, moderate debt, high savings rate, high growth.
2) deflationary spiral, 1930s, asset bubble bursted, stock market crashed, lots of people used borrowed money to invest in stocks are in debt. not on gold standard, very weak stagnant growth.
which one sounds more like what we face now? Personally speaking, I agree with Jim. I am thankful our fed is keeping interest rates near zero to prevent great depression II. inflation is the lesser of 2 evils right now
Gentlemen, don’t misunderstand me. I’m not saying I WANT deflation. Deflation is only necessary as a counterbalance to inflation. Ideally, a monetary system should avoid both and maintain equilibrium.
Nor am I saying I want a gold standard, although it is preferable to the “printing press” standard we have now. Ask the colonial era Spanish how the gold standard worked for them. If your gold reserves increase substantially, or if your population increases or decreases substantially, you can face just as much inflation or deflation. The gold standard works best when the amount of gold reserves mirror your population’s growth/shrinkage. However, at least with a gold standard there is less opportunity for frivolous political standards to manipulate the currency value (I say less, not none).
IMO the idea that encouraging savings through deflationary policy will lead to spiraling economic collapse is logically flawed. Deflationary induced savings would act as an unemployment insurance buffer and would prop up the economy during a recession. The unemployed will spend their savings at the same time production is contracting. This would obviously be inflationary, and would induce consumption.
The market always corrects imbalances. We want the policy that creates the smallest imbalances and thus the smallest pain. Deflation right now would hurt a lot, but why not inflate our problems away right now with the stated intention of moving towards a deflationary or noflation policy? If it is known prior to enactment then speculative debt investing will dry up a bit, and maybe we’d finally force congress to put a permanent lid on debt. Deflation seems to be the only incentive for congress and individuals to not overextend and let the printing presses take the pain away. Inflationary policy surely has not worked and has created pretty large imbalances and debt insecurity.