The fallacy of deflation

Saturday, March 15, 2014 // Written by Enzio von Pfeil

Nothing much to write about this.


  1.  "Inflation is dead". Oh really? Then how come food prices are going through the roof? How come rentals are climbing eve- higher? How come my monthly budget is bulging - despite the same basket of goods?
  2.  "Deflation" is alive. Oh really? That may have a half-life of truth in it when it comes to the developed world. Per this week's Economist, annual consumer prices rose by 0.8% in Euroland, 1.4% in Japan, and  1.6% in the United States. But in the developing world, prices are rocketing. Citing the same source: 11.1% in Colombia 13.4% in Egypt, 14.0% in Poland, and 24.1% in South Africa.
  3.  The proof is in the pudding - and not in the measurement. By this, I mean that "actual" prices are soaring. But these lurches are not being caught by our current way of measuring inflation: the tool box needs re-visiting. For instance, services plays a pretty subordinate role in most "inflation baskets" used to measure prices; however, we all know that services of the doctor, lawyer, dentist etc. are going through the roof.  Thus, today's measurement tools are anachronistic.
  4.  Policy implication. The bulk of today's actual inflation is of "cost-push" nature: weather-induced food prices, politics -induced energy prices, and greed-induced gold, bond, stock and forex costs are such examples. Central banks focus their policy responses to demand-pull inflation, very much along the lines of my framework, The Economic Clock: an excess supply of money begets an excess demand for goods, so up go (demand-pulled) prices, so the Central Bank tightens, thereby creating an excess demand for money - which, in turn, results in an excess supply of goods, or demand-pull deflation. But Central Banks cannot do a thing about sun spots (aka weather), geo-politics (aka Muddle East) or greed (aka graft or price rigging in global financial markets). The policy  implication is simple: once the global Economic Time really improves again, then watch the waves of cost-push inflation team-up with those of demand-pull inflation, all giving rise to massive Central Bank tightening.
  5.   Investment implication. If actual  inflation is in fact much higher than  that mirage, reported inflation, then you'd better not trust those "real" returns on your "safe"  investments.  As a ball park figure, just double the "reported" inflation in order to arrive at actual  inflation.  Thus, America's actual inflation is about 3.2%. Subtract that from its 10-year government bond yield of 2.7%. and you end-up with a real loss of 0.5% per year.  So how can you argue the "safety" of government bonds when they are losing you money each year when measured in today's purchasing power?  Apropos point four above: don't f just buy and hold 30-year US Treasuries: not only are they losing you money in real terms already today; furthermore, they will get stomped-upon the most once these two inflation typhoons clash... Remember that the Americans pragmatically stamp on their money "In God we trust", implying "But cash is better." And I would add: In Gold we an insurance policy, NOT as an investment. Next to avoiding those "safe" government bonds assuring you of steady losses as well as   putting 2% of your portfolio in to physical gold, gain more exposure to stock markets. Based on the "return to the mean", they have provided real returns of 4 - 7% per years, beating even the wildest of my "actual" inflation guesstimates - particularly  in the developed world.
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