The fallacy of deflation
Nothing much to write about this.
- "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?
- "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.
- 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.
- 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.
- 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 trust...as 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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