Oh Goody! A Post On Inflation!

Inflation.  It's a big topic of conversation recently.  The president from China will be meeting with US officials this week to chat up, amongst other things, money.

Speaking of the international currency system, which is dominated by the U.S. dollar, Hu called it a "product of the past" but said it would be a "fairly long process" to make China's own currency an international one.

He also said "the liquidity of the U.S. dollar should be kept at a reasonable and stable level."

Hmm.  That almost sounds like a threat regarding the dollar as the reserve currency of the world, and a demand about the dollar's stability.

Who does he think he is talking to us like that?  Our banker?!
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It has always caused me to scratch my head when the federal government, in their infinite wisdom, chooses to exclude "volatile" food and energy costs from the core inflation rate.  I mean, it's a great idea if you're looking to provide numbers which mean nothing to anyone other than statisticians, but it's pretty damned stupid for those of us living in the real world.

What do you think is going to happen in the next few months and years?  Is real inflation - the effect on the cost of products you buy and use - going to increase or decrease?

One player in the equation is the Federal Reserve bank.  They're in the process of producing $600 billion in "funny money" - that would be US dollars that are literally being created out of thin air.  This is an inflationary act.

Another influence is the huge unemployment rate.  It's officially at around 9.4%, but that is considered a joke, even by those that report the numbers in the oh-so-compliant press.  We're at least at 17%, more likely 25%.

With roughly 70% of the US economy being driven by consumer spending, when those consumers have fewer dollars, spending goes down.  When spending goes down, it eventually causes prices to go down, which is deflationary.

And then there's the whole rest of the world.  Yeah, what they do affects us.  We're no longer the only Big Dog in the world markets.  Those pesky Chinese and Indians, well, they're out there buying up stuff left-and-right.  The gall!

Which do you think will have a greater impact?  The fed printing up Monopoly money (inflationary), the unemployment rate crushing commerce (deflationary) or the rest of the world buying up commodities like they're going out of style (inflationary)?

How about, "All Of The Above"?

The rest of the world obtains dollars to purchase those commodities primarily through trade with the U.S. Over several decades, the U.S. has run lopsided trade deficits that have flooded the rest of the world with dollars.

So what?

China, India and other fast-growing countries use their reserves and the dollars they earn through trade with the U.S. to bid up the price of wheat, corn and oil to fuel their rapidly growing economies. Thus, for example, the price of premium crude oil spiked to two-year highs of more than $90 a barrel recently despite lackluster demand in the U.S., the biggest consuming country.

Huh? You mean that all of that 'happy talk' we've heard over the years that our trade deficit with the world was a good thing for America was all a lie? Shocking, I say!

Pray tell, what might be the impact?

The result is what Mr. Drury calls a "commodities trap." The Fed remains lax on monetary policy because U.S. unemployment remains high and core consumer inflation remains low, while China and other countries translate this lax policy into high commodities inflation. But ironically, the higher prices force American consumers to spend more on food and energy and less on nonessential services, further driving down the core inflation rate and depressing U.S. growth. That leads the Fed to further loosen the money spigot and sets off the chain reaction all over again.

It almost seems like this is saying that a centrally planned and manipulated economy is a bad thing. Say it ain't so! Clinton, Bush and Obama couldn't have ALL been wrong, could they?
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Those "nonessential services" are really going to take a (further) beating.  Restaurants, movie theaters, ice cream parlors, nail salons, dry cleaners.

In my area, I think every single specialty food place has closed except for the burger joints.  Chicken wings, bagels, yogurt and other specialty stores are toast.  Diners and buffet restaurants seem to be doing OK.  In fact, one of the local buffets looks to be absolutely thriving.  But the mid-priced restaurants are dropping like flies.

People in construction are just getting decimated.  It seems like every other person coming into our precious metals store to sell coins or jewelry has some tie to the construction industry.  It's bad.

Tiffany's will thrive (the rich aren't affected by this) as will Walmart (stores for the rest of us that provide value).

Accept The Challenge

This is not a one-size-fits-all problem.

If you think deflation is the likely outcome of our current economic situation, you should be hoarding dollars.  Today's dollars will buy more stuff tomorrow.  Get out of tangible assets.  You want to position yourself to being able to buy those assets in the future when their price is lower.

If you think inflation is the likely outcome of our current economic situation, you should be shedding dollars, and putting them into tangible assets right now.  Your current cash will be less valuable tomorrow.  Get what you need NOW.

My view:  I think we're going to have a little bit of each, depending upon the asset class you're looking to purchase.

Deflation-affected assets -

I, for one, believe that all real estate prices will continue to decline.  Commercial and residential.  As little as 5% to as much as 25% this year (and I'm leaning towards the high end).

I'm looking for some real estate, but I'll wait, probably for 2 more years.  I'm not going to buy an asset that I believe will be worth less than I paid for it.

Why do I believe this?  There are currently 5 million homeowners that are at least 60 days behind in their payments, and they're not even into the foreclosure process.  The current belief is that this will result in more than the 1 million foreclosures that occurred in 2010.

That means that there is a lot more real property coming into an already over-saturated market, and it will necessarily push down prices.  Supply and demand.

With our high real unemployment numbers, I think there will be more business closures.  This will mean more commercial real estate foreclosures as well.  The businesses can't pay their rent, the commercial property owners then can't pay their mortgage, and the banks eventually foreclose.

I think I'd say the same thing about automobiles and trucks.  I haven't done any research on this, as I'm not in the market for a new vehicle, but my gut says people aren't buying, and prices will decline, or at least stay flat.

I'd expect more Barry Bucks to be thrown at both of these industries in the future.  Bailouts work, right?

Inflation-affected assets -

For most folks, the two biggest items are food and fuel, but it really affects all commodities.

Anyone with a prepper mentality has been putting food and essential equipment away for years.  Many have turned to precious metals as a way to protect their dollars.

Be sure you understand the assets you're buying.  Food can spoil.  Medicine can expire.  Gold/silver prices can drop.

Pick your "event horizon" and look a bit past it.  Maybe you're comfortable with a 6 month view into the future.  Are the consumable commodities you need going to rise or decline in price?  Act accordingly.

The further out you feel comfortable viewing, the more current assets would be applied to your plans.  I strongly recommend that you proceed slowly at first, gather more information, then move forward.  This goes double for assets you can't consume like precious metals and equipment.

Along these lines are those services which will likely cost more in the future (if they're even still available at the same quality).  Get your teeth fixed.  Get your eyes checked.  Get that mole removed.  Have that operation.

Quit procrastinating, and get moving!

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Copyright 2011 Bison Risk Management Associates. All rights reserved. Please note that in addition to owning Bison Risk Management, Chief Instructor is also a partner in a precious metals business. You are encouraged to repost this information so long as it is credited to Bison Risk Management Associates. www.BisonRMA.com