Global Deflation - Is This Possible?

"Armaments, universal debt and planned obsolescence - those are the three pillars of western prosperity." - Aldous Huxley

I tend to agree with Aldous.  In times of war government spending creates jobs and prosperity for those that are not in the trenches.  For some that are in the trenches it is better than being at home unable to find a job and wondering why life has dealt you such a poor hand.  A man needs to work for his soul more than anything.  He needs a place to go, where he can feel wanted, needed and a part of something, whether it is fighting on the front line or working on Wall Street.  A sense of purpose goes a long way to cultivating a positive attitude about the future.  Those of you who follow this blog will know that I believe that a lot can be accomplished with positive consumer confidence.

Planned obsolesce is what technology thrives on.  Think back just five years and try to remember what your cell phone could do.  I am unsure if mine could even download emails let alone surf the web, play music, take pictures, give me directions, pay a bill, deposit a check, reserve an airline ticket and then be that ticket at check in, just to name a few.  Technology creates obsolescence and this drives the consumer to upgrade and consume.

So with wars all over the globe and technology creating new products left and right plus a rapidly growing governmental debt burden we should be primed for inflation right?  Not so fast.  There are a number of people that think that deflation could be on its way and if they are correct then we are really looking at a long protracted problem.

In order to create inflation you need to have excessive demand over supply.  Pumping money into an economy and lowering interest rates normally does the trick but the problem is that this works when other economies around the globe are growing and have a demand for your goods and services.  The issue right now is that pumping money into the global pool is not working for two reasons; first there is no demand for the money no matter how cheap you make it, and second the bubbles that burst in the housing and the derivative markets were so large that the influx of cash is soaked up in a nano-second before reaching their intended targets.

With every government around the globe trying to resuscitate their economies at the same time the world is awash with cash.  Furthermore the large companies of the globe are sitting on more than a trillion dollars.  Pumping more money into the system is therefore having no effect.  Those that can borrow do not need the money and those that desperately need the money are unable to get a loan.  Consumers are trying to cut debt as fast as possible and are certainly not interested in adding more debt, so the Federal Reserve is pushing on a string.

Furthermore the recession is driving the prices of virtually everything down.  Technology is one factor that is driving deflation but there are others.  Amongst them is the continual depreciation in the price of housing and other assets.  In addition, the lack of demand is forcing businesses to cut the price of thousands of items.  Look no further than Walmart or all of the discount airfares and hotel prices that abound.  The four stand-outs that are not getting cheaper are gas, food, health care and education.  Of these I would expect that gas prices will start to drop as demand for oil drops.  Food prices should continue to spiral higher as the world demand for food continues to outstrip supply and medical expenses will spiral higher as long as the government meddles.  Education is similar to medical in that the government subsidies are creating a false market for these products and hence drive the prices higher, but these are the only three places where I can see sustained price growth.

Should we therefore be concerned that inflation is around the corner.  For that to happen you require demand to exceed supply, therefore you need the consumer to buy more goods than are available.  Think of what happens at Walmart and other stores on Black Thursday when prices are dropped to ridiculously low prices for one day just to drive traffic.  It is madness and shows in real life what it is like to have demand exceed supply.  In the real world however we have massive unused capacity at the factories around the world and there are million of unemployed workers looking for employment.  Until these two data points start to dip it is hard to see how inflation can resurrect itself.  You need consumers to buy goods but they are out of work and those that are working have seen their pay getting cut or are trying to whittle down their debt burden.  Companies are not necessarily laying people off, but they are not hiring.  In this environment I would expect to see increased productivity numbers as less workers produce more goods.  So until there is a binge of hiring (which I do not see in the immediate future) we will be stuck in this quagmire.

In this environment consumers tend to save as buying assets is a losing proposition.  Just look at Japan who has one of the highest savings rates in the world and who has been stuck in a deflationary environment for two decades.  I would expect to see the US savings rate climb to a double digit number in the coming years and this will create a drag on economic growth for years to come.  Furthermore, interest rates should remain low for years because until there is demand for the money being lent there is no reason for rates to increase.  The incentive to borrow is that rates are low so take on debt, but when no-one wants to borrow rates can stay low for decades.  Once again look at Japan which shows how this situation will be exacerbated by an increase in the savings rate.

Sluggish growth will not help the stock market and therefore I am firmly in the bear camp.  That said there will always be rallies within a bear market so for you traders who can sniff out the next rally I wish you luck.  For the rest of you I would continue to recommend that you sit in cash and start to get used to returns of three percent or less on your money.