Revisiting the Inflation-Deflation Argument

Just as there are two sides to a coin is a misstatement (What about the edge? Isn't that a side?), the inflation vs. deflation argument is simply too large and too complex, complete with changing circumstances and misguided definitions, for most people to comprehend, much less care about.

For purposes of argument, let's just assume that for most people, the manifestation of inflation will be higher prices, and of deflation, lower prices. That cuts through the stringent definition of "increase/decrease in money supply, debt, etc."

Food prices have been going up. Energy prices have been relatively stable. Housing prices have been going down if you're buying, but stable if you're renting. As is readily shown, deflation and inflation have been coexisting quite amicably. The real question is when will the Federal Reserve demand more inflation in order to keep the government's cost of borrowing and printing more money at a minimum?

Currently, the Fed is in a very accommodative phase, meaning that interest rates are as low as they can make them, ZERO, which, in most times, would cause inflation. It actually is, which is the Fed's dirty little secret, but hardly enough to satisfy the politicians, who need to see inflation ramp up enough so that companies and individuals will spend, spend, spend, because they see the no value in holding a currency declining in value.

That day, week, month, year is coming, as soon as home prices stabilize and demand ramps up. Unfortunately for the Fed and our treasured politicians, that day is still far away, as home prices will continue to fall as long as banks keep foreclosing and adding to the already-bloated inventory. That's why the biggest banks are slowing down their foreclosure processes, because they don't want to ignite an all-out depression in home values. There needs to be some balance and at least a perception that home prices aren't falling off a cliff. That scenario would cause even more homeowners to default on purpose (strategic default), figuring that their home will never again be worth what they paid for it.

Since the cost of paying off a mortgage is much larger - for most folks - than what they typically spend on food and fuel and other basic necessities, lower home prices fuel deflation, but there are few who have that advantage because just as home prices fell, banks tightened lending standards, so the overall effect isn't felt across the economy because so few people are actually benefitting from lower mortgage costs.

Meanwhile, just about everything else - besides consumer electronics - is either experiencing price stability or inflation (food, mostly), making the overall effect one of moderate inflation, which is, in Fed terms, fine for now, but not for the future. The Fed needs to see more inflation, which is absurd from a consumer perspective, but perfectly in line with the "unstated" goals of the Federal Reserve. Increased inflation will make today's federal deficits easier to pay going forward. Of course, we'll never touch the debt, another matter altogether, nor will the USA ever be able to meet its obligations for Social Security and Medicare once the baby boomers begin retiring (and getting age-related ailments) in droves.

The end-game will be within 8-12 years, when the US must either significantly restructure those entitlements or default or print amounts of money so extreme as to debase the currency entirely. The Fed and its political friends are taking the slow, "kick the can down the road" approach, leaving it for others to fix. Anyone who believes Barack Obama or any current member of congress wishes to tamper with reforming Social Security should understand that they won't touch this "third rail" of government, only because it means re-election. Maybe, if Obama is elected to a second term, he might tinker with it sometime around 2015 - after the mid-terms and before the end of his second term, though that is wishful thinking.

Generally speaking, the deflationary pressures experienced during much of 2009 have ceased to exist and inflation has begun to creep back into everyday life. The only way to keep the deflationary lid on in one's personal life is either to spend less, save more, use less, or a combination of all of the aforementioned. Of course, doing so lowers one's standard of living somewhat, though not to extremes, which is, after all, the net end result of deflation, much preferable to having one's savings and income constantly eaten away by inflation, the scourge of all savers and the major threat in coming years.

By creating massive amounts of money, the Fed managed to stave off deflation, though not necessarily the nastier aspects of a depression. Absolutely unacceptable levels of unemployment still exist and have not been contained. The underclass of American society has grown larger in recent years as unemployment benefits are morphing into welfare checks. For those at the bottom, life is surely a nasty affair. The middle class is still being squeezed while the upper class continues to enjoy the benefits of very discretionary upper-income tax breaks.

While most of us struggle for solutions and seek answers to the deflation-inflation riddle, the upper class need not worry themselves with these minor details, as they have much more than they need in terms of money and security. The situation won't correct itself, and there seems to be nobody even remotely interested of doing what's right for the "better good."

With that, we see that stocks gained modestly on Wednesday. There was little to move them, as the rhetoric of sovereign default in the Eurozone diminished rapidly into the ether overnight.

Dow 10,387.01, +46.32 (0.45%)
NASDAQ 2,228.87, +19.98 (0.90%)
S&P 500 1,098.87, +7.03 (0.64%)
NYSE Composite 6,999.94, +40.00 (0.57%)

Advancing issues held sway over decliners on the day, 3859-1849. New highs remained well ahead of new lows, 345-54. Volume was not quite as pathetic as recently, though the general volume was and is still depressed by some 30-40% over what it was prior to the implosion of 2008, a fact of life that cannot be avoided.

NASDAQ Volume 1,892,425,500
NYSE Volume 3,431,570,500

Crude oil price gained 58 cents, to $74.67, close to the mean level of the past 18 months. Gold backed down a bit, slipping $1.70, to $1,255.60. Silver pushed past $20.00 during the day, but closed just below it, up 9 cents, to $19.98.

Generally, the market was awaiting some kind of catalyst, though none appeared. Stock indices continue to trade in a fairly well-defined range, initiating thoughts of prolonged stagflation in some.

That very well may be where all of this is heading. Higher prices in a stagnant economy, something of a bland state of despair. It's not very pretty, but about the best image one can conjure considering conditions.