Ben Treece: Inflation or deflation: YesWritten by Ben Treece | | firstname.lastname@example.org
Anyone who has an interest in finance should subscribe to John Mauldin’s biweekly newsletter. His information is timely, relevant and always contains citations, usually from leading economists and money managers. In one of his last newsletters, Mauldin noted that when asked whether the economy will experience inflation or deflation, his “ready answer is, ‘Yes.’”
Many investors believe inflation is simply printing money. Inflation is actually a resulting price increase for goods or services because a currency lost value. Deflation is just the opposite:
Prices drop because of a currency suddenly strengthening. Inflation and deflation occur when the relationship between economic growth, as measured by the annual change in gross domestic product (GDP), and money supply go out of whack.
Contrary to what many people believe, printing money is perfectly OK — if the nation has the economic growth to substantiate it. If the economy expands by 5 percent and money supply does not grow at all, currency becomes much more valuable since there is a relatively smaller amount than there was before that economic growth. This is our main problem with the standad: While it can be good to have a commodity backing a currency, it limits the amount by which the government increases the money supply. In the situation we currently find ourselves in — with a massive national debt — the standard seems like a great idea. On the flip side, when the economy expands and we do not increase the money supply, goods will have to be sold for less than what it cost to produce them. This could spell disaster for an economy in recovery. It is also important to note that between the late 1800s and the early 1900s while the U.S. was on the standard, we experienced a depression approximately once every seven years.
Relating specifically to the United States, Mauldin asserted that we will see both inflation and deflation over time. As I have mentioned before, two factors must be present for inflation to exist: volume and velocity. Following the quantitative easing policies of the Federal Reserve in the past decade, there is plenty of volume, but there is no velocity. Velocity occurs when money turns over in the economy. For example, if you were to have $1,000 on deposit with Bank of America, and the bank was hypothetically only required to have 10 percent of that deposit on hand, it could loan out $900. The money has turned over by one depositor becoming the creditor to a borrower while the bank profits. When banks begin to loan funds to consumers and small businesses, we will absolutely see inflation.
We will likely not begin to see new loans until borrowers are certain that interest rates have bottomed, and that will not happen until interest rates begin to rise. Nobody wants to catch a falling knife, but when borrowers can see a tangible bottom for rates, they will want to snag a loan as cheaply as possible.
I believe inflation will not occur before a bout of deflation. We are already seeing positive economic news but what will truly spark real economic growth in this country will be a sharp decline in gas prices once we begin to tap into our four big domestic oil and natural gas reserves.
Most Americans do not have the option to pay or not pay for oil-based energy. Between home heating and fueling automobiles, this money must be spent and takes away from their ability to purchase consumer goods. Going after our domestic oil will create jobs in the refining and transportation industry, but will also stimulate the manufacturing industry. If manufacturers’ costs are lower, they can justify hiring more employees considering the new increase in demand as well.
I have no doubt energy prices hold back domestic economic growth, so as soon as we can bring those prices down the economy will expand. The Fed will have a difficult task trying to keep the inflation rate relatively similar to GDP growth to avoid high deflation or inflation.
As Mauldin put it best, will there be inflation or deflation? Yes. Make sure that you are positioned accordingly or else your portfolio may suffer the consequences.
Ben Treece is a 2009 graduate from the University of Miami (Fla.), BBA International Finance and Marketing. He is a partner with Treece Investment Advisory Corp (www.TreeceInvestments.com) and a stockbroker licensed with FINRA, working for Treece Financial Services Corp. The above information is the express opinion of Ben Treece and should not be construed as investment advice or used without outside verification.