Understanding Inflation and "Deflation"

8 August 2010

If you at all follow Austrian economics and the role of money supply in inflation and deflation, you will know that we are not now, nor have we ever recently been, "at risk of deflation."

However, if this topic continues to confuse you, just read what Peter Boockvaar has to say. Then you will understand:

"With Treasury bond yields at or near historically low levels on one hand but with commodity prices near 8 month highs, and with the personal feeling that outside of a home, a computer and a flat screen tv, the cost of living seems to only go higher on the other hand, here is another perspective on the inflation/deflation debate. Since June 1981 when (Paul) Volker started to lower interest rates from 20% as high inflation rates started to fall, the absolute level of CPI rose 142% to the high in July '08 (90.5 to 217). Deflation is defined as a decrease in the general price level of goods and services but to quantify the current fall in prices, the CPI has fallen just 1% from its all time high. This tiny price move, notwithstanding we are still near an all time high in the daily cost of living, has led to talk that the Fed needs to do more to avoid deflation at all costs and thus create inflation via more QE (that is, "quantitative easing," or purchasing US treasury bonds with money printed out of thin air by the Federal Reserve, a practice which expands the "money supply" without adding to the wealth of the nation). An example, oil goes from $50 to $85 in one year and the next year falls 1% to $84.15 and we're told there is deflation and deflation is bad.

"The view is that with excess capacity and a lack of demand combining for softer prices, we must have even lower interest rates to spur more borrowing and thus more economic activity to increase demand and thus reduce the large output gap. Think about this, policy makers think we should raise the cost of goods and services in order to cure a lack of demand. The law of supply and demand says lower demand must be met by lower prices in order to get to the proper equilibrium. What the Fed really wants to do is create inflation in order not to deal with an over-leveraged economy in the most responsible way, either paying debt off or writing it down. They want us to pay off the debts with inflation. Inflation is a hidden tax on every single one of us and thus the corollary of deflation is a tax cut. Inflation is good for those who are highly indebted as those debts get paid back with inflated money while deflation or flat prices are good for those who save and have little debt and vice versa.

"In the state of deleveraging the US is in where the low cost of money doesn't matter much to an individual or a business in making spending and investment decisions, artificially low rates mostly spur just refinancing and higher commodity prices. While maybe or maybe not higher commodity prices make their way into government consumer price statistics, the commodity inflation is still there and has to be eaten by someone. Food for thought.

"CPI price level since June 1981."

Peter Boockvaar is the Equity Strategist at Miller Tabak + Co., LLC., in addition to his role as a salestrader on the equity desk. He is often seen on Bloomberg TV, CNBC, and Fox Business and is frequently quoted on Reuters, Dow Jones Newswires, Wall Street Journal, and The Associated Press. He joined Miller Tabak + Co., LLC in 1994 after working in the corporate bond research department at Donaldson, Lufkin and Jenrette. He is on the Board of Directors of Ameritrans Capital Corporation, a publicly traded Business Development Company. He is also president of OCLI, LLC and OCLI2, LLC, farmland real estate investment funds. Mr. Boockvar graduated Magna Cum Laude with a B.B.A. in Finance from George Washington University.

NOTE: If you want to "invest in inflation," you can, thanks to Nassim Nicholas Taleb and his colleagues. Universa Investments L.P. is forming a hedge fund positioned to profit through expected hyperinflation. Well, I don't think that's coming tomorrow. But it's a far greater risk than deflation, that's for sure!
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