So where will be in 1-2 years regarding inflation, deflation, or stagflation? As I said yesterday, the variables that contribute to each of the above issues are the cost of goods, wages, government fiscal and economic policies, the value of the U.S. dollar, and international trade and trade policies. Starting with the cost of goods, here are my thoughts …
Cost of Gods
Currently, inflation is not an issue. In fact, many “media mouths” are claiming deflation is the issue. Frankly, I do not see any place where deflation (other than real wages) is occurring. Even in the depressed housing market, prices are inching up in many regions. Now, if you believe as I do that the economic recovery will more firmly root within 6-12 months, what follows is a rise in inflation, as the cost of goods will rise. Why will the cost of goods rise? Because the price of energy and other commodities will rise relative to the global growth of GDP, thus the cost of food will rise, along with just about everything else that is made or shipped.
Wages
If we go back thirty years, we see a lack of progress on this front. Real wages have declined or remained stagnant. With the continuing loss of manufacturing jobs and the reliance on a service economy, it would appear that real wages will not improve within 1-2 years. Thus, one could reasonably see inflation rising if wages don’t rise with an improving economy, as the consumer will have less money to spend on anything but basics, such as energy and food – too few dollars chasing too many goods.
Government Fiscal and Economic Policies
My guess is within 1-2 years, we will see a reduction in the deficit, but not the debt. Thus, we can expect the government to keep borrowing money. The question is: will the current low rate for U.S. borrowing continue? That depends of the amount of interest in U.S. Treasuries. Currently, it seems we have a bubble forming in that market, and if it should collapse, we could see the cost of borrowing rise. If this happens, then the U.S. dollar remains challenged into the near- and long-term future. Adding to this inflationary environment are the Federal Reserve policies regarding the discount rate and the printing of money. We are currently in a low interest rate environment because the Fed is keeping the discount rate at just about zero and the Fed has bought up trillions in U.S. Treasuries (quantitative easing). Additionally, taxes are sure to rise in the near future at the Federal, State, and local levels – too few dollars chasing too many goods.
The Value of The U.S. Dollar
Generally, the greater the U.S. debt, the weaker the U.S. dollar, and if the dollar becomes too weak, the result could be credit tightening and rising interest rates. Given that the U.S. economy will firmly recover in the next 1-2 years, it is likely the Fed will raise the discount rate (to temper inflation). Keep in mind, if interest rates rise and the dollar remains weak, the result could be an inflationary environment – too few dollars chasing too many goods.
International Trade and U.S. Trade Policy
As long as we are importing more than we are exporting, and as long as our trade policies encourage this, we should expect wages to remain low and the cost of goods to rise with the rise in energy, commodities, and food costs. A negative imbalance in trade means a lower U.S GDP – too few dollars chasing too many goods.
Since my crystal ball is not available, my guess (and I do mean guess) depends on the general and simplistic analysis above. Thus, in the next 1-2 years, if the economy begins churning again, energy, commodity, and food costs rise, real wages don’t improve, interest rates and the debt rise, the dollar remains challenged, and we keep importing more than we export, I suspect we will see inflation after a period of stagnation (6-12 months). Deflation is off the table.
Does this help?
Trade in the day; invest in your life …
