As we head into the homestretch of summer, deflation seems firmly entrenched as the prominent financial theme of the moment, even while, in my view, two other possible outcomes have a higher likelihood: inflation and stagflation.
In effect, that has created an additional theme: how best to protect yourself and your money. I think everyone should be aware of, if not actively pondering, the impact of these phenomena, as well as planning how to manage the risks that the likelier "flations" pose to one's financial well-being.
What's up? Only the things you need
Concern over deflation, Wall Street's current favorite "phantom menace," has reached near hysterical levels lately, so it was interesting to note that the Producer Price Index for July had gained more than 4% year over year.In addition, regarding the Consumer Price Index, Jim Stack made the point in his most recent newsletter that the first half of 2010 had seen a 2.1% annualized increase -- this from a highly publicized statistic that everybody and his brother knows understates inflation. That's not to say that certain items haven't declined in price, but such a reading from the CPI is obviously not your grandfather's deflation.
The Times story, headlined "AARP says brand-name drug prices up 8% in 2009," starts by noting: "A new report on retail prices of brand-name drugs shows that the 217 products most used by older Americans increased by an average of 8.3 percent during 2009, the largest increase in years."
Meanwhile, in The Journal, "What's the beef? Food-inflation fears" was the headline that caught my eye. The article begins: "Cattle prices are soaring toward records, pushing up the cost of beef in grocery stores and adding to the risk of a broader wave of food inflation." In addition to meat, there are plenty of foodstuffs, including coffee, cocoa, barley and wheat, as well as nonedible products, such as cotton, that have been soaring in price.
The fact is that the cost of living is rising on many fronts, including almost anything touched by a government entity, where taxes and use fees continue to ratchet up. Of course, none of the items that are increasing can be linked directly to monetary policy, so folks continue to look at (declining) asset prices, which are more closely aligned with monetary policy, and see the environment as one of deflation. Yet if they looked at their checkbooks, they would have a completely different opinion.
The irony is that these same people didn't consider rising asset prices during our dual bubbles to be signs of inflation.
As I said two weeks ago, I believe it is more likely that we are in for a period of stagflation, which is an entirely different world from deflation. With stagflation, interest rates eventually rise, and bonds do poorly. Companies benefit when they have pricing power and barriers to entry that keep potential competitors away, as do companies that are growing rapidly.
In such an environment, people eventually come to understand that their paper money is depreciating in value over time, so stores of value (which protect against the impact of government money printing), such as gold, benefit as well.
Continued: Is gold really the Fed's guilty treasure?
