Who's afraid of big, bad deflation? It seems like almost everyone, but none more influential at the moment than Federal Reserve Chairman Ben Bernanke.
Given the policy implications of Bernanke's fears (i.e., more money printing), it is worth understanding what his reasoning might be, flawed though it ultimately is.
Inflated worries
In assessing Bernanke, it is important to realize that he has spent a great deal of his academic life studying the Great Depression and is considered by many to be an expert on that period. As such, part of the reason he may be so afraid of deflation is because he assumes -- as many people do -- that deflation equals an economic depression.The idea fueling this view is that in a deflationary/depression environment, people stop buying, companies stop spending, and, though a dollar buys more, everyone has less to spend because of the overall state of the economy.
Deflation and depression can occur together, but they don't have to -- although Bernanke seems to think they do.
Just think for a minute how much debt the U.S. government owes to countries such as China and you will understand how Bernanke might feel about such a scenario.
As I mentioned the last time I talked about deflation, it is this fear of falling prices on the part of the Fed that practically guarantees the opposite: inflation. (This is why I advocate owning gold, a "hard" asset that historically has offered protection against inflation.)
Yet, Bernanke is presumably a rationale man. Have any of his fears been realized? It is true that certain assets have declined in price to varying degrees -- stocks and real estate, to name two prominent ones. But as for an overall decline in the prices of goods and services, what we are experiencing is certainly not, as I like to say, your grandfather's deflation.
Up the down staircase
The evidence has been all around us lately, starting with the Oct. 14 Producer Price Index, which reported a rise in prices of 0.4% during September, compared with economists' expectations of just 0.1%. After the August reading of 0.4%, folks obviously had thought this gain would be more subdued, but that was not the case. (Those who don't think food and energy matter can console themselves with the fact that excluding those items, the PPI rose only 0.1%.)The latest Consumer Price Index, which was released Friday, made headlines because inflation came in below expectations -- but it showed a 0.1% rise in prices nonetheless.
On Oct. 8, a slew of commodity prices -- for wheat, soybeans, corn, coffee, sugar, cocoa, hogs and cattle -- rallied at least 2%, with the first four in that list gaining 4% or better. But not to worry: As long as you don't eat, you probably won't notice food inflation.
Two days earlier, on Oct. 6, Yum Brands (YUM, news, msgs), the owners of KFC, Pizza Hut, Taco Bell and Long John Silver's reported earnings and noted that labor and commodity inflation will hurt its fourth-quarter margins.
In my Oct. 8 column, I noted how retailers are trying to pass along higher costs to consumers either in the form of price hikes or through the technique of reducing unit sizes while selling them at the same price. The latter is something traditional measures of inflation aren't very good at capturing.
Almost as foreshadowing, last month's prices-paid component of the ISM U.S. Factory Index jumped to 70.5 from the previous month's reading of 61.5, despite expectations of 59. I would love to hear the deflationist explanation for that one.
Also last month, on Sept. 29, a little company named FedEx (FDX, news, msgs) announced a 3.9% price increase effective in January. One would think that ought to make the believers in deflation scratch their heads. After all, if we were in the grip of deflation, with all the connotations that conjures up for people, how in the world could something as mundane as transporting goods be rising in price?
Given recent data points like those, along with the persistent high unemployment rates we have seen, it seems obvious that we are in a period of stagflation -- slow growth and inflation.
That, of course, has dramatically different investment ramifications than does deflation. (For more on how to deal with those ramifications, read "Inflation, stagflation and you.") I'm confident the psychology will eventually change toward expectations of inflation, but for the moment we will just have to wait and see when that might happen.
At the time of publication, Bill Fleckenstein owned gold but did not own or control shares of any company mentioned in this column.
