Sometimes it is just amazing how wrong the market (and thus most professional investors) can be. It seems that an obvious outcome is not so obvious if its onset is delayed long enough.
One year ago, as I explained in my June 23 and June 30 columns, it appeared to me that the die had been cast for the economic disaster we've since experienced. Rereading those columns last week, it's hard to believe the Dow Jones industrials ($INDU) were still flirting with 12,000 back then.
I bring this up because, as regular readers know, the winner in the inflation-versus-deflation battle seems clear to me (though the timing of that "victory" certainly isn't). However, the battle continues to inspire much debate on Wall Street and in the financial news media. And I continue to get tons of questions in the Q&A section of my daily Web site.
I feel compelled to revisit the subject yet again, with a little help from my friend Jim Grant -- who, in the latest issue of Grant's Interest Rate Observer, makes important points that I find mandatory to pass along.
Not your father's, mother's . . .Grant starts off by quoting the Bureau of Labor Statistics regarding the fact that May's 1.3% drop in the Consumer Price Index was the largest decline since April 1950:
"It's a funny deflation, though. Deflation, to us, is too much debt chasing too little income. One symptom of deflation is falling prices. In a proper deflation, prices fall broadly, not narrowly. Seventeen months into the Great Depression, the CPI had fallen by a cumulative 8.1%. This time around, December 2000 to date, it's risen by 1.8%."
. . . or second cousin's (once removed) deflationGrant then notes that although the steel industry is operating at a capacity utilization rate of below 50%, was raising prices for the second time since May. "If deflation it be, it's deflation light," he says.
As Grant's colleague Ian McCulley points out, "If we are truly in a sustained deflation, price decreases will eventually spread." And Jim notes: "It hasn't happened yet. Core CPI, which includes food and energy, is 1.8% higher than it was last year. Though its rate of rise has slowed (a year ago, it was rising at an annual pace of 2.3%), it continues to hold above the level to which it sunk during the great deflation scare of 2002-2003."
McCulley proceeds to observe that the Cleveland Fed has its own alternative measure of CPI and that by virtue of its calculation methodology, "it is thus a less volatile price index than headline CPI, and is currently rising by 2.4% year-over-year."
That wasn't deflation beleaguering BudapestThat's not all. Many folks believe that with the economy operating so far below its potential output and with high levels of unemployment, inflation can't possibly happen.
Grant says that would be "a perfect theory, if not for the existence of so many countervailing facts. Bolivia recorded a monthly inflation rate as high as 120% in 1984-86 with unemployment rates in the mid- to upper teens. Bulgaria recorded a monthly inflation rate as high as 242.7% in 1997 with unemployment rates ranging between 12.5% and 13.7%. The greatest hyperinflation of them all was not the 1920-23 German affair but the Hungarian calamity of 1945-46, which occurred in a war-ravaged economy operating well below pre-1939 levels of resource utilization."
Grant sums up his thoughts on the inflation front as follows: "What strikes us is what small effect a mighty debt collapse has had. It makes you fear -- almost -- for prosperity."
Let's hope all of those salient points will assist folks in deciding whether they think we will see deflation or inflation in the future.