Assessing the Greater Long-Term U.S. Price Risk: Inflation or Deflation

July 6, 2010

The quirky discontinuities in U.S. tax law have made 2010 a critically important year for household financial planning.  A critical assumption in this process involves price stability.  Some experts believe the jump in Federal deficit spending and ballooning Fed balance sheet will cause a return to high inflation.  I’m in the camp that anticipates continuing very low inflation and even a possibility of deflation.  Here are my top ten reasons for not fearing future inflation.

  1. Elevated consumer price inflation was the exception rather than the rule during the past 60 years.  The CPI rose 6.5% per annum between end-1965 and May 1985.  Otherwise, inflation averaged 1.3% per annum during the 14 years to end-1965, 2.9% per annum over the past 25 years, 2.4% per annum over the last ten years and 2.3% per annum over the last five years.  Price stability is an easier state to maintain than accelerating inflation.  It takes a perfect storm of things going wrong to produce the latter of these possibilities.
  2. On-year core U.S. CPI inflation in May ranged narrowly between 2.2% and 2.5% in seven of the last eleven years.  All of the other statement years had even less core inflation:  1.8% in the year to May 2009, 1.7% in the year to May 2004, 1.6% in the year to May 2003, and 0.9% in the year to May 2010.  The biggest outlier is the most recent observation, and it’s pointing toward deflation.
  3. Among other advanced economies, excessive disinflation in prices for goods and services has also been the recent tendency. 
  4. Japan’s experience in the 1990s and the Great Depression are the two closest precedents to the financial crisis since 2007.  Each of these examples saw deflation result, not inflation.  Japan’s Nikkei remains 76% below its 1989 peak.  U.S. stocks didn’t return to their pre-depression level until the 1950s.
  5. U.S. asset prices are deflating rather than inflating.  When a 17-year bull market crested 10-1/2 years ago, the Dow Jones Industrial Average was 19.5% higher than now.  The DOW is also 31% lower than its October 2007 high.
  6. U.S. deficit scares in the last thirty years were associated with falling, not rising, inflation.  The 1980s saw CPI inflation drop from 14.8% in March 1980 to 1.1% in December 1986 and core inflation fall to 3.8% from 13.6% in mid-1980 despite a big jump in the Federal deficit-to-GDP ratio during the first Reagan term.  The deficit’s size was still a huge concern in the early 1990s, enough so for H. Ross Perot to capture 19% of the 1992 presidential popular vote while running mainly as a one-issue third-party candidate.  But U.S. CPI inflation from mid-1992 until mid-1997 averaged only 2.7% per annum.
  7. Inflation will continue to be countered by private-sector de-leveraging.  Total debt, not public-sector debt, matters.
  8. Money growth has been very tame in the United States.  M1 rose 7.1% over the year to May, including 2.1% annualized over the latter half of the period.  M1 contracted 1.9% annualized during the past three months.  M2 expanded at annualized rates of 1.7% since May 2009 and 0.9% since both November 2009 and February 2010.
  9. Politicians for the foreseeable future in Washington will err on the side of disinflation or deflation no matter what the consequences for real economic growth.  In doing so, they will be merely following the will of the people.
  10. The U.S. labor force is extremely under-utilized. There is a gap of more than 27 million workers between the level of non-farm payroll jobs and its 1980-1999 trend-line.  The actual labor market is considerably weaker than the measured figures.  Nobody over the age of 50 is likely to see that deficit closed.  I would not make the same bet regarding the possibility of a balanced Federal budget.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.

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