Inflation fears are wrong


The Economist ran an excellent article today “The spontaneous combustion theory of inflation”.  I have been saying the same thing, that inflation is unlikely to be caused by Quantitative easing and the increase in the money supply attributed to QE is irrelevant to inflation and is actually deflationary as it hurts insurance companies and moderate income retirees who depend on bonds. As those parties experience less bond income they will switch to a less inflationary mode, so that is an example of a deflationary force.

The economic recovery has clearly left the moderately skilled workers behind, where they now have lower real income than before the 2007 top and their real income is lower even going back 15 years.

If 1970’s style inflation returns it would have to be a labor union anti-globalization situation which I doubt will occur. Instead as the U.S. economy grows employers can train moderate skill workers to increase the supply. These occupations can be served by people with modest skills and experience so they will act to suppress inflation. Inflation often has an 18 to 24 month time lag and moderately skilled workers can be recruited and trained in less than a year. Or employers can simply continue to use offshore workers.

The 3.5% of the working population that is part of the hidden discouraged unemployed may decide that they should shift gears and become assertive about changing careers and getting employed. Their reentry into the labor force is something that has a good probability of occurring; by contrast it is very dubious how the proceeds from QE can leak out of the banks and into the hands of moderate income consumers who would then create inflation.

The Wall Street Journal ran an article today that shows it is very hard to bring jobs back to the U.S. Globalization let the jobs genie out of the bottle and there is now way the genie can be put back into the bottle. This means continued low pay and low bargaining power for U.S. workers and thus low inflation.

The U.S. is now in a position very similar to the 19th century free enterprise era before the Federal Reserve was created. During that era there were frequent 15 year soft depressions with very low inflation. Since QE and many Fed tools don’t work then investors can’t assume the economy will be bailed out by the Fed. Much of the Fed’s ability to rescue the economy form a crash may have either been due to mild recessions or due to the huge victory of WWII which resulted in windfall business opportunities for Americans for 30 years.

In a way we are worse off than the 19th century because in those days the U.S. had protectionism that kept out foreign competitors thus boosting wages and the total debt load of society was much lower than today’s unprecedented 345% of GDP. The era of globalization including businesses fleeing to foreign tax havens has lowered wages just at the time that society has become more indebted than ever. In addition personal income has become less reliable and more structured towards a flexible type of income which makes it harder to service or grow debt.

These factors don’t mean a depression is coming, rather it is a warning that stock investing is more dangerous than it appears, so please buy stocks only when fundamentals show that prices are low. Currently the best estimates indicate stocks are 66% overpriced, which implies a crash will occur.

Investors need independent financial advice about the risks of inflation hysteria and the risks of overpaying for assets like stocks in an attempt to beat inflation. I wrote an article “Lower unemployment to result in inflation?” The fear is that unemployment will improve, triggering inflation, but this fear is not applicable.




About the author

Don Martin, CFP®

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