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Why Do We Not Have Major Inflation Right Now?

6 October 2009 2 Comments

I had an interesting discussion with someone today regarding inflation.  The question came up why do we not have inflation right now?  Many people talk about it like it is a sure thing yet we don’t have it and these people have been saying the same thing for a while now.

Two Opposing Forces

The main reason why inflation has not gotten out of control in today’s economy is because there are two opposing forces.  On one end you have the inflationary forces due to the monetary policy of governments around the world, especially the United States, in an attempt to prop up a failing economy.  On the other end you have the deflationary forces of de-leveraging and a recession.  These two forces are pulling the economy in separate directions.

The De-Leveraging Of Our Economy

A recession is ugly.  It punishes the misallocation of capital and it punishes excessive risk, unless of course the government gets in the way.  This natural correcting power of capitalism is a healthy thing.  It brings the economy back into balance.  It brings our debt levels down to a more sustainable level.  I repeat… unless the government gets in the way.

The process of bringing debt levels down is a natural deflationary process.  People save more and spend less.  Of course, this is the avoid-at-all-costs deflationary cycle that governments attempt to avoid.  They don’t believe that you and I will naturally, eventually spend or invest that money we save.

The Crappy Economy

Further causes of a deflationary process during the recession is the fact that the economy simply sucks.  Businesses are going out of business (Linens n Things, Circuit City, etc.) which means going out of business sales.  Prices are coming down.  Companies that are still operating are cutting prices across the board to move inventory.

These are all normal parts of a contracting economy that a recession brings about.  It brings the economy back into a balance.  Too many stores, too much inventory, too much debt… it all goes away during a recession.  It’s painful, but its natural.  So, what happens when businesses are done cutting and a more normal balance is restored?

Inflation Time

When the deflationary forces subside, the only force remaining will be the inflationary forces.  Yes, the Federal Reserve claims that they will pull the excess liquidity out of the market in time to avoid terrible inflation, but I believe the desire to prevent a double dip recession will prevent them from doing this.  Inflation is inevitable in my opinion.

As many say, it’s no longer a matter of if, it’s a matter of when.  While, we may not have hyperinflation, high inflation is enough to inflict serious damage, especially on the lower class struggling to get by (via high gas, groceries and every other cost of living item you can think of).  It’s impossible to predict the degree of inflation that we will experience, but I really believe we will experience it to some degree.

How To Prepare For Inflation

With regards to investments, precious metals such as gold will do very well in an inflationary environment.  Other commodities such as oil should also outperform.  Stocks actually hold up decently because companies merely pass on costs to a consumer.  If you have a ton of cash sitting somewhere, maybe it is a good plan to allocate that somewhere.  Remember, inflation punishes savers and rewards debtors (the unofficial official policy of the United States?).

When it comes to your every day items and life, maybe it is wise to stock up on basic necessities that you can store such as batteries, non-perishable goods, etc.

Do you have other suggestions on how to prepare for high inflation down the road?

Update: Gold has skyrocketed today over $1040 and looks to be maybe going higher.  This is most likely sparked by the rumors of more entities looking to dump the dollar as a reserve currency.  Gold prices are paying off those patient gold bugs.  I think it’s still worth buying!