With Treasury bond yields at or near historically low levels on one hand but with commodity prices near 8 month highs, and with the personal feeling that outside of a home, a computer and a flat screen tv, the cost of living seems to only go higher on the other hand, here is another perspective on the inflation/deflation debate. Since June 1981 when Volker started to lower interest rates from 20% as high inflation rates started to fall, the absolute level of CPI rose 142% to the high in July ’08 (90.5 to 217). Deflation is defined as a decrease in the general price level of goods and services but to quantify the current fall in prices, the CPI has fallen just 1% from its all time high. This tiny price move, notwithstanding we are still near an all time high in the daily cost of living, has led to talk that the Fed needs to do more to avoid deflation at all costs and thus create inflation via more QE. An example, oil goes from $50 to $85 in one year and the next year falls 1% to $84.15 and we’re told there is deflation and deflation is bad.
The view is that with excess capacity and a lack of demand combining for softer prices, we must have even lower interest rates to spur more borrowing and thus more economic activity to increase demand and thus reduce the large output gap. Think about this, policy makers think we should raise the cost of goods and services in order to cure a lack of demand. The law of supply and demand says lower demand must be met by lower prices in order to get to the proper equilibrium. What the Fed really wants to do is create inflation in order to not deal with an overleveraged economy in the most responsible way, either paying debt off or writing it down. They want us to pay off the debts with inflation. Inflation is a hidden tax on every single one of us and thus the corollary is deflation is a tax cut. Inflation is good for those who are highly indebted as those debts get paid back with inflated money while deflation or flat prices are good for those who save and have little debt and vice versa.
In the state of deleveraging the US is in where the low cost of money doesn’t matter much to an individual or a business in making spending and investment decisions, artificially low rates mostly spurs just refinancing and higher commodity prices. While maybe or maybe not higher commodity prices makes there way into government consumer price statistics, the commodity inflation is still there and has to be eaten by someone. Food for thought.