So if we are not heading for economic disaster in the coming years, then what will it look like? Lets also take this to its logical conclusion and ask, "How then can I make money in the next couple years?" Now we are talking!
First of all I can best sum up the inflation/deflation debate by saying that deflation is by far the more worrying concern for our economy as a whole. If prices start going down and consumers decide to hold on to their cash for longer and longer periods of time, we will see unemployment shoot up over 20% as economic activity in this country grinds to a halt. A deflationary spiral is like a black hole in that once you cross the event horizon, the gravitational pull is too strong and you get sucked in. With a Federal Reserve and Treasury that are keenly aware of the ramifications of crossing the deflationary event horizon, there will be massive action to try and artificially inflate the dollar before we fall into that trap. I think it is safe to rule out deflation as an economic prospect for the next couple years.
That all being said, there are deflationary pressures. Again, I mentioned in my last post that wages are the biggest contributing factor to inflation. Well, I dont hear too many stories of people getting huge raises these days. This is a big deflationary pressure on prices as people are making less money and getting more and more cost conscious. The price increases (or lack of decreases at least) that we have seen and will continue to see, are greatly just a factor of government intervention in the form of extended unemployment benefits and stimulus spending.
So as unexciting as it is to hear, I believe we will continue in this malaise of modest-if-existing-at-all rises in the price level. The government does have the ability, the firepower, and the motivation to keep this economy from entering a deflationary spiral, and as long as the market has confidence in that claim, we will be able to eke out some modest levels of economic activity.
However the inflation will not shoot up anytime in the near future, at least not until we get some very meaningful reduction in the unemployment rate. This could take another two to three years, as we are currently only generating enough jobs to almost account for the increase in the labor force (college and high school grads, returning mothers, etc...) This does not help us pick away at the over 8 million unemployed people in the country. This could be greatly helped by the current administration if they were able to get some meaningful job creating legislation passed to grease the skids, (tax breaks for small and mid-size companies that hire new people...etc)
So with a very boring slow growth economy for the next few years, or a "New Normal" as Mohammed El-Erian of PIMCO calls it, how do we make any money? Well we could hold cash at the bank and earn 0.02% on it. We could try and lock it up for longer term in search of a better yield and maybe get a one-year CD for .85%. We could buy a 10 year treasury Note for 2.59%. The good news is with this is that with Inflation being nothing right now we can chalk these figures up as pretty close to Real return (nominal minus rate of inflation), but there has to be some better investments out there.
Well in this sort of scenario we can actually take advantage of the fear mongers and beat them at their own game. By shorting stocks and bonds and publicly espousing doom and carnage in the business press, the Dr. Dooms of the world have actually created a pretty attractive risk yield in certatin markets, which more rational investors can take advantage of and get paid on. One area that is particularly lambasted and getting some signs of market pricing fear are muni-bonds. Right now a municipal bond fund will pay a much better yield than any laddered CD or Money Market, and I believe that fears of defaults coming from major municipalities is very overdone. That being said, there are some areas I may want to avoid, like Michigan and Arizona where there are some deeper strucural problems that were unveiled by this last downturn.
I am also a fan of the "bet on blue chips" right now. With our largest corporations holding incredibly large cash balances, they are not out in the capital markets trying to invest in growth, so they are more and more electing to just pay their shareholders cash. The dividend yields on some of these companies are well over 3 and 4%. That doesnt mean that there wont be a significant amount of principal volatility, where the value of your shares go up and down violently. There is still a very fragile market psyche and a lot of headline risk that can move market prices. But if you invest in solid companies that are paying you cash consistently and reliably then its called "getting paid to wait" for this dyslexic market to figure itself out.
BY FAR, the best investment that you can make right now is education and training on yourself. In an increasingly competitive job market, where there is not a lot of extra room on many payrolls it is imperitive for people to continually enhance their resumes and bios. Even those with jobs right now have to realize that there are a dozen people who would line up to take that job from you for less money. And increasingly these people standing in line are educated and sharp. Therefore, take some evening classes, buy a book, get some professional licenses, or numerous other options. While you might make a 3% yield on some great dividend paying stock, you could also get a 20% pay increase with certain credible skill sets added on to your resume (or at least hopefully avoid a 100% pay decrease).
Please let me know your thoughts on questions. It is getting late and some of this stuff may not translate as well from my brain to the screen as I would hope.
Your post is a very holistic look at the current economic situation, well done. I agree that the Fed is keeping a close eye on deflationary trends, so that lessens the likelihood of significant or persistent deflation. You mention wages as a source of deflation; housing is also deflating but that is a much more complex subject. In Colorado Springs, home prices have decreased (single family homes in particular are still going down) but rental prices have increased slightly over the last two years. On the one hand, the cost for a family to have a roof over their head has stayed the same (in terms of rental rates) but on the other, the value of that roof has decreased by 14% (in Colorado Springs) since the 2007 peak. I don't think this decline can only be attributed to distressed properties selling cheap and dragging down prices in general. Given the number of people who have had either a bankruptcy or a forclosure in the last two years, there are now fewer buyers than before. Add to that the number of people who are unemployed, and the list of potential home buyers gets shorter yet. Investors are picking up some of the slack, but most of them will only purchase property at a price that will generate a solid cash flow. All that being said, the drop in home prices doesn't directly fuel deflation; as long as rent prices remain stable, the cost of housing remains relatively constant for the average consumer (of course the stability of rent prices varies across the country). What the drop in home prices does do is destroy wealth and savings. It also makes homeowners (or former homeowners) feel less secure and less willing to spend their income. The destruction of wealth and loss of security very much tends to fuel deflation and these effects will linger for years, even after home prices begin to rebound.
ReplyDeleteThe bottom line: significant and persistent deflationary pressures exist in our economy today. The deflationary pressure is, of course, balanced against inflationary pressures to produce the aggregate result. I strongly feel that our economy is presently at a tipping point and it's anyones guess where we go from here.
On another note, I would compare the U.S. economy to an iceberg and the government's ability to steer the economy to a 5hp outboard motor. The government can certainly do things that inspire (or destroy) confidence and change some economic numbers in the short term. When it comes to fundamental, sustainable growth, however; a long-term, disciplined approach is necessary.
Thanks for the comment! I appreciate the feedback as always!
ReplyDeleteI especially like your last two paragraphs and would only say in response that I believe we will be balanced on this tipping point for at least a couple of years. The government will be running that outboard motor at full tilt to keep this iceberg from dropping into deflation while the lack of jobs and growth will keep us safely from any dangerous inflation.