INFLATION

How bad will it be?

September 27, 2009

>> It depends on whom you ask. Some experts say we cannot fail to have rampant inflation, if not now, then soon. Others say no; it won’t happen. Both sides—will and won’t—have plenty of ammunition:

“We will have high inflation:”

The Obama administration has put a $787 billion stimulus program in place and forecasts a budget deficit that will grow to over 12 percent of Gross Domestic Product (GDP) in 2009, the highest percentage since 1945. It has also bailed out banks and auto companies with billions of taxpayer dollars.
The Federal Reserve is keeping interest rates near zero. This encourages borrowing and higher prices.
In another action, the Fed is slated to nourish the credit markets with $1.2 trillion by buying mortgaged-backed securities and longer-term Treasury bonds. The total of this purchase and previous actions comes close to $2 trillion.
China has launched its own giant stimulus program. This increases the global supply of money, adding fuel to the financial fire.
Cambridge Energy Research Associates estimates that half of new oil and gas production slated to come on stream is now likely to be deferred on cancelled. The likely result: higher oil prices.
Businesses have reduced their inventories. This could create inflationary pressures when demand starts to pick up.
A hedge fund, Universa Investments, has been launched with the stated purpose of earning high returns when high inflation seizes the economy. (Bear in mind, the principals may be smart guys, but they’re can’t reliably predict the future.)

“We won’t have high inflation:”

The U.S. economy is riddled with excess capacity. The Federal Reserve tells us U.S. factories in the third quarter were using only about 70 percent of their capacity. Lots of people are also unused: The Bureau of Labor Statistics reports the unemployment rate has reached 9.7 percent, and a record number of Americans (5.6 million) are receiving unemployment benefits.
According to the US Census Bureau, 15 percent of all homes in the second quarter of 2009 were vacant, which means about 19 million homes are just sitting there, empty and unattended. Most of this slack has to be taken up before the housing industry can show substantial growth.
The government gave some banks many billions of dollars, which would tend to promote inflation, except that little of the money is being lent. The banks are mostly sitting on it, nullifying a substantial portion of the impact. Further, the speed with which money is being spent has slowed to a walk. These are key points to bear in mind when measuring the amount of money at work in the financial system.
The Nelson A. Rockefeller Institute of Government reports that state tax revenue dropped by a record 12 percent early in 2009. The loss of tax revenue has continued into the second and third quarters, with many states reporting declines of 20 percent or more, compared with a year earlier. The response: widespread cutting of services and staff, thus adding to national unemployment and under-employment.
The Federal Reserve has reported that U.S. household wealth fell by $11.1 trillion in 2008, a drop of 18 percent. The swoon of the stock market has added trillions to that momentous loss of wealth.

Who’s right?

That remains to be seen. But a simplified analysis seems to suggest cause for concern, not alarm: It’s generally accepted that the total amount of money in circulation is a key factor in estimating the chances of high inflation. With that point in mind, the fact that the federal government has added several trillions to the money supply does not loom as large as some fear, because U.S. households have lost over $11 trillion in wealth. The comparison is not exactly apples to apples, but it still suggests that on a net basis, federal spending will not necessarily overheat the economy. In addition, the excess capacity in our system must be gradually absorbed before we start to have serious worries about rampant inflation.

Self-defense: Bad as the stock markets may seem, they have historically offered the most practical and effective way for the average person to accumulate wealth faster than the rate of inflation. If serious inflation does rear its head, Treasury Inflation-Protected Securities (TIPS) are worth considering; the interest they pay varies with the rate of inflation. To learn more about protecting yourself from inflation: www.ehow.com/how_2221947_protect-savings-from-inflation.html

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