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Buzz 'Flation



Editor's Note: As some Minyans aren't Buzzin', we wanted to share the "flation" discussion from today's Buzz between Profs. Reamer, Succo and Toddo.

Scott Reamer (01:11:38 PM)

I can't help but wonder why I am not reading/seeing much talk about the nearly across-the-board declines we have seen in financial markets in March so far. Commodities (gold, silver, oil, etc.), stocks, (small caps & large, tech and financials, materials and energy, etc.), corporate bonds, treasury paper, foreign currencies, and all manner of foreign stock exchanges.

We wrote about the extraordinary correlation of worldwide equity markets last week. And we have posited for a long time now that such a correlation was principally due to the worldwide reflationary efforts of the G7 central banks (our correlation piece actually made that same case from a complexity theory perspective).

There is much more data needed, but the action across these geographies and asset classes is what a deflation - a worldwide deflation looks like. It starts in assets - the riskiest assets - then progresses through safer and safer investments.

Though the probabilities of my Pabst Blue Ribbon bet with John and Kevin that the Fed eases by June 30th 2005 is now a much longer shot than 3 and 6 months ago, I stand by the principle behind it. If this deflation continues, I think it is a near certainty that the Fed eases by the end of 2005.

Todd Harrison (01:19:06 PM)


Is it possible that we're seeing inflation (in things we need) and deflation (in hard goods as a function of a lack of pricing power) simultaneously?
And isn't this a textbook recipe for stagflation (sluggish growth, inflation and high unemployment)?

John Succo (01:19:20 PM)

I am in agreement, Scott, on your points about deflation (although I think stagflation is what we will have) as the ultimate environment.

The excesses only have been increased. The Fed has only provided a dose of morphine, not a cure. The cure is too painful for bureaucrats.

I only disagreed on timing. I think the Fed at this point cannot allow an all out run on the dollar and have to attempt at first to stabilize it. This also gives them a higher base from which to "begin" easing (I actually think they never stopped; they just bought long bonds with the money).

Scott Reamer (01:39:01 PM)

Todd: yes it's possible to have inflation in certain sectors and deflation in others. Certainly the two forces can co-exist. I would observe parenthetically that what you define as 'need' and 'want' could also be characterized by 'markets with government intervention' and 'markets without government intervention' respectively. Cell phones, PCs, clothing, automobiles; all have been declining in price for years, each are relatively 'free' markets without much federal intervention in the exchange of those goods between willing buyers and sellers. Housing, oil, education, health care; all have massive government intervention in their markets (directly or indirectly) and thus are completely out of touch with the normal deflationary forces of free markets. But I digress, as this is not really the important larger point.

Please don't confuse a cyclical increase in "inflation" in say commodities with the very real secular macroscopic deflation that has been underway since roughly 1995. As I wrote in the past regarding the deflation/inflation debate: one can have declining inflation rates in some sectors and outright deflation in others; both are still within a secular deflation regime.

Here's an analogy that might be useful. Just because the price of stocks have gone up since 2002 (a cyclical asset "inflation" thanks to the Fed) doesn't mean that the secular "deflation" in asset prices (that started most noticeably in 2000) has gone away. Indeed, the cyclical inflation of stocks can coexist within a larger regime of a secular deflation in stocks. And of course this makes sense intuitively: prices of all things are non-linear; they go up and they go down; the real question is whether they are going up or down secularly.

That's what I think is going on: a secular deflation in everything - as evidenced by the tight correlation among both asset classes and geographies. What we saw in 2002-2005 was a cyclical reflation within a secular deflationary regime. It will only be a matter of time in my opinion before the Fed realizes this and starts 'marking down' the price of the commodity that they control: short term credit.

Heck, I feel so strongly, I've got a case of Pabst resting on it.

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