U.S. Inflation – Yes or No?

Although the din about rising inflation has diminished since about 2010, we still hear concern from clients now and then, particularly when discussing bond portfolios. Investors worry that committing to longer bonds at current “low” interest rates is a bad idea, just in case we end up with rampant inflation. (We won’t discuss here what actually happens to bond portfolios when inflation rises quickly, but it’s not as bad as you think). Many investors think they see inflation today in higher food prices, or higher gas prices. But what they’re seeing is not, as economists describe it, inflation. It’s not anything like the inflation of the 1970s in the US, and its not anything like the inflation now infecting, say, Argentina.

Inflation is defined as widespread price increases, affecting virtually all goods and services in an economy. That’s what we mean when we say an economy is experiencing “inflation”. Singular, isolated price increases for bread, or gas, or health care are just that: isolated events. In our economy, while bread and gas rise in price, auto insurance, homes, and computer prices fall. In Argentina, prices for every item are rising nearly daily. Go to a restaurant, and you’ll see the menu prices in chalk on a board so they can be changed the next day, or even midday. Buy a dress and you might find the current price sticker hides older, lower price stickers.

We’ve said for years now that we don’t expect inflation for the foreseeable future. In fact, we think monetary and fiscal policy has been geared toward preventing deflation over the past five years, and we think we’re in for doses of much the same in coming years, no matter who is in office. Two factors influence our thinking: one is the giant deleveraging that the US economy is undertaking. People who are struggling to pay down debt don’t buy boats, houses, and trinkets. They save. And so they are.

The second factor is the large retiring-age population in the US. I can’t count how many times a client has said to me, “Gee I just don’t spend what I used to spend,” or “I don’t feel like I need anything,” or “I never buy clothes any more,” or “I think I’ll sell my home in Podunk, it’s too big for me now.”

Between less consumption as everyone pays down debt, and less consumption from the huge Baby Boom generation, we don’t think there’s much urge to spend all that cash the Fed and the administration have pumped into the economy.

Aside from the supporting factors for our opinion, there’s the evidence: where, after four years of profligate money creation, is inflation? Surely it shouldn’t take so long to show up, if it’s going to.

The U.S. probably has another 7-10 years of low inflation in store, maybe more. Japan, which also endured a real estate bust and has an aging population, is well into its second decade of an epic struggle with deflation, and while there are differences between the two economies that might account for degree, the basic theme is the same: forces are afoot to encourage less debt, more savings, and lower prices.