It's Still Not Time to Worry About Inflation

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As the Trends editors observed nearly 20 years ago, "We live in a deflationary world driven by advancing technology. Our economy's challenge is to harness the positive manifestations of deflation and avoid its negative manifestations."

We believe that the many investment professionals and policymakers who fear inflation in the present context have truly misjudged the situation. And we argue that recognizing and responding to the underlying deflationary trend is crucially important for both investors and policymakers.

Consider the facts. Economist A. Gary Shilling has identified five types of deflation that currently dominate the U.S. economy1

  1. Wage-price deflation: In addition to worker dismissals, cuts in wages and "hours worked" are being used to reduce labor costs. This is easier today because of the weakness of organized labor. It is also exacerbated by the skills gap, which has created a vast over-supply of people who lack crucial technical skills.
  2. Commodity deflation: Commodity prices continue the decline that started in early 2011; this is due to new supplies entering the market faster than demand is growing. This will only accelerate, especially in the energy sector as the United States ramps up natural gas exports. This is bad for economies based on extractive industries, like Russia and Iran, but good for consumers.
  3. Tangible-asset deflation: Excessive inventories of tangible assets, especially housing, have depressed prices since at least 2007.
  4. Financial-asset deflation: Shilling believes stocks are overdue for a decline when investors realize that weakness in global economies will not be offset by huge injections of liquidity by central banks.
  5. Foreign-currency deflation: The dollar is reasserting its traditional role as the global safe-haven currency in the face of geopolitical uncertainty; this drives down the price of imports for American consumers and American industry.

These deflationary realities are neither "good" nor "bad," in and of themselves. The question is whether we have an environment that leads to "good deflation" or one that leads to "bad deflation."2

Good deflation is the result of new technologies that enable rapidly increasing productivity and output as the economy grows rapidly and as supply outpaces demand. Bad deflation stems from financial crises and deep recessions, which increase unemployment and depress demand below the level of supply.

As Shilling notes, during the "golden age" of the Steel Technology Revolution, railroads efficiently connected the nation for the first time, enhancing productivity and supply across many industries...

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