Inflation Outlook 2010

A day or so ago I walked past a newspaper rack and noticed that the Wall Street Journal headline was, "Inflation at 44-year Low." I no longer read the Wall Street Journal, ever since it was purchased by Lester Murdoch, figuring that it either is or ultimately will become a right-wing propaganda machine, just like Fox News.

But I was taken by the headline, thinking it's probably both sincere and accurate. I think it's also a harbinger of what's to come in the future. With the United States at all time high debt levels, since World War II, one only need consider the alignment of financial realities to see what’s in store. Over the next 2 to 3 years, barring unforeseen natural or international conflict or disaster I believe that the world economy and the United States economy in particular, will recover. It may take a while, and there may be detours and bumps, but in the longer term, I agree with Warren Buffett that the long-term is, “pretty darn certain.”

With interest rates held so low for as long as necessary, I believe that our monetary policy will eventually take hold and produce the sort of robust recovery that people are longing for at the moment. I believe the stimulus package was necessary and will be effective. If anything, it was too small or partially mis-targeted.

I don't believe that trouble in Europe is going to derail the recovery. It may slow it up, and it may spook the chickens, who ran for cover at the first sign of adversity. But, I don't think that the combined economies of Greece, Spain and Portugal are big enough to drag down the forces at play, which will ultimately combine to heal the United States economy.

But, just as certainly as I believe all of the foregoing, I also believe that we are in trouble and in a much longer-term, we may be doomed to second class citizenship in the world economy. The pinnacle of economic superiority of the United States may never be reached again. I have said all along that I believe that the long-term prosperity of the United States, not the mid-(3 to 5 year), or short-term prosperity will depend upon how the United States handles its deficits. I've learned enough about politics, politicking, and the ways of the United States Congress to see the handwriting on the wall that it will not be handled well.

Specifically, I do not believe that the Democrats will permit a significant enough scaling back of benefits and entitlements, such as Social Security or Medicare to make a dent. Oh, “Damn the Democrats!” you may say. But, I also don't believe that the Republicans will allow the necessary tax increases in the right locations, such as a carbon tax, to balance the budget. So, "Damn the Republicans!" too.

So, where does that leave us? In the absence of burgeoning real gross domestic product increases, had through technology, innovation, and hard work, it leaves us with only one viable alternative for controlling and managing our debt. That, my friends, is by allowing inflation.

Growth could be choked off by increasing interest rates, while allowing the dollar to plunge and maintaining a responsible economic profile to the world. But, I don't think the politicians will have the fortitude for that either. And, I certainly don't think the US population, which has been living in a precarious, niggardly financial environment will tolerate it either.

The representation has been made that when the economy gets booming we have the mechanisms in place and a sufficient mastery of them to throttle back the economy without sending us into recession (I'm talking about the next recession, not the one were in) or allowing inflation to get out of hand. Given the two choices, I think those who run our country, including the banking policy makers and the Federal Reserve, will choose inflation over another dose of financial misery for Main Street.

Why does all this matter? It matters, because if you are an investor it’s of extremely high value to be able to predict these things and adapt to them in advance. That's what makes your investments called the "smart money."

Once the recovery from the current recession takes hold and begins to develop both power and momentum, I believe it will already be time to begin scaling back one's investment in equities, more commonly known as stocks. That will be necessary to protect gains made during the expansion. The expansion is in progress. I have said there will be detours, bumps, setbacks and distractions during this period, such as the most recent stock market volatility. But, I'm convinced, the trend line remains positive in the short to midterm.

Where then will there be opportunity? To answer this question, I will ask another one. What sort of investments do well during periods of inflation? The first two things that come to mind are gold and real estate. An easy answer is that gold will do well, as will other commodities, such as oil. Another interesting hypothesis, which I believe to be true, is that right about now would be an excellent time to go bargain hunting in the real estate market.

Do I expect to do this? No. But, the reason for me is primarily my age. I would limit this advice, generally, to individuals who are at or under the age of 55. That is because it may be quite a long time before the bountiful ship I foresee reaches shore. There may also be a considerable amount of leverage involved, and I'm not keen on those of us who are over the age of 55 accumulating large quantities of new debt.

But, from what I can tell, bargains abound, especially in markets such as Las Vegas or Arizona or Florida, where prices have plummeted. Caveat: if the recent BP-Gulf of Mexico oil spill, gets caught up in the loop current, cross Florida off the list.

Even if we are not in a position to fully capitalize on the proposition that rampant inflation sometime within the next 5 to 10 years is virtually inevitable in the United States, what can we take away from this reality?

We are in a period of extreme volatility, sort of like the hurricane season of investing. How do we adapt to that? We steer a steady course, keeping our eyes on the horizon and not the choppy waves right in front of us, remaining ever mindful of the basic rules of economics and keeping a close eye on the stove.

Based upon where we are right now, what should be our present course and tack? All I can say is this, "I'm going full sail [in securities], and, so far, it's been a great and highly profitable ride!

Alert: Just now (mid-August 2010), prior to publication of the newsletter which contains this, I'm issuing a caution. In view of the political sentiment in favor of US Federal deficit reduction in the near term, as best personified by the tea party movement, I am beginning to pull back my equity investments in favor of bond funds. Whether or not this sentiment will have the power to stall the recovery remains to be seen, but I believe it is bad for the recovery. I agree with President Obama that long term deficit issues should be addressed and dealt with, but I also agree with Paul Krugman, Nobel Laureate economist that the current political climate for deficit reduction could stall the recovery. Right now, I'm starting to hedge my bets.