At some point, inflation

Sometimes it’s useful to look beyond the current headlines to what may be coming over the next 3 to 5 years.

From my vantage point, what I see coming is inflation.

Currently, the news is filled with signs of deflation. Asset prices are collapsing. Housing prices are down significantly. Almost anything, other than U.S. Treasury securities, seems to be down over the last year.

Commodities have been particularly hard hit. It wasn’t that long ago that oil was at $147 per barrel and people were talking about it going over $200. Now, it’s below $40.

But, what has changed? Mostly, demand has dropped dramatically. As Economics 101 will tell you, when the demand curve shifts down and the supply curve stays the same, you get lower prices. I think I can safely say that has happened.

So, why had demand been crushed. In a word, deleveraging. The economy as a whole–businesses and consumers, at least–have been paying back debts to keep from going bankrupt. Not everyone is succeeding.

This reduction in debt has led to a tremendous fall-off in demand for goods and services of all sorts. You can see that clearly in the GDP and employment numbers. For those those who thought only Wall Street was in trouble, take another look.

But, the biggest debtor out there–the U.S. government–has been borrowing and printing money like it’s going out of style.

Eventually, such borrowing and printing will get credit markets going. And, when they do, we’ll all owe a lot more debt and have a lot more dollars chasing the same number of goods. In other words, inflation.

I don’t think it will happen soon. Although the Fed is printing money and Congress is finding all kinds of ways to spend it, economic activity has slowed down so much that all it’s doing is making deflation happen less quickly. Eventually, and over the next several years, economic activity will pick back up again and this will be visible in the so-called velocity of money.

When that happens, the demand curve will shift back up and prices will recover. But–and there’s always a but–the government will be in a lot more debt and there will be a lot more dollars chasing the same amount of demand.

In 3 to 5 years, and perhaps sooner, the news won’t be about deflation, but inflation. And, that inflation will be a lot higher than in the 80’s, 90’s or 00’s. In fact, it wouldn’t surprise me to see $300 a barrel oil and double digit inflation rates (not the core rate, but including food and energy).

With that in mind, you may want to consider inflation-proofing your portfolio over the coming years. Think about companies that can jack up their prices and customers will still pay. Think about commodity producing companies. Be wary of bonds with low payouts or higher risk of default.

It may not happen right away, but over the next several years, get prepared for inflation.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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