Waiting For Inflation?

Over the last several years we have seen a significant increase in the Federal debt and the recently concluded budget deal suggests that both political parties are now on board for continuing deficit spending.  Moreover, this antipathy to fiscal austerity is currently in vogue around the globe.

Conventional wisdom would hold that continuing deficit spending is conducive to increasing inflation.  Up to now, this has not happened.

While understanding the root causes of inflation, and assessing the outlook, is complicated, history suggests that easy money policies eventually do lead to inflation.

Inflation typically develops through rising costs, labor and/or raw materials, or rising prices as demand pressures supply.  Currently, supply for most products and services appear to comfortably exceed demand, as witness the reluctance of business to add capacity. 

The cost side is a bit more complicated.  Commodity prices, particularly energy, have been very soft, leading to little or no raw material cost pressure for most end products.  Labor costs may be a different matter.  Throughout most of the recent economic recovery, wages have been relatively stagnant and work force participation has been unusually low.  However, there are some signs that this may be changing.  Wal-Mart recently raised wages across the board, the UAW is in the process of negotiating significant increases in auto company labor costs, and businesses seeking workers for the Christmas season are reporting a need to improve offers.

Investors should be cautious.  Any sign of inflationary pressure is likely to precipitate a series of interest rate increases by the Fed.  This will, of course, allow you to invest new money at higher yields, but rising interest rates will pressure exiting fixed income investments.

All comments and suggestions are welcome.

Walter J. Kirchberger, CFA®