For a 20-year period starting in 1980, the financial markets cheered each time a successive lower inflation number was reported by the government. The high inflation rates of the 70's were devastating to the economy and people had a strong desire to see those days disappear forever. While inflation is still with us, since 1980 the rate of increase has steadily fallen. The latest figures showed 0% inflation from February through March, and a 1.7% increase since last March, the smallest increase since 1966. The financial markets cheered.
The celebration is a hollow one, however. The conquest of inflation is a classic case of the generals fighting the last war. As I have been saying for the last 18 months, deflation is the new beast in the forest. And guess what, the effects will be more terrible than all but the worst-case inflation scenario. The disinflation trend has been in place for 23 years, and I am confident it will not end soon.
There have only been two instances of deflation in America, the 1840's and the 1930's. The economic effects were complete and the social aftermath led to the largest wars in US history. Deflation is an idea that needs to be treated with tremendous respect, because the results will utterly change your life. The change does not need to be for the worse, however.
The first evidence of actual deflation demonstrated itself in the stock market. Within a year of the March 2000 top, you could buy thousands of stocks for much lower prices. The next group to be hit with falling prices was areas of business expenses. The Producer Price Index has been in negative territory more or less for the past 18 months. Big-ticket items and durable goods have seen steady declines for quite a while. The travel industry was hit next, and now falling prices can be seen in some quarters of the consumer world.
In order to turn what will be very negative to most people into a positive for you, simply hold on to your cash. In a deflationary environment, prices of everything around you will be cheaper tomorrow than they are today. The guy that just bought the Anaheim Angels learned that last week. There is no reason to rush out and expand your business if it means you have to take on debt in order to accomplish that. The trick to keeping ahead of your competition today is having cash on hand to make a great deal on whatever new idea is coming along. Others in your industry are too busy struggling to pay off debt to worry about expansion right now. Don't make any long-term investments either. It took 23 years for the disinflation trend to reach 0%. It is not suddenly going to reverse itself. The deflation trend will not last 23 years, but it will be with us for a while, at least.
Also, beware of how the experts interpret the data relating to the economy. In addition to the insane idea that 0% inflation is a good thing, experts will praise the improving productivity numbers that will be associated with the early stages of deflation. Overcapacity due to productivity improvements is partly to blame for our current problems. This will simply extend the deflation trend.
Coming up: Next week Keenan will address insider buying and selling over the last 6 months.