Inflation. Seriously?

July 29, 2010

Clients continue to ask about inflation. How to hedge against it. When to expect it. Our response? Don't worry about it.
Currently, deflation is the issue. Inflation may occur down the road. But not, in our opinion, any time soon. The logic is simple.
There exists a connection between inflation and unemployment. When there is a large number of unemployed workers, they serve as a labor reserve, and so restrain wage inflation, which has an impact on price inflation. The short-term Phillips Curve posits an inverse relationship between inflation and unemployment. When unemployment is high, inflation is low. Inflation high? Unemployment must be low.
Take Japan. They cut rates. Overspent. And incurred a decade of deflation. Like the U.S., Japan represents one of the largest global economies. And their economy behaved much like ours is currently.
Simply put, the economy has too much slack, too much capacity, to stoke the coals of inflation. Weekly hours are near record lows. U6 unemployment sits at 16 percent. The 10-year Treasury yields 2.96 percent. Bond buyers expect more softness--not inflation.
Inflation may lay on the horizon. But the horizon remains distant.

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