I was recently reading the Wall Street Journal (courtesy of the Agoura Hills Renaissance Hotel) and came across an interesting article by Scott Patterson titled 'Inflation Fears? Not In This Job Market'. In it he explains an interesting theory around inflation in a poor job market like the one we have today. I feel that this article is more relevant than usual for InvestingDecoded readers because inflation is a bigger issue than normal these days and can potentially impact investing strategies for you and me.
The Big Deal About Inflation Today
The reason why inflation is more important today is simple - the amount of government debt out there today. Inflation is a fairly simple concept with a lot of science behind it. All it is is the rising of prices over time. It's the reason why a Hershey's bar used to cost 5 cents and now costs $1.49. With the growth of industry, the scarcity of resources, and the increase of consumer buying power, prices tend to rise.
However, another driver for inflation is the supply of money. The theory is that the more money is available in a given economic system, the less value it has and, therefore, the more you'll need to buy things. Over the last few years, the government wars in Iraq and Afghanistan, TARP bailouts, and economic stimulation packages have literally cost the government trillions. To pay for these, the government has essentially had to increase the money supply substantially - they had to print more money on a scale not seen since WWII.
With this increased supply, there is a growing concern in the market that inflation will run rampant in the near future - thereby devaluing the buying power and earning power of consumers and corporations respectively.
What Patterson Has To Say
Scott Paterson's article, however, takes a more contrarian view on the inflation issue. His argument is that history has shown that inflation is not really a threat as long as the unemployment rate is high. The rare exceptions to this rule include the oil crisis of the 1970s. With 9.5% unemployment today, the chances of investors' worries about inflation running rampant is just not going to come through. Generally, economists feel you need a rate around 4.8% or lower before inflation can significantly accelerate. This rate is therefore known as Nonaccelerating Inflation Rate of Unemployment (NAIRU). What this says is that until the unemployment rate recovers significantly, we shouldn't really have to worry about inflation.
My Take On All This and What it Means For You
Scott Patterson actually has some very valid points. A lot has happened over the last 60 years that could easily cause inflation to skyrocket, and if his theory has held through that whole time, there a good chance that it'll hold through this time as well.
However, there are some very important caveats here. This downturn is distinctly different in both magnitude and source from all previous ones. The fact that the bedrock of the financial system was shaken like never before (e.g. Lehman Brothers survived a Civil war and 2 World Wars but couldn't survive this downturn) I feel speaks volumes. The percentage of our debt load when compared to GDP is close to the highest it has ever been. These things could easily turn Mr. Patterson's theory on its head. Therefore, although I don't think the inflation issue is huge at 9.5% unemployment, I think it'll be a big deal at something higher than what history suggests.
For us investors, this means that we need to plan for inflation in our portfolios. In other words, buy more commodities (Oil Included) and international based companies during inflationary periods. Stay away from companies that require a lot of foreign resources to make products that they sell locally (as much as I shouldn't say this, Accenture would be a good example).
Inflation is a dry and, for most people, not very interesting concept. However, in this environment of huge government spending, it has become a much bigger part of the equation for even individual investors and how they should allocate their portfolios.
Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!
The Standard Disclaimer:
The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.
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