Inflation Will Vanish

No doubt commodities have been on a tear. There is also no doubt that inflation has jumped back into the economic picture here in the US. Wheat Gold Oil. You name it it is likely to have gone up. Gasoline has lagged and Nat gas has lagged although they are both up. I don't think this is likely to last though as I am already seeing deflation pop into the picture.

The US consumer (courtesy of Fred Hickey from the Barrons round table in January) is about 70% of the US GDP and about 19% of world GDP. In other words the US consumer is king. The consumer is still spending but barely at positive growth rates year over year. The retail sales numbers show that. Most retailers except for WalMart are hurting. Interesting if you look at Walmart they have been actually cutting prices. Hard to believe when so many commodities are running that Walmart is cutting prices. I think it is interesting to look at the Manhattan real estate rental market as well. In February price increases in some locations were met by prices declines in others so basically a slight rebound from January. I quote the most recent REGNY report ( http://www.tregny.com/manhattan-apt-rental-report.jsp ), " In general, however, we’re seeing more inventory on the market than we have in a long time, and landlords struggling with excessive vacancies continue to offer concessions to support existing prices or attract new tenants quickly." This quote to me shouts deflation. "Landlords struggling with excess vacancies continue to offer concessions to support existing prices." If the banking sector continues to retrench then the Manhattan rental market will only get worse due to its large exposure to the financial industry.

So deflation does exist. It exists in the rapidly deflating housing ownership market and has now spread into the real estate rental market (at least in Manhattan). It exists in the credit markets. Credit is becoming more and more difficult to get with each passing day. Fannie Mae has to pay a lot more for money and that makes it more difficult for them to lend to home owners which then leads to existing home owners cutting prices to move their homes. HELOCS are getting tougher to get. Refinancing a mortgage has become problematic as the equity in the home has dropped from lower prices. The asset backed commercial paper market has stabilized although at much lower levels than previously. LIBOR has fallen back in line which should help home owners with ARMs but LIBOR does bear watching. The private equity sector of finance has come to a crawl as lenders are less willing to lend to fund equity purchases. The US stock market has taken about a 20% hit, so money is vanishing there as well. The cumulative effect on this is that there will be less dollars to lend, decreased sums of dollars from asset sales (housing and equities) and fewer dollars to buy goods. This will lead to possible deflation. This is why the Fed is pumping so much money into the system and will do so for the foreseeable future.

A disclosure here. In 2004 when the Fed kept rates at 1%, I worried about inflation as I thought the US was well on its way to recovery. I even emailed the Fed to tell them they were making a mistake by keeping rates so low. They politely responded with a form email. So its not like I am an inflation lover. But rather I see real signs that deflation is a problem and it is already starting to spread. I think it is possible that the US dollar rallies strongly as inflation pulls back and that commodities are likely to pull back as well. The key question is how bad does the recession get? If the US went into a deep recession then deflation could spiral. If the recession were mild lasting about two quarters then price pressures that exist now would some what pull back. If the US consumer continues to have trouble getting access to cash from asset sales or job losses increase then inflation should follow suit and vanish as well.