One of the significant fears of investors which has driven oil, copper, other commodities and even coffee to very high prices has been that the Fed’s easing will result in massive inflation. There has even been forecasts of hyperinflation due to the excess printing of US$. We have all heard that inflation is a monetary phenomena with many pointing to “The Great Inflation” of the 1970s as Alan Meltzer titled it. But, nothing could be less simple than more printed US$ equates to higher inflation.
The issue from my study is who is doing the buying with those extra dollars? When government was in direct charge of the spending as it was during the “Great Society” initiative, government was directly in control of sending for building materials and the hiring of individuals to run this massive social program to provide housing and other services to the poor. Government routinely over-paid for virtually everything including the salaries of those hired to run this effort. Competing in the job market against private sector immediately began to drive labor costs higher. This prolonged wage pressure resulted in an inflation spending psychology which eventually was snuffed out by Paul Volcker with record high interest rates.
The latest Dallas Fed release of the Trimmed Mean PCE shows that inflation has been stable to lower the past 6mos and is likely to fall even more. I show below the one-month, six-month and 12-month data as reported. Link: Intriguing is the trend in the 1mo data from Jan 2012 which has fallen month-over-month from Jan 2012’s 2.2% thru June 2012’s 1.4%. This is reflected in the 6mos moving average as falling from 2.0% to 1.7% and the 12mo moving average from 2.1% to 1.9%. If these trends persist, we should see 12mo inflation fall towards 1.5% or lower within the next 6mos. Inflation is not a current problem and by my analysis not likely to be a problem.
This time government spending is not directly by government, but is directed by the hands of individuals who have received government support. Federal government has supported state governments to keep state and municipal employees employed; Federal government has expanded unemployment and food stamp benefits; Fed government has provided support to GM, many banks and “Green” initiatives. In each of these instances government provided US$ but did not direct the spending. Wage growth has remained flat to low and very importantly these US$ have been “Non-Inflationary”.
Even though investors and speculator have driven oil and other commodity prices to high levels in anticipation of rampant inflation and a debased US$ vs. global currencies, rampant inflation as a consequence of greater money supply has not occurred. Individuals are hoarding US$ worldwide in fear of their own currencies being more debased than the US$. This is not inflationary and not likely to be in the future.
The most likely scenario the next several years is that easing inflation fears have a good chance of causing the currently high commodity prices to return closer to economic supply/demand levels. All commodity prices are likely to fall. This can bring additional pressure to lower inflation. Inflation is part of the Prevailing Rate and falling inflation historically results in higher stock prices. To see how this works I call your attention to the Capitalization Formula:
If inflation drops to 1.5%, then the SP500 Earnings Trend Index rises to $1,685
The belief that inflation is simply a monetary phenomena has not been proven the past few years. It is in my opinion more important how the newly printed US$ are spent. In the current environment individuals, institutions and coprorations have hoarded US$ as a store of value and inflation is modest to falling. Falling inflation makes the returns on stocks more valuable.
Optimism is warranted!