Risk of Stagflation vs. Deflation

RGE Monitor

RGE Monitor

  • Roubini: U.S. and global economy are at risk of a severe stag-deflation. A severe global recession will lead to deflationary pressures. Falling demand will lead to lower inflation as companies cut prices to reduce excess inventory. Slack in labor markets from rising unemployment will control labor costs and wage growth. Further slack in commodity markets as prices fall will lead to sharply lower inflation. Thus inflation in advanced economies will fall towards the 1% level that leads to concerns about deflation
  • MS: Inflation will be lower in the near term but there is now high risk of high inflation in the long term. Why? 1) It is doubtful that policymakers will be able and willing to quickly and fully reverse easing when things stabilize. 2) The likely sharp rise in government debt in several countries should increase political pressures on central banks to keep interest rates low. 3) If potential GDP growth has slowed a lot, global recession will not create as much slack and disinflationary pressures as is widely believed
  • JPMorgan: It’s normal for inflation to lag behind growth for quarters after global economy moves from strength to weakness. Slowing growth means slowing inflation eventually. Currency depreciation may lead to higher imported inflation in emerging markets
  • Comparisons with 1970s Great Stagflation:

  • Like the 1970s, 1) inflation was driven higher by commodities with negative supply shocks (though this time coming from poor weather, trade barriers and environmental regulations rather than OPEC) and 2) growth is slowing globally led by U.S.
  • Unlike the 1970s, 1) no wage-price spiral, 2) no Nixonian price controls in the U.S. (but controls do exist elsewhere), 3) commodity price rises also due to positive demand shock, 4) credit crisis and asset deflation in developed world spreading globally, 5) falling inflation in developed world

Jeremy Siegel: Even in a Bearish Market, Bullish on Stock

In an open discussion with executives in the Securities Industry Institute, Wharton professor Jeremy Siegel examined investment strategies in the current market. Siegel, author of the landmark books Stocks for the Long Run and The Future of Investors, drew upon historical records in making sense of the current downturn.

Based on Siegel’s analysis of data from 1802 to the present, stocks have outperformed every other major asset class — including treasury bills, bonds, and gold — over the entire period, including important sub-periods. A dollar of gold in 1802, for example, would be worth just $2.45 in December 2007 after adjusting for inflation. In contrast $1 invested in stocks would have grown to more than three-quarters of a million dollars. Stocks have delivered 6.8 percent return per year after adjusting for inflation. “It is remarkable how consistent this has been across all long-term periods,” says Siegel, who also teaches in the Investment Strategies and Portfolio Management program for investment professionals and individual investors. “Equities are about the last asset class that you can buy at or near its long-term historical value.”

The gap between stock and bond performance has been widening. While bonds have delivered 3.5 percent returns above inflation over two centuries, returns are going down. Since the end of World War II, bonds have delivered only a 1.7 percent real return per year. Currently Treasury Inflation-Protected Securities (TIPS) have a real return of about 1 percent. Of course, for experienced investors who can recognize values outside the triple-A bond market, there may be opportunities. “Safe bonds are of no value today. They are one of the worst values,” Siegel says. Continue reading

Effects of Rate Cut


Investors Hunt for Effects of Rate Cut

NEW YORK (AP) — A big rate cut by the Federal Reserve and the stock market’s huge rally in response to that move has many on Wall Street wondering: Now what?

The Fed’s decision Tuesday to slash its benchmark federal funds rate by a larger-than-expected half percentage point sent stocks soaring and lifted the Dow Jones industrials nearly 336 points. It also raised questions about the Fed’s next step and how markets might fare in the coming months.

“I think it’s probably going to help stabilize things. It seems to me that the Fed had enough room on the inflation front to really get out ahead on this,” said Bruce McCain, head of strategy for Key Private Bank’s investment management unit.

Before the Fed’s decision and even with recent moves to cut the rate it charges to loan directly to banks — known as the discount rate — Fed Chairman Ben Bernanke left some investors asking whether the central bank would cut rates at all in the face of concerns about inflation.

With that question answered, investors rushed in and put stocks a good deal above their recent lows in August. The Dow’s jump — its biggest one-day point gain in almost five years — left the blue chip index only about 1.9 percent below its record close of 14,000.41 reached in mid-July.

Still, some on Wall Street will likely question whether the Fed’s rate cut signals a deeper unease at the bank about the effect of tightness in the credit markets and widespread weakness in the housing sector. Continue reading