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Vectra Bank Expert Jeff Thredgold

...flation Investing

Written by Jeff Thredgold, President, Thredgold Economic Associates

August 17

What’s it gonna be? Inflation or deflation?

Argument #1…Inflation
Let me think now…inflation is going to be a huge problem in coming years.  Did you see the incredible $1,400,000,000,000 federal budget deficit last year, with the same, or higher, budget deficit this year?  Did you see a similar budget deficit projection for next year? 

Have you seen that the spend-happy Congress is now running a budget deficit of $160,000,000 every 60 minutes?  Have you seen projections of $1,000,000,000,000 annual budget deficits for years to come?

Have you seen how the Federal Reserve has seemingly lost its collective mind, with a near tripling of its balance sheet during the past three years…all with money essentially created out of thin air?

questionmarkThe net result according to many “experts” must be a big surge in inflation in coming years.  That’s why I better buy gold and other “hard” assets, and reduce my ownership of any financial assets such as bonds. 

That’s why gold is back over $1,225 per ounce, with people who market gold saying it is “a great time” to buy gold (when have they ever said anything different?)  That’s why the experts say gold is soon likely to climb above $2,000.

Argument #2…Deflation
Let me think now…deflation is going to be a huge problem in coming years.  Have you seen how residential real estate prices continue to decline?  Have you seen how commercial real estate prices continue to weaken?  Have you seen how much slack there is in the labor market, which could easily place downward pressure on wages?  Have you seen how confidence in Washington DC is so low?

Have you seen how U.S. inflation continues to decline?  Have you seen how the Consumer Price Index (CPI) now shows prices rising only 1.3% during the past 12 months?  That the “core rate” of the CPI (excluding food and energy prices) is up only 0.9% during the past 12 months, the smallest rise in 45 years?

Did you see that when Japan’s asset and housing bubble burst in the early 1990s its economy went into eight consecutive years of deflation?  Have you seen how the Japanese economy is dealing with deflation again? 

Have you seen that declining prices are soon followed by declining incomes?  Did you know history suggests that escaping a deflationary economy can be more challenging that dealing with inflation?

The net result according to many “experts” must be a big dose of deflation in coming years.  That’s why I better buy high-quality, longer-term, fixed-rate U.S. government or corporate bonds and reduce my ownership of any “hard” assets, like gold. 

That’s why investors have already pushed bond prices so high that the 10-year and 30-year U.S. Treasury bond investment returns (known as yields) have already fallen to around 2.65% and 3.75%, respectively...which, excluding a few weeks during the financial crisis, are the lowest levels in decades.  That’s why 30-year fixed-rate conventional mortgages are below 4.50%.  That’s why the experts say bond prices will move even higher, with yields falling even further.

Inflation...or Deflation?  

Two very different schools of thought. 

Two very different investment plans.

German Rebound

Most of the global community’s attention is focused on impressive economic strength across much of Asia and, to a lesser extent, the modest economic revival in the U.S.  In addition, the recent strong performance of the German economy is noteworthy.

The German economy represents roughly one-fourth of the euro zone economy.  However, Germany accounted for nearly two-thirds of the bloc’s second quarter economic expansion ( 

During 2010’s second quarter, the euro region economy grew 1.0% from the first quarter (real or after inflation), with growth up 1.7% from 2009’s second quarter.  The 1.0% quarterly growth pace was the strongest in more than three years.

Best in 20 Years
By comparison, the German economy grew 2.2% from the first quarter.  When measured in the same manner as in the U.S. (comparing apples with apples), the German economy grew at nearly a 9.0% real annual rate during the second quarter, the strongest quarterly growth pace since German reunification 20 years ago.

Such solid growth compares to a 2.4% real annual growth pace in the U.S. during 2010’s second quarter.  Even worse, new U.S. trade data suggests the already meager 2.4% second quarter U.S. growth pace could be revised sharply lower to something near a lackluster 1.0% to 1.5% annual pace.

Solid German performance is not indicative of solid performance across Europe.  While the French economy grew a reasonable 0.6% from the prior quarter, the Spanish economy struggled to a 0.2% growth rate.  The Greek economy declined 1.5% from the prior quarter.  Northern Europe increasingly represents the economic “haves,” while austerity-impacted Southern Europe represents the “have nots.”

Germany, the world’s fourth largest economy, saw exports lead the way, while employment surged.  The German unemployment rate has declined for 13 consecutive months, with the latest rate at 7.6%. 

Germany has regained all of the jobs lost during the financial meltdown.  In contrast, euro zone unemployment is at 10.0%...a 12-year high…as fiscal austerity to reduce unsustainable budget deficits and enormous national (sovereign) debt levels is now “required” across Southern Europe in order to sustain investor interest.

Tension Times Three
Even as German economic performance has rebounded, tensions run high.  Various euro zone governments see aggressive German exports as taking business from other euro nations.  In addition, the German government has opted to go its own way in regard to limiting stimulus programs.

Stronger German performance stands in sharp contrast to five years ago.  Unemployment was above 13 percent, more than five million people were jobless, and the nation was a symbol of labor market inflexibility (The New York Times).   

In addition, tensions run high with powerful German unions, who agreed in recent years to wage concessions and fewer hours worked in order to largely maintain employment levels.  Aggressive unions will demand their financial share of recent successes sooner rather than later.

Political tensions also run high as German voters were sharply critical of the Angela Merkel-led government’s financial support of Greece and other euro nations to survive (so far) the Continent’s sovereign debt crisis.  In reality, government support was as much to save German banks (huge investors in Greek, Spanish, and Portuguese bonds) as any interest in helping its Southern neighbors.

Finance Expert Right Boarder