The Big Picture for the Week of December 18, 2011

A reader asks;

Will you comment a little further on deflation, disinflation and inflation? With gold on a slide, the euro approaching parity, world deleveraging, and the US consumer only shopping the "blue light specials" - seems that the economic climate is vastly more complicated than ever before and deflation may be taking hold.

My conclusions here are not very dramatic, no need to load up on whiskey, gun powder, jerky, ivory soap, cans of tuna or, to add a new one to this joke, bacon (see the picture).

The back drop seems to be increasing extremes of long standing patterns. For example we have deflation in asset prices which is the bad kind of deflation. In certain countries and certain sectors here we have what looks to me like a debt deflation which would be very bad depending on how far it ends up going. We have creative destruction in certain consumer goods (we just bought a DVD player at Walmart for $39) which is a good deflation.

As far as inflation, for many years we enjoyed a little inflation (for the most part) which it turns out is a good thing. People have been grappling with serious inflation with education and healthcare costs for quite a while and while I am not sure that it is getting worse it is not improving. I have a post every November griping about how much our health insurance is going up for the next year.

The price of propane to heat our house has gone up a lot but it has been lumpy; one year was a massive increase and it has been the same for the last couple of years (maybe this is because of how they positioned in the market?). Gas at the pump is up a lot over the last few years but it moves up and down such that sometimes we benefit and sometimes we get hit. I know people talk about the cost of groceries and produce having gone up but candidly I am not sensitive to this other than I know blackberries at Costco have gone way up.

The push pull here leads to the search for the right term for the situation. Someone will make a fortune for coining the right term ala stagflation back in the 1970s. Seriously, the push pull is part of the complicated times we live in idea in the reader's question.

One reader noted that now may not be so complicated, he noted what was going on in the 1970s versus now. A point of differentiation between now and the 1970s is the threats that sovereigns are facing. Perhaps that does make things more complicated, perhaps not, that seems like a subjective thing and this part of the conversation opens us up to a discussion of recency bias.

To the question of gold, I don't think is broken in terms of how it should behave but during short stretches I think anything goes. If we have meaningful price inflation for some period of time and/or dollar devaluation then I think gold would do what people would expect but it may not do so with the magnitude that people would hope for; I have to wonder whether the move up in gold over the last ten years was some sort of pricing in of what might be coming.

As for the euro story, it strikes me as a story of relativity in terms of looking at the EURUSD obviously if the euro stays the euro and it goes down then it will provide some consumer benefit for various goods but not for healthcare, education or most items from the grocery store and so I don't think will have a huge an obvious benefit to most Americans.

Lastly as far as deleveraging; it needs to happen. I don't know how painful it will be but I tend to believe that tearing off the band aid is the better way to go. I believe that had we done the hard thing a few years ago we would at this point understand what the end will look like along the lines of Iceland's improvements. At this point, we have not done the difficult things and we have absolutely no idea what the resolution will look like (mostly we just have guesses and opinions about what should be done, not what will be done).

My conclusions have been the same for quite a while which is that GDP growth will be sub-standard but positive. Equity market growth will be sub-standard but positive. Price inflation will be higher than what we have been accustomed to (as measured by CPI) but not ruinous. I still believe yields should go up and be a little higher than what is comfortable but not be ruinous either.

The idea behind the not ruinous meme is that the US is still the richest country (not per capita of course), is still just about everyone's largest customer, is still at the epicenter of the vast majority of global comings and goings all of which adds up to the world having a vested interest in our getting by. Getting by is not the same thing as being wildly prosperous as a country but more like still being a viable customer who is generally able to function. Hence my comments in past posts about slogging through while other countries do prosper wildly.

About the picture, Joellyn saw that at the store, went back to buy it but they were out so she special ordered it. It is Rogue Brewery and Voodoo Doughnuts which of course are both from Oregon. As an amusing note, Rogue was one of my nicknames in college. Even more amusing, a couple of weeks ago I watched the last half an hour of a show on the Travel Channel about doughnut shops. I saw enough of the show to see four shops profiled and we've been to two of them; Voodoo in Portland and Top Pot Doughnuts in Seattle.