|
Pinnacle e-Letter Inflation Concerns No Cause for Panic Rumbles about impending inflation are making their way into news stories and dinner conversation across the United States, elevating fears that higher interest rates will follow and a recession is looming. But if you step back to look at the bigger picture, you see that the United States does not have an inflation problem. Two things are happening in this country: The dollar is falling in the foreign exchange market, and spot commodity prices are going through the ceiling. Many people have grasped on to this and said, "This is the coming inflation." Situation very different 30 years ago The circumstances were reversed in the early 1980s after the United States cut taxes, freed trade and deregulated. Foreigners tried to buy assets located in the U.S. but had a hard time finding sellers. From 1978 to 1985 the dollar more than doubled in value in the foreign exchange, bringing about three major changes in world production markets:
As these changes played out, the United States developed a huge trade deficit and started supplying foreigners with dollars, causing the value of the dollar to stabilize. Weak dollar, high commodity prices connected Today, the situation is the complete opposite. Foreign countries are doing a fantastic job of implementing low-rate flat taxes and other pro-growth policies. Investors are taking advantage of these opportunities and pulling some of their money out of the United States, which is what is causing the value of the dollar to drop and, in turn, dollar-denominated commodity prices to rise. It should be no surprise that the dollar is weak at the same time that commodity prices are high, because they are interrelated. As an example, a ton of copper is sold in the United Kingdom in British pounds. That price, multiplied by the dollar price of the pound, should approximately equal the dollar price of a ton of copper being sold in the United States. Commodities like copper, gold and oil are freely traded products. If the prices get out of line, they'll be arbitraged by the physical movement of the commodities. In other words, free trade keeps prices in check. Whenever the dollar depreciates, dollar prices will rise relative to the prices of goods in the currencies against which the dollar has depreciated. At some point when the United States trade deficit drops sharply, and it will, the dollar will hit bottom and start rebounding. Other indicators don't point toward inflation Beyond the weak dollar and high commodity prices, nothing else jumps out as a serious indicator of inflation. Consumer price inflation hasn't increased much in the past four or five years. In fact, when commodity prices are taken out of the Consumer Price Index, there is hardly any inflation whatsoever. And that has been true for a long time. In addition, the market's 10-year Treasury note yield is really low at around 3.7 percent. When you subtract the Treasury Inflation Protected Security (TIPS) yield, which provides protection against consumer price inflation, the market's forecast for inflation over the next decade is extremely low and actually down from its recent high several years ago. Interest rates know how to forecast inflation. When inflation is coming, interest rates go very high very quickly. That is not happening this time around. Inflation is not on the horizon. Likewise, interest rates aren't going to rise dramatically anytime soon. We are in the midst of an economic slowdown and probably a mild recession, but the good news is that we'll come out of it quickly. The economy should bounce back before the next president takes office. What happens next will depend on the policies the winning candidate puts into action. That is where the potential for serious economic damage lies. Vote carefully. Dr. Laffer, prominent national economist and advisor to many national leaders, moved his economic research firm to Nashville in 2006. His economic acumen and influence in triggering a world-wide tax-cutting movement in the 1980s have earned him the distinction of "The Father of Supply-Side Economics." He became a Pinnacle client and later accepted a role as a principal economic advisor to Pinnacle. Return to the May 2008 e-Letter
|
Comments? Please contact us.
