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Deflation + Inflation=Stagflation

May 27, 2008

Mark on the markets

Mark Patterson

Deflation + Inflation = Stagflation
Deflation is a scenario when assets lose value, like we have in the credit and housing markets. I would not doubt that we also have a lot of weakness in autos and durable goods such as appliances.
Inflation is when we have growing prices for other assets, such as food and energy.
Typically in economic cycles we will experience either inflation, deflation or neither to any harmful extent. But this economic cycle has other challenges. Stagflation is an evil combination of deflation and inflation, and that is what we are experiencing.
Two weeks ago the CPI or consumer price index was released by the government. CPI is a gage that measures inflation on the consumer side. The number was expected to show a .03 increase in CPI, but only went up .02%. Market bulls pushed the markets up in relief that inflation was in check. The curious part of this number is that the decrease in prices for hotel rooms and furniture was offset by the largest spike in food prices in 18 years. I know that that is not a good statistic for INN owners in the Valley, but most people really are unaffected by a decrease in Lodging and furniture prices, but everyone has to buy food. Fuel for our cars is at record highs, and I hope heating oil prices recede before next winter, because I can see some real suffering with home heating oil over $4.00 a gallon.
Many elderly people rely on a fixed income. But the other side of this Stagflation is deflation. The Federal Reserve, Led by Ben Bernanke, has lowered interest rates in an effort to stimulate the economy.
Housing is weak and liquidity was added to the credit markets to entice banks to lend more money and get us out of this “credit crunch”. This lowering may have helped some, but has hurt the US Dollar, which makes commodities like oil more expensive and short term rates like treasuries and CD’s which are relied upon for income by many, stink!
The “FED” has worked themselves into a tough position, where they can’t lower rates to help the economy, but will probably have to raise rates to attempt to slow inflation and help the US Dollar.
I would expect some tough going for our equity markets at least through the summer, yes we will have rallies, but until we get a handle on this stagflation, we will go nowhere fast.
Mark Patterson is a registered investment advisor with MHP Asset Management LLC, and can be reached at 447-1978 or Mark@MHP-Asset.com