The Deflation Situation

Posted: Jun 22, 2011 12:01 AM

These days, investing is really quite easy from the standpoint of only having to make one of two choices. 

In order to make that choice, you must answer the following question: Are we in an inflationary or deflationary environment? 

Your answer will determine how you invest your money.

If it’s inflationary, buy stocks, junk bonds, commodities, precious metals, and real estate. 

If it’s deflationary, buy treasuries; keep a lot of cash, and short the following: stocks, junk bonds, commodities, precious metals, and real estate.  Simple, right?

As a CFP, I see most people choosing inflation. 

After all, hasn’t their grocery bill jumped dramatically in the past year?  What about those gasoline prices? 

In most people’s minds, the immediacy of what hits their pocketbook on a daily basis influences their investment decision. 

As an economist, I’m driven by supply and demand.  If there is a greater supply than demand, the price will ultimately reflect this imbalance. 

Banks, governments, and speculators, have often times tried to usurp this economic principle, only to see their efforts ultimately fail.  Housing, employment, and wages continue to spiral downward, thus supporting the case for deflation. 

So, it comes down to the tiebreaker, the small businessman. 

As a golf course owner, the number of people applying to cut grass on my course has tripled over the past year, thus allowing me to reduce wages. 

However, in order to stay competitive, I have established reduced specials on my greens fees, which ultimately lowers my income. 

Unfortunately, my golf carts are gasoline driven.  Watching oil recently decline from $114/barrel to $90/barrel (down 21%), is a positive.  Lower wages, lower revenue, oil costs (first rising then falling), all add to the deflation case.  

 File:Median and Average Sales Prices of New Homes Sold in the US 1963-2010 Monthly.png

So, for me, deflation is the overwhelming winner. 

As long as commodity prices stay elevated, the inflationists will still stick to their story. 

Ultimately, and perhaps grudgingly, they too, will see the light and become deflationists.

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