The Herald Bulletin
---- — The weather distortions this year have created more than just travel and meeting interruptions. The extreme drought in the West has led to the loss of cattle and crops. This in turn spurred commodity prices higher. The bill at the grocery store is rising faster than many household budgets are prepared to absorb. I asked my wife what she thought about inflation and her response was less than positive.
True enough, inflation raises the price of goods and services, but that in itself does not make inflation all bad. Again I asked my wife if she wanted assets like the value of our house and investments to appreciate. She replied sure, but what about food costs?
The story for the 2014 equity and bond markets will have some short-term conversations like Russia, debt ceilings, elections and things we can’t even forecast. But at the end of the year the story will be about the Federal Reserve and Janet Yellen. The massive amount of quantitative easing (QE) that has flooded the markets with cash has all been in the name of creating what my wife seems to despise — inflation.
As you go to bed at night, say a prayer for mild inflation. No, The Federal Reserve does not want hyper-inflation of five percent or more a year, but they do need home values to rise. Banks loan money for houses more than they loan funds for family vacations. They expect to be paid back either way, but they charge greater interest for a personal loan than a home loan. While you may return from vacation with great memories, the bank has no asset to protect future repayment. In contrast, the house provides a piece of collateral in the event you fail to make good on the promise to pay — provided the house appreciates or at least remains stable in value.
If the value of the house falls — think 2008 — then the asset is worthless as collateral. The value falling is considered deflationary. The Federal Reserve put on a full court economic press, adding over $3 trillion to its balance sheet and our economy, all in the name of keeping asset prices higher and avoiding deflation. Yes, they want job growth too, but they needed asset prices to move higher. They needed to create inflation and they did.
Inflation is fickle. The Fed acknowledges that its actions can lead to bubbles (irrational asset prices that have to decline eventually), but also note that it can’t completely control where the money goes. Is the bubble in U.S. Treasuries? Is it in farmland or in the stock market? Worse yet, is it in grocery prices? One secret characteristic of a bubble is you aren’t aware it’s a bubble when you are participating in the excitement.
Conversely, you can’t comprehend how distorted prices can become before a crash. Sudden surprises in things like weather can amplify inflation. Rising food costs are part of the economic cycle and the rising population growth.
Unfortunately we must take the good with the bad in order to see appreciation in our portfolios and house values.
Joseph “Big Joe” Clark, whose column is published Saturdays, is a certified financial planner. He can be reached at email@example.com or 640-1524.