This post provides an update to various past posts discussing deflation and “deflationary pressures,” including the most recent post, that of January 27, 2016 titled “U.S. Deflation – January 27, 2016 Update.” I have extensively written of “deflationary pressures” and deflation as I continue to believe that prolonged and deep U.S. deflationary conditions are on the horizon, and that such deflationary conditions will cause, as well as accompany, inordinate economic hardship. [note: to clarify, for purposes of this discussion, when I mention “deflation” I am referring to the CPI going below zero. Also, I have been using the term “deflationary pressures” as a term to describe deflationary manifestations within an environment that is still overall inflationary but heading towards deflation.]
The subject of deflation contains many complex aspects, and accordingly no short discussion can even begin to be a comprehensive discussion of such. However, in this post I would like to highlight some recent notable developments.
Of note, the shortfall between the Federal Reserve’s stated inflation target (2% on the PCE Price Index) and the actual inflation reading continues. This 2% inflation target has been “missed” (inflation has been less than 2%) for well over three years. For reference, here is a chart of the PCE Price Index from Doug Short’s post of June 1, 2016, titled “Minimal Change in the April PCE Price Index“:
These readings can be compared against the CPI figures. As one can see, "core" CPI remains somewhat higher than the "core" PCE Price Index:
Janet Yellen briefly commented about inflation in the June 15, 2016 FOMC Press Conference:
Our inflation outlook also rests importantly on our judgment that longer-run inflation expectations remain reasonably well anchored. However, we can’t take the stability of longer-run inflation expectations for granted. While most survey measures of longer-run inflation expectations show little change, on balance, in recent months, financial market-based measures of inflation compensation have declined. Movements in these indicators reflect many factors and therefore may not provide an accurate reading on changes in the inflation expectations that are most relevant for wages and prices. Nonetheless, in considering future policy decisions, we will continue to carefully monitor actual and expected progress toward our inflation goal.
Trying to assess and/or predict the possibility of U.S. deflation is very challenging for many reasons. Among these reasons is that there are many different measures that are supposed to predict and/or depict the possibility of deflation, and they can show apparently contradictory readings. Among these measures are both survey-based as well as market-based measures.
Another challenge is that deflation in the U.S. has been relatively non-existent since the beginning of the 20th Century. As such, knowledge and "practical experience" with deflation is lacking. As seen in the below chart (from Doug Short's June 16, 2016 post titled "A Long-Term Look at Inflation") with the exception of The Great Depression prolonged periods of pronounced deflation have practically been nonexistent, especially after 1950:
However, there are many reasons that I believe that U.S. deflation of a pronounced and lasting nature will occur. Among the reasons are the following:
- As mentioned above, the continuing inability to "create" inflation to rise above the 2% goal.
- Prolonged and pronounced economic low- and no-growth levels experienced globally. While there is widespread consensus that U.S. economic growth will remain positive for the foreseeable future, my analyses indicates that the economy continues to have many highly problematical areas and that the widespread consensus concerning current and future economic growth is (substantially) incorrect. Substantial economic weakness (i.e. contraction) and deflation often occur simultaneously.
- A continued "flattening" of the Yield Curve, as discussed in the June 21, 2016 post "The Yield Curve - June 21, 2016."
- Continual indications of "deflationary pressures." I have written extensively concerning these persistent "deflationary pressures," which have manifested in a variety of areas.
- Worrisome trends in various "market-based" (and to a lesser extent "survey-based") inflationary expectations. While there are many of these measures, one is the “10-Year Breakeven Inflation Rate.” It is described in FRED as:The breakeven inflation rate represents a measure of expected inflation derived from 10-Year Treasury Constant Maturity Securities (http://research.stlouisfed.org/fred2/series/DGS10 ) and 10-Year Treasury Inflation-Indexed Constant Maturity Securities (http://research.stlouisfed.org/fred2/series/DFII10 ). The latest value implies what market participants expect inflation to be in the next 10 years, on average.Here is the long-term chart, with a reading of 1.50 percent as of the June 23, 2016 reading:
source: Federal Reserve Bank of St. Louis, 10-Year Breakeven Inflation Rate [T10YIE], retrieved from FRED, Federal Reserve Bank of St. Louis, June 27, 2016: https://research.stlouisfed.org/fred2/series/T10YIE/
- Disconcerting readings and trends from the State Street PriceStats Inflation Series.
- An additional concern is the seemingly (very) high levels of inventory, as seen in various measures, such as Total Business: Inventories to Sales Ratio (currently seen at 1.40 as of the April 2016 reading, updated as of June 14, 2016.) While, for many reasons, it is difficult to know how much of a future problem this seemingly elevated inventory level is, it definitely has the potential to be highly problematical and a substantial "driver" of future price deflation, especially during an economic contraction.
It should be noted that there are many other measures of current and future inflation that imply little or no worrisome trends. However, as I have mentioned previously, the methods in which deflation "plays out" is not necessarily incongruent with various indicators seemingly indicating little chance of deflation prior to a deflationary period.
In conclusion, I continue to believe that significant (in extent and duration) U.S. deflation is on the horizon. As discussed in the November 14, 2013 post (“Thoughts Concerning Deflation”) deflation often accompanies financial system distress. My analyses continue to show an exceedingly complex and difficult future financial condition in which an immensely large “financial system crash” will occur, during and after which outright deflation will both accompany and exacerbate economic and financial conditions.
The Special Note summarizes my overall thoughts about our economic situation
SPX at 2000.54 as this post is written