Sense on Cents

Inflation? Deflation? What is it going to be? As we continue to navigate the economic landscape, that question – perhaps more than any other – is of paramount concern. As I assess the economy and the markets, I envision the following:

> Ongoing deflationary pressures in real estate. Foreclosures hit a record level based on a report this morning.

> A likely increase in deflationary pressures from wages as unemployment continues to increase, hours worked do not pick up, and average hourly earnings are stagnant. How are corporations reporting earnings? Not from growth in top line revenue, but from cutting costs, including headcount.

I firmly believe these two overriding forces most concern the Fed and the threat that the deflationary forces could grow if not counteracted. How does the Fed counteract these pressures? Keep the liquidity pump running via a 0-.25% Fed Funds rate and now increased speculation of perhaps more quantitative easing in the form of purchasing more mortgage-backed securities.

What has been the result of all this liquidity running into the system? A significant decline in the value of our dollar. What does that create? Inflation. That’s good, right? A little inflation will provide some pricing power which supports our equity market. Not so fast. The inflation is not directly addressing the deflationary pressures in real estate and likely deflationary pressure in wages. The inflation is being generated primarily in commodities. What does that mean? Prices for food, gas, oil, and other raw material inputs will increase. As those prices increase, the cost of living in America will increase. Regrettably, that increase in cost of living will not be offset by an increase in wages.

Daily Finance provides a preview of the coming rise in food prices in writing, Sticker Shock at the Supermarket: Food Prices Poised to Rise:

If there’s any silver lining to a recession — albeit a thin one — it’s that consumer prices typically go down. Make no mistake, deflation is a sign of a sick economy, but at least the net effect of cheaper prices for the basic necessities — food, clothing and shelter — helps folks get by when they are struggling to make ends meet.

But consumers should brace themselves for things to change, especially at the supermarket. As the global and U.S. economies emerge from the downturn, economists predict that there is going to be some sticker shock at the checkout line. Food prices, they say, are heading higher and when you combine that with an unemployment rate that’s expected to linger near a three-decade high for at least another year, it’s even more unwelcome news.
The U.S. Department of Agriculture expects overall food prices to rise as much as 4 percent in the U.S. by the end of 2010. Yet, some economists think they could climb by as much as 5 percent. Even using the government’s more conservative numbers, the price for eggs is forecast to rise 3 percent and beef is seen increasing 2 percent. Lamb, seafood and fish? All three categories are expected to jump as much as 5 percent.

A 5 percent boost in your grocery bill may not seem terribly devastating, but consider this: If you spend $300 a week on groceries now, you’ll need to squeeze a raise of about a thousand dollars a year out of your boss (don’t forget withholding tax) just to keep up with higher chicken, beef, pork and dairy prices. Good luck accomplishing that little feat with a 9.8 percent unemployment rate and companies looking into every nook and cranny in order to cut costs.

Why again are these prices poised to increase?

the weak U.S. dollar means we will be exporting more of our homegrown food overseas, causing prices to rise at home.

The consumer will continue to get squeezed, but the wizards in Washington will be able to pronounce that the overall level of inflation is stable. Really?

-3 + 3 = 0 is not the same as 0 + 0 = 0 !!!

What a world.

LD