The Prospect Of Deflation

Includes: IPE, SCHP, TIP, TIPZ
by: Doug Short

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By Ted Kavadas

Deflation and the potential for such a condition to develop is currently a topic of paramount importance, for a variety of reasons. [note: to clarify, for purposes of this discussion, when I mention "deflation" I am referring to the CPI going below zero.]

As one can see in the various professional economic forecasts mentioned in this blog – as well as the continually low readings from the Federal Reserve Bank of Atlanta’s series titled "Deflation Probabilities" – there is virtually no expectation of deflation either in the near-term or for the next few years.

Is this widely-held expectation of virtually no chance of deflation realistic?

For a variety of reasons, I believe that it is not.

There are many signs in the market, the economy, and conditions experienced by businesses that indicate that the onset of deflationary conditions is (at the very least) something that should be closely monitored.

I have already written of the disconcerting price action of Gold – and its signal of "deflationary pressures" – in the post of April 15 ("Gold’s Decline And Implications") as well as the May 20 post (on Doug Short’s blog) titled "The Recent Decline in Gold." Other recent notable posts on the topic of falling price levels can be seen in my post of June 5 titled "Expectations Concerning Lower Prices" and Doug Short’s post of May 31 titled "PCE Price Index Update – Sorry Fed, The Disinflationary Trend Continues" - in which the April Core PCE Index value of 1.05% is the lowest ever recorded. For reference, here is a long-term chart of that measure:

Other signs of possible "deflationary pressures" that I am monitoring include the price of copper and other commodities, as these commodities appear vulnerable to price declines from a technical perspective – as well as international aspects such as various economic characteristics being experienced in China.

In addition to my observations above, there are many other disconcerting economic traits that, in aggregate, signal "deflationary pressures." This is not to say that we are experiencing deflation – as the CPI and its variants are currently above zero – but rather that certain manifestations of deflation are being experienced to varying degrees.

While many will undoubtedly worry about deflation when it becomes a headline topic, waiting for such a level of "certainty" will likely prove costly.

This Special Note summarizes my overall thoughts about our economic situation.