I'll admit it: I'm scared to talk about inflation. It's hard to understand why such a nerdy economic term gets people so riled up... but it does. The last time I mentioned inflation was low, I was enthusiastically ridiculed by all three people that read my writing. However, I will not live in fear. So, I'm just going to come out and say it: Over the last few years, inflation has been almost non-existent. According to the Bureau of Economic Analysis, PCE (or Personal Consumption Expenditures) has only averaged 1.4% since 2009. PCE is not a perfect measurement, but it's clear to me that inflation is not a problem right now.
Let me follow that up right away by acknowledging something: Yes, all the contortions of the Fed, and the various bailouts and stimulus programs we've seen in recent years are inflationary. In a vacuum, those things would cause rampant inflation. However, the real world isn't a vacuum; it's a vast, complex system - and there are many things working to keep inflation very low.
The most significant thing keeping inflation low is our economy, which is still weak. That weakness translates into low demand, and it is very difficult for prices to rise when demand is low. Another thing keeping inflation at bay is globalization. With so much of our "stuff" made in parts of the world where labor is incredibly cheap, businesses are competing with each other to cut prices. Further, improving technology is lowering prices for all kinds of things.
Obviously, not all of this is bad news. It's ridiculous to argue that the ability to buy an amazing computer at a cheap price is a bad thing. However, low inflation has significant implications - especially when it comes to the Fed. In fact, the Fed is so concerned with low inflation, they are actively trying to increase it. Let me explain: Most economists think a moderate level of inflation is a good thing. Inflation tends to encourage spending and investment. After all, if your money is worth less every day, you might as well spend it today. It also helps lessen the impact of debt, because borrowers end up paying back their debt with less valuable dollars.
However, the Fed striving to increase inflation has much less to do with how glorious inflation is, and much more to do with fighting off the opposite of inflation: Deflation. With deflation, as cash sits in your wallet, it becomes more valuable. That doesn't sound so terrible, does it? But here's the problem: That encourages people to keep money in their wallets, which hurts the economy. Deflation can become a vicious cycle: As more people cling tightly to their cash, demand drops more, which can cause even more deflation, which causes more people to cling to their wallets - it's not a good situation.
Deflation is particularly brutal when there's a lot of debt in an economy. That's because with deflation, the value of your money increases over time, which means a fixed mortgage payment gets more and more expensive every month. Thankfully, we don't have much debt in our economy right now. Phew... The only problem is that's completely wrong - we still have huge amounts of debt. That's why the prospect of deflation is especially spooky in today's world.
I want to be clear: I'm not predicting deflation. In fact, I think runaway inflation is equally likely. However, it's an odd environment we're in; both inflation and deflation are well within the realm of possibility. So what's the answer? How should you position your portfolio for this strange situation? As is often the case, there is no magic bullet. The best answer is to save a lot, spend a little, and diversify as much as possible.
Brad Blackburn, CFP®, is the owner of Blackburn Financial, Registered Investment Advisor. Blackburn Financial is located at 121 Cottage Ave, Cashmere. He can be reached at 509-782-2600 or email him at email@example.com