Wednesday, April 20, 2005


It is amazing that inflation fears are everywhere. The Fed Beige Book does not normally move the market but this time words about the strengthening of inflation worries has dropped stocks and bonds.

Is has been said that Generals and Brokers fight the last war. The big bull market that ended 1929 ended in a protracted deflationary spiral. The big bull market that ended in 1969 ended with a protracted inflationary spiral. We are currently in an inflationary down trend that started in 1980. Long term interest rates have fallen from 15% in 81 to 4.5% in 2005. Is the decline over? Is the next problem the same as the last one?

I believe the next big problem will be deflation not inflation. The forces at work are killing one old inflated industry after another. I just wrote about the dying circulation of news papers. Folks are still reading the news and responding to advertising. They simply do not need reams of newsprint to dispose. This is another example of the law of substitution at work. The CPI probably shows that the cost of the average newspaper went up from 41 cents to 43 cents last year. So what? How many people saved the 43 cents by reading online news? The price of internet service may have gone up but the number of people who added a new service, such as VoIP, is not captured except in the deflator measures of prices.

I can't remember the numbers but I recall reading that revenues at the baby bell phone companies will be down significantly this year. Newspaper circulations are dying. Electronics are reducing auto fuel consumption. Consumer interest costs are not tax deductible. Productivity is reducing the cost of product after product. Office, retail and mall space is going begging. Will baby boomers who have not saved adequately for retirement suspend spending while playing catch-up?

The market has "believed" for two years that long-term interest rates must go up. EBAY has put back into circulation billions of items that might have been hauled off to dumps or languished in basements and attics. Why do interest rates need to go up if consumers can recycle used goods as a fraction of the cost of new goods?

The economy should be strong for the next few years. There is no need for interest rates to go up enough to choke off the expansion. After a good strong non-inflationary expansion, interest rates may hit the lows of the 30's.