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Wham! Pow! Zap! Argh! 2012 Forecast
Commentary on the News
Monday, December 13, 2010
Ed DeShields

There’s a near-epic battle going on around the world between inflation and deflation.  Could the New Year bring us closer to the end of our age of economic tranquility?

Structural imbalance is the way most economists prefer to describe it.  To keep our world economy thriving everything must keep growing.  Everything.  We must produce more, sell more, and yes – we must create more and more debt.  We must find more oil at reasonable prices because all modern work is simply a factor of the productivity oil produces (think “horsepower”).  After all, with a single gallon of gasoline a man with a machine can easily produce the work of 300 horses. 

As long as the economy keeps expanding life is nice.  Once the engine slows down, bad things usually happen.

So, which will win; inflation or deflation?  Can’t we just re-balance and get back to the status-quo?   

No one really knows for sure. 

The outlook for 2011 is skewed towards inflation.  Inflation is by far the more common outcome when there is too much sovereign debt that cannot be repaid by ordinary means.  Take a look at the balance sheets and the obligations of practically every developed country and you will realize that most of the developed world is structurally insolvent.  

When word got out last week about extending the Bush tax cuts, the bond market sold off with great fervor.  True to the old adage that “stocks are for show and bonds are for dough” new fears of a protracted economic imbalance caused investors to head for the exits.  “Long” interest rates -- the kind that support mortgages and auto loans -- immediately jumped affecting an already dismal housing market.  About half of the loans in the refinancing pipeline where suddenly unworkable. 

The sell-off was big this time.  Let’s pray that the sellers were not foreigners voting against the monetary future of America.  That wildcard would mean the New Year will not start off well.   But, be an optimist and mark one up for inflation.

The New Year will likely see even higher oil prices.  You may not have noticed, but 2010 was the second most expensive year for oil ever (other than 2008).  It was 11% more expensive than 2007 and 27% more expensive than 2009.  It’s unlikely this is a supply and demand issue – but I won’t go there in this article.  Let’s just mark up another one for inflation and hope for the best. 

After years of steady prices for commodities prior to 2004, they are again nearing their all-time peak.   Commodities have been compounding at an average annual rate of slightly more than 10% over the past decade.  If you were getting that rate on your 401k, you’d be thinking you’re rich.  The New Year may finally tell us whether they will break out and surge upward from here, or be rejected by the market and collapse creating a massive plunge not unlike the one seen in the stock market in 2000 and 2007.   My vote?  I’d give inflation the nod for commodity prices to continue upward pulling prices upward with it.

Jobs.  Well what can I say?  We’ve lost 8.5 million jobs since the election.  To regain these jobs, we’d have to gain over 300,000 new jobs per month for the next five years to get back to where we were.  That’s not going to happen.  We’ve never gained 300,000 monthly jobs consistently since they started keeping records.   Unemployment will remain near 10%, or greater, for at least ten years.   Mark up one vote for deflation.   

Gold is a bell-weather for confidence in the currency market.  As long as gold continues to increase in value it doesn’t bode well for confidence in the dollar, or any other currency for that matter.   Watch for the Euro to crash, and with it many will propose a new world currency (the leading contender is the IMF and UN’s Bancor currency).   

The amount of money now hoarded at banks is up about 1.4 trillion.  Virtually all the stimulus money is stuck in the banking system being held by the banks.  This money is sitting there ready to be released.  It’s hot money looking to a home.  As this money finds its way into to the system it’s going to create new bubbles all over the system.   Give inflation two votes.

In conclusion, the battle between inflation and deflation is likely to grind on for a long while before it transitions into a MOAIP (mother of all inflation problems) due to the structural imbalance across the world.  

So all I want for Christmas is a quiet tranquility before I have to worry about 2011.

About Ed DeShields

Last week: What a Good Keynesian Wants You to Believe

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