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Are We Facing an Inflationary Spiral?

The last several columns have dealt with the realities of the marketplace, particularly the world of common stock investing. If you have not had a chance to read the last 2 columns in particular, it may be worth taking the time to review what was covered. The overall perspective that I have taken on the stock market for the last several years has been one of “selective investment.” In other words, I have advised that the most successful approach to common stock investing has been one of careful analysis and individual stock investment as opposed to simply plunking down your money on mutual funds. That is not to say that some funds haven’t done well, they have. Particularly funds which replicated the major stock market indexes, as those funds have matched overall market performance.

Unfortunately, many investment banks and investment advisors have recommended various sector funds, which mean your returns will be as good as that particular sector has performed. As we move beyond all of the stimulus packages and FED interventions, and we come to the bottom of the governmental bag of tricks available to artificially support the economy, we need to be very wary of inflation and its impact on a vast number of economic sectors. Clearly, the sectors which will suffer the greatest devastation from inflation are logically going to suffer the worst returns on investment, specifically returns on common stocks.

To address the question; are we facing an inflationary spiral?

History does and in fact has repeated itself time and time again with regard to the economy. Every time I hear a discussion by the financial market pundits wherein they assert “we can’t make those same mistakes again,” I cringe because we can and in fact we have repeated the same mistakes over and over again. The “we” I refer to is governmental policy. I specifically addressed governmental policy in my recent presentations to BCU staff at the Vernon Hills headquarters. It is important to understand the government’s economic policies in particular, as they have direct impact on our personal financial well being. The current path we travel has ultimately brought about strong inflationary pressures on the prices of both goods and services. The reason that inflation takes such a toll on individual wealth is that rarely are individuals able to time increases in earnings or savings simultaneous to the increases in prices.

The huge deficits incurred by government spending leads to issuance of more and more government bonds to finance the deficits. As the market place loses its appetite for US Government bonds, interest rates will necessarily have to rise to improve that appetite and to maintain a market for our debt. As interest rates rise, the cost of doing business across all lines will rise correspondingly. This leads to more and more price increases, at a time when wages will still be frozen due to the large availability of work force.

It is this mismatched timing of the price increases and earnings increases that causes the pain. The reason that this most recent recession poses unprecedented challenges is that unemployment levels have remained extremely high throughout this recession, and continue to this day. With such high levels of joblessness, there is no pressure on employers to increase wages. On the contrary, wages have remained constant or even declined across most employment sectors over the last two years. A quick trip to the grocery store, the gas station, the movie theater, or the bank for that matter, will reveal constant price increases for goods and services week after week. A large part of the price increases is due specifically to increased demand for goods world wide. We have frequently discussed the impact of the “global economy” on our finances. We cannot escape the fact that over the last ten years we have opened up the global market to as many as 2 billion people in China, India, Indonesia, and other countries that have been emerging into the global economic landscape.

China and India alone have increased their consumption of feed grains and oilseeds to levels never before seen. These basic commodities are so intertwined throughout the economy that they in turn directly affect the costs for fuel, transportation, and food processing facilities. China, for example, used to import grain and oilseeds for human consumption. Now, in an effort to improve their standard of living, they import these commodities to process into animal feed to increase their production of beef, pork, and poultry. This redirection of foodstuffs to the new purpose greatly reduces the efficiency of use of these products: the beef and pork and poultry that are produced feed less people than the grains and oilseeds themselves would feed.

Hence, in recent weeks we have watched gold prices climb to near $1500 per ounce, silver to $41 per ounce, and crude oil to $115 per barrel. While gold and silver are barometers for inflationary times ahead, crude oil and commodities mentioned earlier are integral raw materials needed in vast spectrums of manufacturing and food processing. A look back to the period from 1979 through 1983 will give you a perspective of the kind of price increases we could endure. What we cannot predict is the governmental economic policy response to these troubling signs we see.

The most prudent course of action for individuals under these circumstances remains holding a cautious approach to financial matters. We should attempt to add to savings if at all possible; purchase necessary “big ticket items” (appliances, automobile for work transportation, housing {whether securing a lease or buying a home}at current price levels and low financing costs; and plan for education expenses through universities and colleges which allow for pre-payment at current tuition levels. There are many things we can do individually under our personal financial planning which could blunt the impact of the coming inflationary period. Use some professional help such as BCU Investment Advisors or an advisor of your choice to guide you to a more secure financial future.

©Patrick J. Catania 2010
The views and opinions expressed herein are solely those of the author and do not necessarily reflect those of Baxter Credit Union, its Board of Directors, or its employees. The author is responsible for the content. Readers should consult with, and seek professional advice from their own attorneys, accountants, and financial advisors with respect to their individual financial needs and circumstances.

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