Inflation

[squiffy]

You are correct in the long run. But you are skipping an intellectual step.

High demand for energy in China, U.S., and India due to growing economies causes them to bid up the price of energy. Then natural disasters and terrorism may sharply reduce the available supply of oil, further increasing prices.

These higher energy prices translate to higher inflation in the economy in general, if the price rises last long enough. Period.

Then eventually, as prices rise enough, people change their behavior in response to the prices, in theory, by buying less gas, seeing fewer movies, driving less, buying smaller cars, taking fewer vacations on airplanes, etc.

And yes, in theory, this slows the economy down, which hopefully will eventually cool off prices.

BUt the economy is very complicated and there are political problems at work too.

If you are involved in a huge and expensive war for 20 years, this can keep pushing inflation up for a long long time, and prices won't necessarily drop naturally through reduced consumption. Or Congress can waste tax money building useless bridges in the middle of nowhere that no-one uses, or by increasing welfare payments to people who have 11 children and don't work or pay taxes.

Do you remember inflation in the 70's. Post-Vietnam inflation, oil embargo inflation, aging U.S. factories and low productivity, high union wages and restrictive work rules, etc. Inflation can always rise very high to 15% or more, and stay high for a long time, if the right devilish mix of conditions arises.

[chardog]

[ QUOTE ]
You are correct in the long run. But you are skipping an intellectual step.

High demand for energy in China, U.S., and India due to growing economies causes them to bid up the price of energy. Then natural disasters and terrorism may sharply reduce the available supply of oil, further increasing prices.

These higher energy prices translate to higher inflation in the economy in general, if the price rises last long enough. Period.



[/ QUOTE ]

I am "correct in the long run".. meaning you think I am incorrect in the short run? In the short run we have seen the price of oil more than double and core CPI (not to mention the 10year US treasury yield, a barometer for future inflation) has trended DOWN. How do you explain this? Because the "price rises have not lasted long enough"....?

[wiseheart]

To the person who didnt believe we will
see short term inflation.

The Philips curve. Unemployment is down.
Those familiar with economics see that
this leads to short-term inflation.

[squiffy]

The long term bond market is a barometer for nothing, but the rates buyers are stupid enough to accept. Have you seen the speeches by Greenspan and by various Board Governors.

What happened to banks that loaned out money at 5 or 6% in the 1960s after the inflation of the 1970s. And what happened to bond holders? Was the bond market in the 1960s a barometer for hyperinflation and stagnation in the 1970s? I think not.

If oil prices are high for one day and drop back down, of course they won't affect core inflation. But if energy prices are high enough for long enough, of course they will affect inflation.

What do you think caused the inflation in the 1970s? Low energy prices????

This is a greatwebsite that everyone should check out. Saw it mentioned in the papers the other day.

http://www.federalreserve.gov/boarddocs/speeches/2005/

[squiffy]

First of all, the distinction between CORE inflation and energy prices is an artificial distinction, which I presume is drawn to determine how persistent long term price changes are.

If oil prices jump for one day, that won't necessarily produce price rises that are transferred to other products by businesses with pricing power.

But you cannot ignore the short term effect of higher oil prices on the spending power of Americans and businesses. If you have to spend more money on gas and transportation, you have less money in your budget for food, clothing, entertainment, etc.

Of course, you can also reduce your driving. So it's really a question of what consumers will do less of. In theory, they should buy less because oil prices are higher. If their driving is essential, and their demand for gas is highly inelastic, then they should by about the same amount of gas, pay more for it, and have less left over for other things.

You are saying that INFLATION is NOT causing the economic slowdown. But you are ignoring the INFLATION in oil and energy prices, which are a commodity which Americans purchase.

It is precisely that inflation in prices for a key commodity that is draining Americans' budgets and reducing the volume of gas they can buy, and or reducing the other items they can purchase, thereby slowing economic growth.

You are relying on the ARTIFICIAL distinction between CORE inflation and energy prices to cloud your characterization of the economic cause and effect.

Oil and energy are a key good. For purposes of analyzing economic growth, you need to put energy prices back into the analyis.

If you only use the CORE inflation rate, then you are ignoring energy and oil. If that is the case, there is no way to explain the slowdown in the economy that you are predicting.

If CORE inflation is down and nothing else matters, then people should be buying more and the economy should be growing faster.

[squiffy]

If you predict high inflation, you definitely would not buy bonds, unless they have some sort of escalator or inflation protection.

Generally bonds have a fixed price and long term bonds are at a 40 year low or so. So if you lock in record rates, and war and energy shortages cause the government to fund debt by printing huge amounts of money, that is not supported by actual work or wealth that Americans have generated, then rampant inflation could destroy the value of your bonds.

As another poster mentioned, commodities are one possibility but we need to be careful here.

If you physically owned 1 billion pounds of magic non perishable food, you would be in great shape. The food is inherently valuable, and in theory, you can just keep charging more money for the food, so that your real profit keeps pace with inflation. Or I suppose you could just barter, to take theinflation risk out of it.

But if you buy a company that makes money selling some commodity it's a bit trickier.

It's never been clear to me how well the stock market in general does in inflationary periods. I suppose it depends on the cause of the inflation and the degree of the rise. Mild inflation does not seem to be a problem.

But ultimately high inflation seems to be bad for most stocks and bad for the economy. It seems to slow economic growth and wreak a lot of havoc. And its not always easy for businesses to pass the high prices on to the consumer. And if they do, the consumer should buy less, slowing economic growth. If consumers buy less, business may start laying people off and you can get into a nasty stagflation cycle as in the 1970s.

So in an inflationary period, if you were going to invest in stocks, you would try to choose some product which people will NEED to buy, without regard to the high prices. Food, household items, and health care, to name a few.

I mean people do adjust. If heart operations get too expensive, I guess you could go to a shaman or pray a lot instead, but most people would be reluctant to substitute prayer for a skilled surgeon. So demand for food and health care should be relatively inelastic, and even with price rises, people will pay for those items.

But with everything else, people will just try to buy and spend less, in theory, as prices rise. Eat out less, travel less, fly less, subscribe to fewer magazines and cable channels, buy fewer CDs and DVDs, buy fewer computers, etc.

[FishHooks]

In theory it does, when unemployment is up people dont spend as freely and save more becausethey dont feel economically secure and they value the dollar more. However when unemployment is low people spend much more because they feel much more secure, but this is defiately not a bad thing.

[FishHooks]

[ QUOTE ]


Of course, you can also reduce your driving. So it's really a question of what consumers will do less of. In theory, they should buy less because oil prices are higher. If their driving is essential, and their demand for gas is highly inelastic, then they should by about the same amount of gas, pay more for it, and have less left over for other things.

[/ QUOTE ]

Very good point here. Gas is highly elastic in the long run, but in the short run its usually highly inelastic untill people adjust their behavior. People will defiantly start driving less and conserving more, which will bring the price back down. However the refinery problem is huge and I'm not sure how that will affect us long term, it very well could move the demand curve into a more inelastic state.

[FishHooks]

In theory stock prices should keep price with inflation. People spend more the company makes more (in terms of dollars not purchasing more). Then the company has a big cash flow and they can either give higher divident yeilds or buyback stock. They usualy buyback stock which will normally increase the price of stock and since the company will hold more of the stock it also becomes less volitile. So the stock market should go up. However long periods of inflation will really hurt because the buyers can't keep taking the hits of higher prices.

[squiffy]

In practice many stocks don't do well in times of high inflation. If you have stagflation, higher inflation and higher unemployment, people are not earning enough to pay the higher prices.

Pick one commodity, like energy. Hold everything else constant. Energy prices are rising faster than people's salaries now. So hold money supply and earnings constant.

As gas prices go up, everyone has less left in their budget, after buying gas to buy everything else.

Stock prices, over the long run, depend on profits earned by corporations. If people have less to spend, most corporations will not earn as much profit.

So stock prices should go down.

Only certain companies, selling certain essential high demand products, will keep pace with inflation.