Deflation downright daunting
Don Bauder
January 16, 2003
The latest buzzword is "reflation" – arriving slowly.
Increasingly, economists and analysts are concluding that the world's central banks are terrified of global deflation. Ergo, they will reflate – flood the world with liquidity.
Yesterday's news that the Producer Price Index was flat in December and down 0.3 percent excluding food and fuel will heighten deflation fears. For 2002, the index was down 0.4 percent excluding food and fuel.
With reflation, bond yields will rise and bond prices go down. Gold could continue up. Real estate could thrive if rates don't rise too much. And stocks might jump initially, although they will eventually suffer from rising interest rates.
But not all economists agree on these points.
In his January letter, bond guru Bill Gross of Pimco Total Return Fund in Newport Beach sees a "global grand scheme. The economic world's disparate interests are currently aligned because (of) a common enemy: deflation."
Such trends as globalization, excessive debt and China's surplus of cheap labor have raised deflation fears.
Japan cut its interest rates almost to zero. The U.S. Federal Reserve made 12 cuts in the federal funds rate, bringing it down to a paltry 1.25 percent. The European Central Bank is more cautious but has brought rates to below 3 percent.
The United States isn't admitting it, but it's aiming for a gradually weakening dollar, Gross says. That would be inflationary.
"Every weapon in the global arsenal will be fired at some future point to prevent declining prices and a concomitant economic collapse," Gross says. Reflation will mean that yields on Treasury paper will go up, bringing prices down, but this won't come quickly, he says.
Bert Dohmen of the Los Angeles-based Wellington Letter says, "Reflation will be the important, long-term trend worldwide over the next several years." Therefore, gold will continue to rise, he says.
But, like Gross, he says inflation won't come back quickly. Stocks will do well selectively, and are no sure thing, Dohmen says. Companies with good cash flows and dividends – including some utilities and telecoms – look good, he says. Homebuilding stocks look good.
But overall, "the trend for the next several years will be 'stuff,' rather than paper assets," Dohmen says. Many other commodities should do well, along with gold.
"There is a lot of reflation already out there," says Gary Schlossberg of Wells Capital Management in San Francisco. "The dollar's decline contributed to a rise in industrial commodity prices. Pricing power for big corporations should improve over the year."
He looks for a rise in bond yields of about three-quarters of a percentage point, and that will hurt bond investors, although there will be a snapback at some point.
In the gentle reflation, "there will be a friendlier environment for equities," Schlossberg says.
Ross Starr of the University of California San Diego says Japan will fight deflation by setting targets for low inflation. The U.S. Fed is ready to do the same if things worsen, but that isn't likely.
"Europe, Japan and the U.S. would be more prosperous if the U.S. had a higher inflation rate now, but the U.S. won't inflate to benefit the world," Starr says.
In any case, as the economy recovers, bond prices will fall, he says.
Hogwash, hogwash, hogwash, says A. Gary Shilling, economist of Springfield, N.J., reacting to reflationary talk. Deflation – not reflation – will be the dominant force of the next decade.
What about all that money the central banks will be printing to defeat deflation? "You can lead the money horse to water, but you can't make him drink," harrumphs Shilling, noting that the Fed's 12 interest rate cuts didn't create inflation or recovery.
"They can flood the banks with money, but the banks are scared to lend and creditworthy borrowers don't want to borrow," Shilling says. "So we're pushing on a string."
The dollar's weakness will only be temporary, he says.
He notes that all the liquidity created by Japan hasn't brought inflation. That nation is still deflating. Shilling still likes bonds.
"There are not many of us who like bonds," he says, but he is frequently doing battle with the consensus, and is quite often right, as in recent years.
He likes some stocks, particularly regional banks. "They can borrow short at lower rates, and lend long at nice spreads," also pay decent dividends, and there is a possibility of takeovers," Shilling says.
--------------------------------------------------------------------------------
Don Bauder: (619) 293-1523; don.bauder@uniontrib.com |
