Eat Chocolate and Buy New Underwear
…and other financial commentary

Lynn Harsh

Winners and losers are made in every type of economy, and it’s more likely the winners will be thoughtful and better informed about the root of problems and what to do with their assets. Few of us are ideally suited to weather an uncertain future, but since we’re in one, we might as well do the best we can. I’m forwarding some comments to ponder.

Informed people are not claiming our economy will quickly return to vibrant health. The serious arguments today are over which demon to fight—inflation or deflation—and over how long a time. Since the survival or comfort conditions for each are different, it is wise to think about them carefully.

What if it’s deflation, which worries plenty of people right now? In that case, you might want to put off spending money buying a house or five-year’s worth of underwear or a large stash of chocolate. Prices for most things we need fall during deflationary times. If you have dollars left after the recent carnage, they will become worth more—because there would be less of them in the economy as a whole.

The argument for deflation goes like this: We are experiencing a reduction in liquidity (the availability of cash), a general decline in prices on big ticket items, decreases in investment spending, and resultant rising levels of unemployment (pushing down wages). Treasury Bill yields and long bond yields have shrunk and risk spreads have widened—usually signs of actual or potential deflation.

Most people accumulate debt during these times. Even though costs for the big items we buy are lower, our incomes don’t increase enough to offset the lower costs. In other words, new underwear and good chocolate might cost 10 percent less, but your income might be 15 percent lower—if you have a job (most of you will). During deflationary times, most businesses face increasing debt, too, because prices are lower for the goods and services they produce. Many go out of business. This increases unemployment.

Deflation is very difficult to stem. It took a decade for Japan to beat deflation and regain economic health. Let me repeat that—it took ten years for Japan to overcome deflation. Sustained deflation leads to economic depression.

The better part of wisdom during deflationary periods is to pay down debt; lock in fixed income assets at the best rate you can get (consider T-Bills); save as much as possible; and choose dividend-paying stocks or shares of companies that make products you will find in anybody’s medicine cabinet or refrigerator.

Deflation means fewer dollars are moving around in the economy. This only happens if government chooses not to print new money, while at the same time getting less from us in taxes. That means government has less money to spend. That is, deflation is only likely if politicians decide to stop spending and printing so much money.

Hmmm.

So … I’m betting on buying new underwear, chocolate and other basic necessities during the next year… and preparing for inflation not too far down the road.

Moderate deflation may lurk around for a while, and there’s a chance it’s gone too far to be stopped. But our economy has become addicted to creating wealth through artificially elevated prices. Government is particularly vulnerable this way. One example: if Congress permits deflation and the recovery takes a decade as it did in Japan (and in America in the 1930s), our government will have to pay retirees more than the current estimated payout value of Social Security benefits. Remember, a dollar is worth more during deflation. Multiply that problem times the other huge government entitlement programs and you can see why elected officials can’t allow deflation, at least not on purpose.

To further underscore my skepticism about laissez-faire deflation, let’s do a little math. Add up the public debt created by Medicaid, Medicare, Social Security and the pharmaceutical bill, with the immediate and deferred cost of the war. That amount is more than $30,000 for every man, woman and child in America. Then add in the costly new TARP (bail-out bill) we taxpayers own. Who knows the size of that bill! Subtract from that potential total, the likely revenue government will get from taxes, investments and other sources.

Think of the proposals for new government-run programs like health care, increasingly regulated labor markets, and a decaying infrastructure (bridges, roads, etc.). A slowdown of government spending is not in sight—at least I don’t see it. The result will be lots of red ink.

Government’s remedy for red ink is green ink—printing money. I believe the Federal Reserve and Congress will use any means within their powers to prevent deflation. Printing money for continued spending creates inflation.

Two key reasons we haven’t already experienced runaway inflation are technology and the expansion of global labor markets. Technology makes us more productive. New labor markets in emerging nations moderated the inflationary pressures that businesses experience during an economic expansion. These factors do not favor America so much now.

Intentional inflation is theft—a secret tax, if you will. You might even call it taxation without representation. And whether its inflation or deflation, most of us will experience decline in our standard of living for some years to come.

Can either scenario be stopped? Sure! Government can reduce spending, eliminate regulations and taxes that hurt job growth, and stop printing money to pay for debt.

So like I said, I’ll be needing chocolate!

During inflation debt like your mortgage payment is smaller in relative terms than rising prices and salaries. So, keep your job and make your payments. Consider investing in food, energy, comfort items, precious metals and necessities that nearly everyone has in their household.

Money market funds that beat inflation, if you can find them, are good places to park dough that you might need to access quickly.

Whatever you do, please don’t hoard, panic, live in fear, or bury your head in the sand. People who do this cannot see the opportunity that will certainly come knocking during these times. And it will knock. They cannot reach out a hand to help others. They cannot see the hand reaching out to help them.

There are 535 reasons for us to educate ourselves and speak up. That’s how many members of Congress run this country on our behalf, but they really aren’t the bosses. We are. In Washington state, another 149 people serve temporarily as our part-time elected leaders. We will get the quality of government we ask for, and right now most of us are asking our elected officials to guarantee us too much stuff, paid for with someone else’s money.

Some of you reading this article have experience or personal opinions about these matters. It’s your turn to comment. Feel free to disagree with me or add to what I’ve written here. Regardless,

I’m going to eat chocolate.