This is a questions I think about a lot. Because what we decide to invest in from this point forward is basically dominated by what we think will deflate and what we think will inflate. (Does anyone use the word “appreciate” anymore?) No one seems to argue that we’re in a recession and the “de-coupling” theory seems to be getting shot down more with every passing day. So it’s looking to be a global slow down.
Going back about 30 years or so, historical data seems to indicate that recessions are initially deflationary and then as we climb out of the recession, or as time passes, we start to experience inflationary pressure. And this is true for most of the first world economies. This is probably due to the lag effect of the Fed policy flooding the market with cheap money when we’re in agreement that a recession is upon us. As the cheap money effect kicks in, we start to see economic growth and inflation. Similar to what we experienced going from 2002 to 2003 and 2004.
Once there’s agreement that there’s no growth in the near future, everyone starts to look for ways to reduce costs. This tends to put a deflationary pressure on prices. What if corporate America not only lays off domestic workers, but also increases it’s flight to cheaper production and off-shore activity in order to further reduce costs? What if constricted credit remains tight or is tightened-up more in the future? In other words, what if the cheap money is put to work mostly in places outside of the USA? This scenario would lead me to think that if we dont get the growth factor from the cheap money and other countries do get it, then we’ll experience inflation on products with a global demand while we remain in a deflationary mode for things specific to our economy, like housing and wages.
I dont know how this will play out, but it seems like that’s where we were headed in 2002, but then a lot of cheap money got directed into the real estate market and that’s where most of the domestic economic growth was created from 2003 to 2006. Where will the money go this time?? Will it be able to find another vehicle in the USA?