Third quarter was a volatile quarter. The return figures shown on subsequent pages makes that point abundantly clear. Despite the collective efforts of central banks worldwide, there is a persistent problem finding an elusive solution. With the holidays quickly approaching, there may be one gift that would make central bankers, and some investors, celebrate: inflation!
You might ask… Isn’t inflation supposed to be bad? Yes! Unless you don’t have it and you need it. The Federal Reserve has two primary mandates: price stability and full employment. Price stability doesn’t literally mean prices don’t increase, but that they increase in a slow, methodical, and semi-controlled manner. If there is anything financially worse than inflation is deflation and that is the battle being fought across the globe.
In a deflationary environment, prices actually decline. While that may sound great on the surface, it is a very destructive dynamic for an economy. If you know prices will be lower tomorrow, you might put off your purchases until tomorrow. Better yet, the longer consumers put off purchasing goods and services, the lower the future expected price. This is a destructive cycle that only reduces economic activity.
To combat global deflationary forces, central banks around the world are promoting very accommodative monetary policy with the desire of keeping interest rates at or near zero to encourage spending and low cost financing to drive economic growth.
Unfortunately, the lack of economic growth around the globe is leading to several factors that are keeping prices depressed and, in some cases, falling. Commodities, such as oil and most metals, have sharply fallen due to reduced demand.
Another challenge is foreign currency valuations. Since most of the world economies are struggling to generate growth, a common tactic has been to lower their currency valuation to make that country’s products more cost competitive in international markets. Countries are seeking to grow their way using foreign markets as export engine for domestic companies. The effect of all this competitive currency devaluation is the importation of lower prices into the United States which is keeping prices lower and hindering the Federal Reserve’s desire to raise interest rates off this zero percent floor. As you see in the graph, year over year inflation has dropped to 0.0% in September 2015, perilously close to deflation.
Fed Chairwoman Yellen cited improvements to the labor market, but supported the decision due to the “recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.” The Fed felt that the slowdown in the Chinese economy could pose meaningful risks to the global economy. Meanwhile, most Fed Committee members acknowledged that “the improvement in labor market conditions met or would soon meet one of the Committee’s criteria for beginning policy normalization.” Fed officials also noted a potential downtown in the global economy could spur stronger demand for the safe-haven dollar, putting additional downward pressure on inflation.
So, this holiday season, do your part to make prices go up. Even just a little bit. One way to do that is reduced productivity! Best wishes to you and yours for a happy, relaxing, and less productive end of the year!