Price Levels

Everyone’s attention seems to be focused on whether we’ll see deflation or inflation in the US economy (and in the global economy) as we move forward.

On the deflation side, we have the moribund housing market, falling or stagnant consumer spending, along with falling incomes and rising unemployment, and on the inflation side we have truly massive money creation led by the Fed, followed by the Treasury, and finally by the Federal government in the form of federal stimulus packages, all on borrowed money.

Which of these two forces will prove to be more powerful?

I live in San Francisco, one of the more expensive urban centers in the country. In my neighborhood, I see flyers posted that say “One Hour Massage, $40”. It caught my attention because I think that price is half to a third the price you would have paid two years ago. Basic economics: if goods and services won’t sell at a given price, then the price will fall.

The bond market may provide us with a clue, as bond investors are highly concerned about inflation. The yield on the bellwether 10-yr US Treasury bond has been dropping rapidly. Since mid August, the yield has fallen from 3.8% to close below 3.2%. This may mean that bond investors are taking a stand on deflation, but it may also mean that investors see the rally in the stock market ending soon, and they’re getting back into Treasuries for a safe haven. The surge in gold prices to close above $1,000 for six days seems to lend support to the safe haven thesis, but it also could support the inflation thesis.

Oil and copper are also important signals to the strength of the global economy. Both seem indecisive after strong gains this year. The same can be said for the CRB commodities index, which is up 25% from its low this year, recorded back in March.

Given all this indecision, we may see a bifurcation, with certain commodities and services rising while others fall. We await, with bated breath, the next round of economic developments. The latest labor market data indicate that the US economy shed 263,000 jobs last month, for a total of about 7.2 million jobs lost so far during this recession. That is a truly stunning number, made all the more serious when one considers that the economy must create 150,000 jobs or so each month in order to simply keep pace with population growth.