Painful Solutions to our Debt Crisis

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)


Last week’s contribution - "Inflation? I Spit in your Face!" drew an interesting question.

How does our national debt factor into the equation of my non systemic inflation argument? The answer is an easy one and somewhat of a copout. It depends on how the government intends to correct our addiction to the debt problem and looming crisis. Debt in itself is inherently deflationary if you agree with the premise that it must be serviced and eventually repaid. The whole process of deleveraging, reducing the amount of debt, is anything but inflationary for individuals and companies as we saw in 2008 on steroids!

Let’s walk through some scenarios on how Uncle Sam can attempt to fix the problem.
One way to eradicate ourselves of debt is print our way out. The Federal Reserve would monetize by essentially printing money and buying up all of the Treasury bonds, notes and bills. As you can imagine, that would flood the system with more money than it has ever seen and likely cause our currency to completely collapse, which would make all assets denominated in dollars (oil, grains and other commodities) skyrocket to crisis levels. It would also likely trigger more systemic inflation with money velocity soaring along with wages.

Think about the million, billion and trillion dollar Zimbabwe notes or the Weimar Republic post WWI with folks using wheelbarrows full of money to buy groceries from always bare store shelves. Dollars would be worth much more today than tomorrow so people would spend them as fast as they came in. Prices and interest rates would rise day after day, week after week and month after month until the crisis abated. The U.S. Treasury and government would also lose credibility and investment grade credit ratings around the world for a measurable period of time. Our economy would likely collapse.

The opposite end of the spectrum would be strict austerity to cure our debt problems. In that case, government spending would be cut, cut and cut some more, triggering rolling recessions with intermittent periods of stability rather than recoveries. In an extreme case, as we’ve seen abroad, strikes, protests and even riots could fill our city streets. It would “feel bad” for an extended period of time, perhaps a decade or more, but the U.S. would emerge with a very lean and competitive society at the end.

The best possible - and most unlikely - scenario to cure our debt problem would come from organic economic growth. By growing the economy, the percentage of debt to GDP would be reduced, not to mention all the added tax revenue that would come in to the Treasury. I don’t think anyone really thinks this can work now.

One proposal in Congress that I totally disagree with is to simply raise taxes on the wealthy to solve the countries addiction to debt. To begin with, I have seen study after study that shows decreased tax receipts from an increase in tax rates. Increasing tax rates generally hinders economic growth. Additionally, roughly 75% of all discretionary spending (cars, travel, non-staple retailers, leisure, etc.) is done by those making $250,000 or more. How do you think that group would react to having their tax rates rise dramatically? In fact, many of those folks are small business owners, which our economy is built on, and run their finances through their personal tax returns. How do you think a sharp rise in taxes would affect their hiring?

Before someone responds by telling me to look at how well the economy did with higher tax rates under Bill Clinton, those were different fiscal times. We did not have a debt crisis or a structural unemployment problem. The ground was very fertile for growth in the mid 1990s following the S&L Crisis and recession of the early 1990s.

Look, in the 1940s, the top tax rate was more than 70 percent! And the economy grew like a weed. I can’t imagine anyone arguing that our economy could survive rates even close to that today. It would be worse than the Great Depression. My belief is that trajectory is more important than the absolute rate. By cutting taxes from 70% to 60%, that is incredibly stimulative. By raising taxes from 30% to 40%, it is highly restrictive.

I have said for three years that we have run out of painless solutions. It’s going to hurt! Pick your poison. If I were in Congress and not beholden to special interests (HA!), I would cut $100B to $150B from the federal budget every year for the next 10 years. No area would be unscathed, including entitlements and defense. That would certainly curtail growth and make us look more like a European country than the U.S.
At the same time, I would completely revamp the tax system and broaden the tax base. Too many people have used gimmicks and loopholes to avoid paying taxes. We need to remove so many of the insane deductions and credits. The time has come. Sorry big oil, but you have made hundreds of billions of dollars over the past decade and your subsidies and tax credits are absurd. Sorry big corporate farms, but paying you not to grow crops is ridiculous when food prices are at all time highs. When we had a glut of crops and the farming industry was on the verge of extinction, I may not have agreed with the subsidy, but I understood. Now it’s an embarrassment.
At the same time, we need to incentivize R&D in cleaner and greener energy, but not superficially as we’ve seen. We really need to make it appealing for entrepreneurs. Look at how many of the great companies were born during a recession in someone’s garage. Anyone know of a company called Microsoft? The government needs to step up and allow that ground to be fertile again.

Finally, I would be naïve if I thought this could get through Congress without any compromise. While I do not believe in higher taxes, especially in the corporate world where companies just park themselves offshore, I understand that there has to be some give and take. On the social security front, I would accept raising the tax rate and the amount where it is capped in return for also raising the age to 70 over the coming decade or so with further increases if life expectancy increases.

So in the end, I believe there is only one scenario where our debt crisis leads to systemic inflation and I do not think that path is likely. We have become a country of instant gratification and whiners, me included. If America is truly going to solve our debt problems and reliance on foreign capital, we are all going to have to sacrifice over this decade.

FYI, I will be on CNBC’s Worldwide Exchange from 5:35 a.m. to 5:55 a.m. on June 7.

Feel free to email me with any questions or comments at Paul@investfortomorrow.com.


Until next time…

Paul Schatz
Heritage Capital LLC
http://www.investfortomorrow.com/
http://RetirementPlanningConnecticut.com/

Follow us on Facebook at www.facebook.com/heritagecapital and on Twitter @Paul_Schatz

Inflation? I spit in your face!

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

Before I dive into today’s controversial topic, I want to say goodbye to one of the true pioneers in business television, Mark Haines from CNBC’s Squawk on the Street who passed away suddenly this week at the far too young age of 65.

From his FNN days in LA to the CNBC merger to the host of Squawk Box to creating all of the popularly used on air nicknames to his final spot hosting from 9am to 11am, Mark Haines was the consummate professional. 

Never shy or intimidated by a guest, Mark would not hesitate to challenge your view and force you to defend your position.  With his unique eating habits and flair for the dramatic, Mark Haines was one of the faces of the network.  You can Google some of his more interesting moments, like cutting his tie in half, donning an Army helmet during the Dotcom collapse and calling for a stock market bottom in March 2009. 

When I started marketing to the media to build my profile in the mid 1990s, one of my long-term goals was to be interviewed as the stock market opened by Mark Haines.  Thankfully, I achieved that goal several years ago and have enjoyed every interview with Mark ever since, especially the one where he challenged my view about using different analysis in deflationary times than inflationary times. 

I never met Mark Haines in person, but he is someone who has been part of my business life for decades and will be sorely missed.  May he rest in peace…

And now to the topic at hand.  With so much attention paid to commodity inflation lately, I thought a good item to discuss inflation in general. 

Longtime readers have known that since 2007, I have been in the deflation camp, not believing for a minute that serious, structural and systemic inflation was anywhere in our immediate future.  And I still share that view today.  Comparing this period to that of the 1970s, or Argentina, Zimbabwe or the Weimar Republic is just plain absurd in my opinion.

YES, we have commodity inflation.  I agree!  But I side with Ben Bernanke that it is more transitory than structural.  Real inflationary problems usually have certain DNA markers, such as money velocity in the financial system.  Essentially, that means banks take in money and create many, many more dollars from that single dollar.  Today, we still see record amount of cash held at the Fed on behalf of the banks.  Add to that, more than $1T on corporate balance sheets and you can easily conclude that companies are in no rush to deploy their capital.  In other words, a dollar is worth more tomorrow than it is today.  That’s the opposite of inflation where a buck is worth more today than tomorrow!

Other systemic items include capacity utilization.  While those numbers have climbed from almost depressionary levels below 70, they are nowhere near the 85%+ that would be worrisome as you can see from the St. Louis Fed graph below. 

Look out of your window at the housing and job market.  With housing stable at best and the average person’s largest asset, you would be hard pressed to offer that there is even the slightest of inflation here.  And the employment picture, while much better than in the heat of the crisis, continues to show more than 9% of the workforce unemployed, 10% if you trust the Gallup poll below. 

But digging a little deeper, the “real” unemployment rate, taking into account the underemployed and discouraged (U6) is almost 20%, according to Gallup.  I am not sure anyone can use this data to support the inflation argument.

Turning to one of the most important measures of systemic inflation, wages and wage growth, you can see below further evidence that supports my thesis that structural inflation is not a problem.  Think about what happens when everyone makes more money than last year and the year before.  Most people spend it!  More dollars chasing the same number of goods and services.  So prices rise.  When wages fall or stay flat, like they have most of the past 11 years, you have fewer or the same dollars chasing the same number of goods and services.  Prices stay flat or fall.

Remember, inflation is measured by price changes on year over year basis.  If oil goes up 100% in 2011 and remains at that same level in 2012, inflation is actually 0% in 2012 even though prices are high.  It’s the year over year change that signals inflation.

In the end, while it is painful at the pump and at the grocery store, I do not believe that consumer commodity inflation is here to stay and will be a long-term, systemic problem.

FYI, I will be on CNBC’s Squawk on the Street at 9:35am on May 31.

Feel free to email me with any questions or comments at Paul@investfortomorrow.com.

Until next time…

Paul Schatz

Heritage Capital LLC

http://www.InvestForTomorrow.com

http://RetirementPlanningConnecticut.com/

Follow us on Facebook at www.facebook.com/heritagecapital and on Twitter  @Paul_Schatz

Stock Market Building Towards THE Peak

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

As I write this Federal Reserve Chairman Ben Bernanke is just beginning his first ever, "official" press conference. As savvy as he is, (remember his first 60 Minutes interview right at the bear market low?) I doubt that we will hear anything unexpected in his remarks or his answers to media questions.

The latest bull run in stocks that began on March 16 remains alive and well. A few weeks ago, I offered that since we saw some of the key indices making new highs, that boded well for the others to play catch up. Since then, the Dow Industrials, Dow Transports and S&P 500 have scored fresh highs with the Nasdaq 100 a few cents away.

On the flip side, volume remains woefully pathetic and eventually that's going to matter. Sector leadership is very good, BUT the key financial sector is behaving very poorly. With the indices at new highs and this group in a downtrend, something has to give sooner than later.

So far, nothing has changed in my thinking that a possible significant peak is building sometime this quarter. Besides what I've already mentioned, I am focusing on the junk bond and small cap areas where the first sign of evaporating liquidity should be seen.

The initial decline from any major top is going to look exactly like every other small pullback, only in this case, the next rally will fail short of new highs and a sharp, relentless decline will ensue. As always, we will take it one step at a time and do our best to protect the gains we've been fortunate enough to make.

I hope that none of you are sitting back, complacently believing that we survived 2008 and all is good in the world. That we are on the cusp of another decade long bull market to untold riches. In case you haven't realized it, the stock market (and many, many, many mutual funds) is at the same level it was 12 years ago! That's essentially 0% return on your money BEFORE inflation! So factoring in that pesky inflation thingy, you end up with a significant loss.

I urge you! I beg you!! You have a plan in place in case you get into a car accident. You have a plan in place in case your house burns down. Don't sit back and hope that everything works out with your money. Now is not the time to procrastinate. It's the time to put a plan together. Investors don't plan to fail; they fail to plan!

Feel free to email me with any questions or comments at Paul@investfortomorrow.com.

Until next time…

Paul Schatz

Heritage Capital LLC
http://www.investfortomorrow.com/
http://RetirementPlanningConnecticut.com/

Follow us on Facebook at www.facebook.com/heritagecapital and on Twitter @Paul_Schatz

Fearless Forecast 2011

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

One of the most worthless yet enjoyable topics of the year is the pundits annual forecast.

An unusual amount of time is spent discussing this in the media, but after January, no one ever reviews again nor seems to care. I usually end December with an idea of what I see ahead and then adjust according to how many others agree with me. As you know from reading the blog, I don’t like to be in the majority as that group is typically wrong.

Before I get to my forecast, which is not my annual “Shockers” list due out later this month, let’s do a quick review of what I envisioned for 2010.

Stock market - I thought we would see a generally flat market, somewhere between -5% and +5%, not the 15% we so gladly enjoyed! I thought the April peak would stand for the year. Stocks did go higher at the end of the year, but that call was pretty much correct. I forecasted a double digit decline, but thought it would unfold in Q4. We saw a 16% hit during the summer.

Long-term treasuries - would be a surprise leading asset class. They actually melted up through August and then melted down through November, finishing up 9%.

Dollar - I was bullish the dollar in 2010 and it gained a whopping 1.37%.

Gold - I was positive on gold and it gained 29%.

Inflation – It’s been the same forecast for 2010, 2009, and 2008. Inflation remains under wraps and not problematic.

Economy – I thought GDP (gross domestic product) would hang in above 0% during the first half and slip back into negative territory later in the year. I was right on the first part, but wrong on the second part.

Bernanke & Co. – Short-term rates would not be touched in 2010 and they are still in the same spot as they were 12 months ago.

So now, let’s get to my forecast for 2011

 The sooner I get it out there, the sooner I can be proven wrong! As always, I had a lot of fun thinking about it and creating it, although it has no bearing on how we manage money for our clients.

Stock market – We are now in the 3rd year of Obama’s term (presidential cycle) and traditionally, it’s the most bullish of all with an average return of 17% and only one down year in the past 70 years. When you examine the stock market decade by decade (decennial pattern), you find that the first few years of the decade tend perform worse than later in the decade. That’s two nice contradicting pieces.

Let’s add the almost uniformly bullish predictions from Wall Street into the mix with the average strategist forecasting double digit returns. Even former Merrill Lynch honcho and usually skeptical Richard Bernstein sees a 15-20% return for stocks. That’s shocking and worrisome! I have research dating back to 1990 and that group has been wrong roughly 75% of the time, although they hit the bulls eye in 2010. Kudos!

For 2011, I think the stock market will end the year modestly in the black, but only in the mid single digits. I envision corrective behavior in the spring with a more significant correction in late summer to fall.

Long-term treasuries – After attempting to rally in Q1, bonds resume their slide during the first quarter and into Q2, but firm up during the second half of 2011.

Dollar – I remain bullish on the greenback over the long-term, even if we see another selling wave back to the old lows. Ultimately, I think the dollar index will hit 100 and the euro will slide back below 100.

Gold – Clearly, after back-to-back strong years, gold is due for some pause to digest, in the short, intermediate and long-term. That can take shape in many ways. I think 2011 will bring a significant increase in volatility and I would not be surprised to see a $100 down day during the year. When all is said and done, I believe we will see at least $1500 hit during the first half of the year, but not another vertical assault like we saw in 2009 and 2010. Based on history, the year should end up with modest single digit returns, best case scenario, but outperforming its cousin, silver. Should that roadmap unfold anywhere close, that could set the stage for a monster blow off to the upside in 2012. But that’s getting laughably ahead of myself.

Inflation – Unlike the past few years, I see headline inflation percolating a bit, especially during the first half of the year, but the core (excluding food and energy) remaining tame.

Economy – If this was a “normal” recovery, GDP should explode higher this year, but especially during the second and third quarters. But I just can’t subscribe to the “normal” recovery theme. The economy has been juiced with free and easy money for years and once that spigot is turned off, similar to what FDR did in 1937, I believe we are in for trouble. Thankfully, Congress learned from their predecessors’ mistakes in 1937 and did not allow taxes to increase in 2011. Don’t underestimate how much that saved the economy and markets!

Federal Reserve – As the voting members of the FOMC turnover, expect the Fed to mirror Washington and get stuck in gridlock. Bernanke loses some internal power with Kevin Warsh sliding more towards the hawkish side and Plosser and Fischer coming back to dissent and push a more neutral stance once QE2 runs out by June. Keep a close eye on the two year note as the markets may force Bernanke’s hand later in 2011 to take action he clearly won’t want to take.

Unemployment – Sadly, the jobless recovery continues and unemployment stays stubbornly elevated above 8.75%. I think it’s going to take a second recession to cleanse the system and get put unemployment on a path back to 6% or lower sometime later this decade.

Natural Gas – Surprise! Surprise! Finally, the bulls take control and natural gas ends up as one of the top performing assets of the 2011.

So that’s it. Another fearless forecast in the books. I may add some items next Friday as I continue to read, research and digest, but I think you get the picture. As always, I am eager to hear to your comments. Please don’t be shy about emailing me!

FYI, I will be on CNBC's Squawk on the Street on Jan. 11 at 9:35 a.m.

Feel free to email me with any questions or comments at Paul@investfortomorrow.com.


Until next time…


Paul Schatz
Heritage Capital LLC
http://www.investfortomorrow.com/
http://RetirementPlanningConnecticut.com/

Gold Continues Safe Haven Status

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

Before I get to the theme of today’s post, I wanted to offer a quick stock market update. Several weeks ago in Let's not Forget the Dead, I mentioned that our investment models raised some warning flags and although I still had a generally positive “feel” on stocks, we did some significant selling around Dow 10,400 and S&P 1116 to carry at least 50% (if not more) cash in most portfolios.

That changed last week as the 8-10% decline across the major indices was enough for our models to start putting money back to work on July 1. While I do not believe this is the launching ground to new 2010 highs, the odds do favor a 5-10% rally over the coming weeks as earnings season officially kicks off next week with Alcoa. This is one period where I will be dancing very close to the door and not be overexposed to risk.

Now, on with the “meat” for today…

Although the second quarter of 2010 was not kind to the equity markets, the forces that be rewarded precious metals investors, along with their cousins in the gold and silver mining stock sector. Gold tacked on another $100 plus as fears over a European sovereign debt default saw Euro currency investors run for the exits under the cover of gold and the U.S. dollar. But wait… gold and the dollar rallying together? Don’t they always trade inversely (opposite) like the rest of the commodity space? They usually do during “normal” times, but these times are far from anything “normal”.

Gold and the dollar (including U.S. treasuries) have been some of the few safe havens this year in the financial markets. What’s different now from 2008 is that during the deflationary, panic-driven collapse that hit after Lehman’s bankruptcy, all assets except for the Japanese Yen and U.S. treasuries were decimated, including precious metals. This year, and specifically since the April peak in the stock market, the metals complex was added to the “protected” list.

Although our posture on gold often swings from very positive to very negative (and everywhere in between), we’ve been bullish over the intermediate-term since our contribution entitled Gold Getting Ready for Another Assault. At the same time, and over the past three years, we’ve remained very negative on inflation, meaning that we do not foresee any meaningful rise for the foreseeable future. While that may run counter to your intuitive thinking, gold and the Consumer Price Index (CPI) do not have a very strong historic correlation, which says that gold is not the perfect hedge against inflation.

Since its major bottom in October 2008, gold has rallied roughly 85% without any sign of inflation. At the same time, the dollar is essentially unchanged. We believe that gold’s shine during the attempted, but failed, reflation by the Fed as well as its performance during the current mild deflation continues to indicate a solid bid (underlying strength) beneath the market as global investors seek refuge from paper currencies. Until that sentiment changes with another tsunami of powerful, deflationary deleveraging, precious metals can continue to be bought into normal, routine and healthy bull markets corrections, like the one we are currently seeing.

I am scheduled to be on CNBC’s The Call this Monday, July 12th, between 11:05am and 11:20am. You can view all of our past media appearances, good, bad and disastrous right here.

Feel free to email me with any questions or comments at Paul@investfortomorrow.com.

Until next time…

Paul Schatz
Heritage Capital LLC
http://www.investfortomorrow.com/
http://RetirementPlanningConnecticut.com/

Is Inflation STILL Dead?

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)


Last week, I talked about the Summer Rally Trying to Begin. The stock market was showing classic signs of being washed out of sellers with so many indicators reaching extreme levels, like pulling the rubber band and finally letting go to snap back in the opposite direction. Everything was set up for a rally to begin, unless of course, it was one of those once every 10 or 20 years where the system temporarily breaks and we see an elevator shaft mini crash. The odds heavily favored the rally.

Fast forward a week and the market is basically in the same spot. We saw two modest down days and one big up day, plus today (June 3) which is up slightly as I write this. Stocks are “supposed” to get in gear to the upside now, but they are certainly taking their sweet time. The longer it takes to really get going from an extreme oversold condition, the less powerful the rally usually is.

Since I stand by my year old forecast that the next rally is the last one before a major correction sets up, the market continues to live on borrowed time. As a bull, I would like to see the Dow Jones close above 10,500 to confirm the bottom has been hammered in and set the stage for a move towards 11,000. I reiterate my risk/reward comment from last week that it’s plus or minus 5% on the downside and 10-15% on the upside.

Although I’ve been very positive on gold since Gold Getting Ready for Another Assault in mid March, my position has not changed one bit in the past THREE YEARS that inflation is dead, kaput, dormant, asleep, etc. As I’ve mentioned before I am far from a gold bug, even though our firm has more assets in our two gold strategies than the other seven and rising gold has significant benefits here.

Research has shown that gold is not a good predictor of inflation nor is it the best protector against inflation. In industry jargon, you could say that gold is not highly correlated to the CPI, which is the consumer price index, a popular measure of inflation.

For a long while, I’ve struggled to figure out how I could be positive on gold, yet still believe that deflationary forces are the dominant player in our economy. Deflation, the general decline in the price of goods and services, is the exact opposite of inflation and was the topic here last year, DEFLATION: The REAL Boogeyman to Fear. During “normal” deflationary times (if you can even use such a cavalier word for this), which there are only two modern day examples, almost all assets decline in value. It’s often referred to a black hole or spiral as the gravitational pull sucks everything in and won’t let it out.

Anyway, during deflation, as we saw in the 1930s and Japan since 1990, gold declines along with other hard assets. As we saw in 2008, there is mass run to the safest currency, the U.S. dollar, along with other “safe” instruments like treasury bills, notes and bonds.

So, if I think deflation has more to play out, how can this foot with being positive gold?

My answer comes from looking across “the pond”. The Atlantic Ocean, that is. The only way I can see gold rallying during another bout of deflation is if we see a stampede away from paper currencies. We’re all watching the mini collapse of the Euro currency now as their problems continue to worsen. What if those problems spread to Asia and back to America later this year and into 2011 and 2012? Wouldn’t that cause the global governments to fire up the printing presses that would make 2008 look like a picnic? That’s the only way I can see gold rallying with deflation. It’s not a pretty picture and I pray the various Feds and governments wake up fast enough to head off that stampede.

Back to inflation (or the lack thereof) to finish this post. I never bought the idea when the Fed began printing money and creating all these cutting edge, outside the box programs that inflation would rear its ugly head. And when they went to Red Alert, their quantitative easing programs and began buying treasury bonds and mortgage backed securities, I knew Bernanke was in panic mode that a deflationary spiral was setting in.

I’ve said this for three years now. Ben Bernanke would light up a cigar, open the best bottle of wine he could find and do a victory dance if the Fed could somehow engineer a little inflation. With wage growth negative, capacity utilization modestly recovering from the abyss and money velocity tame, there is almost zero chance for problematic inflation until we overcome the deflationary pressures.

FYI: I will be on CNBC’s The Call on Mon., June 7 between 11:05am and 11:20am.

Feel free to email me with any questions or comments at Paul@investfortomorrow.com.

Until next time…


Paul Schatz


Heritage Capital LLC


http://www.investfortomorrow.com/

DEFLATION: The REAL Boogeyman to Fear

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

Over the past year, there has been so much talk about the coming inflationary problem. Some have even speculated that we would see hyper-inflation, like Zimbabwe, Argentina or the Weimar Republic post World War I, where we would need a wheelbarrow full of money just to go grocery shopping. I have not been in that camp. Rather, I am MUCH more concerned about the opposite of inflation, and that is deflation.

In the grand scheme of things, there is a very long-term cycle at play around the globe. If we start with inflation (prices going up and increasing) that leads to disinflation (prices going up at a slower pace). We then move to deflation (prices going down sharply) and finally reflation (prices going down at a slower pace). Our economies and markets tend to function best with mild inflation or disinflation.

At the most basic level, inflation involves too many dollars chasing too few goods, which causes prices to rise. Deflation, however, is too few dollars chasing too many goods. It’s a simple supply/demand analysis. Since late 1998, our economy has struggled with periodic bouts of deflation that really began with the explosion of the Internet. Think about it for a minute. Besides the convenience of shopping from your home or office, why do most people use the Internet? Because it’s cheaper for the exact same product! The Internet has actually caused many goods and services to decline, which is deflationary.

Look at computers, for example. I remember paying $2500 for laptop in the mid 1990s that wasn’t even 1/1000 as powerful as the one I am using right now for less money. Technology is actually a deflationary force that benefits the economy.

If I had to grade it, that sort of deflation would be considered mild or acceptable deflation. The problem we are facing now is much more serious. Every month the government releases a figure called Hourly Workweeks for Production and Non- supervisory Workers, which lets us know the average number of hours worked each week. During economic expansions, that figure tends to rise as companies have more demand and need to produce more so workers work more. It’s fairly simple.

Today, the average workweek is down to roughly 33 hours, which continues to make new lows month after month. Couple that with a dramatic decline in hourly earnings and the U.S. economy is left with wages at 1982 levels. Think about that. The average worker is making the same money as he/she did two decades ago! Since we already know that too few dollars chasing too many goods is deflation, this is not and has not been good news for years.

I have heard all the arguments that the Federal Reserve has printed TRILLIONS of new dollars and that is certainly inflationary. But that doesn’t accurately tell the story. I agree 100% that Helicopter Ben Bernanke & Co. are trying to print their way out of this mess. But they’re not even close. The credit market used to represent more than $50 trillion dollars. Yes, you read that right. $52T. That entire market has essentially been vaporized by the financial crisis. It really doesn’t exist anymore. The alphabet soup of products like CLOs, CMOs, SIVs, CDOs. POOF! Gone. May they rest in peace.

So if the global financial system lost $52T and our Fed, along with the European Central Bank and Bank of Japan printed roughly $10T, that’s still $42T that’s been removed the system, like a giant sucking sound! Try to fathom the global economy losing $42T of spending power. It’s not a pleasant thought! With the banks realizing trillions of dollars in credit write downs and the urgency to raise immediate capital for solvency, that doesn’t support too many dollars (inflation) in the system.

Going a step further, banks have reigned in lending (reducing credit), thereby hampering the economy from a “real” recovery by preventing money from freely flowing. Again, too few dollars in the system is deflationary. I guess this column wouldn’t be complete without mentioning housing, but that really is part of the whole credit market collapse. If the average person’s single largest asset is their house, and prices have been falling for several years, it only adds to the already worrisome deflationary condition.

Deflation is much more difficult to cure than inflation. It’s referred to as a spiral or black hole since once you get into it, gravity pulls you deeper and deeper in. There have only been two examples of this, the Great Depression and Japan for the past 20 years. World War II was the final fix for the Great Depression, but Japan has yet to find a way out. Non-Main Street experts have warned that Japan could actually remilitarize to try to solve their mess.

The most common medicine for deflation is abnormally low interest rates for long periods, coupled with running the printing presses 24/7 and enormously high government spending. In other words, exactly what’s been going on here for the past year. HOPE is one of the worst words to use when it comes to the financial markets or economy. But let’s all do it to make sure that the U.S. isn’t slipping into a deflationary spiral.

Next week: I’ll go to the other side of the spectrum and spend some time talking about inflation and what it really looks like.