“Biflation” is a term that I think best describes our current rate of inflation: Everything you own – your house, your retirement account – is going down in value, while everything you need – food, clothing health care and energy – is going down.
Click here to read a column I recently wrote about biflation in The Sunday Wall Street Journal.
Jerry Laurain, Chief Investment Officer of First Tennessee Bank Wealth Management, responded by sending me a piece he wrote at the beginning of the year. He calls it In-De-Flation. Here’s what he has to say:
January 2, 2011
Word for the Year: In-De-Flation (pr. Indy-flation)
Forget about inflation. Forget about deflation. What we are experiencing now is the worst of both worlds. We’ve got in-de-flation. Like indigestion, it doesn’t feel good.
In-De-Flation (IDF) is what happens when the prices of what you need to buy (food and fuel, for example) are going up and the prices of what you already own (a home, a car, a computer, for example) are going down. In trading terms, it is when your long positions are going down and your short positions are going up. It is not a good thing.
Most people think of inflation in terms of the Consumer Price Index, or CPI. That’s fine for academic work and economists, but real people are more sensitive to their personal or familial cash flow. Imagine this scenario.
Your income has not changed appreciably in four years. Your home has declined in value by at least 20%, from say, $250,000 to $200,000 (your mortgage, however, is still stuck at $225,000). Because of higher energy prices, it costs more to heat your home and drive to work. Clothes for the kids cost more than they did last year. A bag of groceries that formerly cost $25 seems to be running around $30.
State and private university tuition seems to go up by at least 8% a year. Your employer changed health care plans and the result is a larger deductible and a highly monthly contribution.
You probably aren’t saving enough for retirement and you may be under insured. If your spouse works, you are probably at risk of losing at least one income. With your real income and assets going down, your expenses and liabilities going up, you are stuck in a financial death spiral with dim prospects for getting out alive.
Is there a solution to this dilemma? There are two possibilities: earn more or spend less. Earning more could be somewhat problematic. It might involve additional education or possibly relocation. Additional education is going to cost money, unless you can talk your boss into picking up the tab. Relocation isn’t going to be easy given that you are upside down on the mortgage.
That leaves spending less. From my personal experience, that’s a lot easier said than done. Not only that, but if everyone tried it at the same time, the economy would grind to a halt; that’s the so-called “Paradox of Thrift.”
The government’s response to this sad state of affairs has been the application of fiscal and monetary stimulus. Spend money, lower interest rates and make sure that banks have plenty of capital to lend to Wall Street, Main Street and all of corporate America.
Economic statistics indicate that the plan is starting to work. Employment numbers are slowly improving. Corporate earnings look much better. Leading indicators are pointing higher.
But we have a long way to go. If the stimulus results in higher home mortgage rates, don’t expect the housing market to recover any time soon. And if the stimulus results in higher energy costs, that could choke off the green shoots pretty quickly.
When prices are going up and interest rates are low, a prescription to spend less and save more is about as appreciated as the doctor’s advice to stop drinking, stop smoking and lose weight. The resulting behavior is likely to be the Scarlett O’Hara line from Gone With the Wind: “I can’t think about that right now. If I do, I’ll go crazy. I’ll think about that tomorrow.”
Chief Investment Officer
First Tennessee Bank Wealth Management