Worry About Deflation Not Inflation

05/10/2010 8:27 am EST

Focus: MARKETS

Joe Battipaglia

Market Strategist-Private Client Group, Stifel Nicolaus

Joseph V. Battipaglia, Market Strategist-Private Client Group, Stifel Nicolaus, reviews some of the reasons why he is more concerned about deflation than he is about inflation.

MoneyShow.com: Joe, everybody it seems to me seems to be worried about inflation. Now you are worried about the exact opposite: Deflation. Can you tell us why?

Joe Battipaglia: If you boil it down to its essence, inflation is a monetary phenomenon, and what we have happening here is that credit demand is shrinking, not expanding. The actual demand for credit in the private sector even now has contracted, so consequently, what you have is money shrinking, not expanding, and we have an economy that has excess capacity in labor, in fixed plan, and in fact, in production of goods and services because we have taken a step down from where we were. So, consequently, what we think is happening is that there is pressure for prices to fall, not rise. That is why housing is still a problem area with slippage. That is why Walmart dropped the price of 10,000 units.

Q: I noticed that and no one really sort of picked up on that, did they?

A: No, no. They thought that that was a ploy of some kind. Well, it speaks to Walmart's financial strength that they can put the pressure on their competition, but it also points to the fact that the consumer is not the same one that was wild-eyed for three years during 2004-2006. Wage rates are stuck at zero. That is really troubling to me. We had that labor report come out, jobs created; unemployment went up because more people think they can come get a job. That is not bad, but wages did not move. If we do not see wages moving higher with slack labor, that means wage rates are actually going to go down in time. That is why the Fed is staying at a flat rate policy, not because they want to help the stock market—although that is a side benefit—not because they want to help the banks because the banks are now too well capitalized, but because this deflation threat is still with us.

Q: Now, we actually have seen deflation for quite a number of years in Japan, and we have seen it in parts of Europe, also, haven’t we?

A: In the case of the Japanese, they went with the fast stimulus, easy money, and they continued with the stimulus, and now 15 years later, they still have a slow-growth economy, a deflation scenario, and their national debt has gone to 200% of GDP.

Our national debt is going to run through 100% of GDP and someone might say that is inflationary. It isn’t, as long as the Federal Reserve does not monetize the issuance of that debt. If they stand pat, then you have this phenomenon of what I am talking about where there is actually deflationary pressure. The inflation will not come from commodities. It will not come from monetization of the debt. It will come from the fact that the economy just does not have that gumption to buy and consume and credit is coming down.

Q: There is no pressure to raise wages.

A: In fact, many companies who have been hiring workers, particularly unionized shops, have brought in a second-tier or a third-tier laborer. Instead of a $45 wage and benefit package at Ford, they are coming in at $15 to $20, so it is a whole new ballgame now in terms of how compensation works in America. Bad for wages; ultimately it means deflationary pressure.

Thank you.

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