Monday, February 9, 2009

A Deflationary Mindset

Phil Gramm famously stated in July that "this is a mental recession." He followed up with further quotable remarks and some explanation of his statements (you can read a Washington Times writeup here). Dispite anything else he said, his comment implying an imagined-recession as Americans were paying $4 for gas and fearing pink slips was what grabbed media attention. Though Mr. Gramm was quickly proven wrong by economic data that confirmed the existence of a very real recession, I understood his point: The current dire warnings perpetrated by our president and media that are predicting economic catastrophe are NOT promoting a quick recovery. A consumer is not encouraged to stimulate the economy via purchases, investment, or job creation if he is being force-fed predictions of the end of the world.

Alongside the general discussion about shrinking GDP and worsening employment numbers, many observers have been debating whether the current stimulative policies will result in massive inflation or crippling deflation. Proponents of the first idea claim that the rampant creation of money (TARP, Bailouts, Stimulus Bill, etc.) will result in Zimbabwe-like hyperinflation. Though the government is creating a couple trillion dollars, I personally believe that the huge stock, commodity, housing and derivative market losses will offset this fresh money. I nevertheless strongly disagree with the recent stimulus bill (at least in its most current forms), but for other reasons. I disagree because it is full of pet projects and pork, it will surely increase America's borrowing costs over time, and it will be my taxes that eventually pay off these debts. I'd like to keep much of the money that I plan to make.

Therefore, I think that deflation is the more likely monetary problem, though the condition that I'm calling "a deflationary mindset" is the primary concern.

Capital and capital markets remain relatively frozen. Credit card and loan companies have raised lending standards, lowered lines of credit, and have generally slowed their rates of lending. Leveraged buyouts are non-existent. Many companies still holding mortgage-related assets have decided to let portfolios run-off (whereas their business model pre-meltdown was the continued accumulation of such assets).

Even more bleak and reflective of my "deflationary mindset" principle is the change in consumer purchasing habits. The savings rate has approached 3% of income over the past few (recessionary) quarters, while it averaged below 1% from 2005 through the first quarter of 2008 [graph below]. Most retailers and restaurants (excluding a few value-oriented entities) are suffering huge month-over-month and year-over-year declines in overall and same-store sales.

Frugality is in vogue.

The attitude of both boomers and younger adults has changed from overconsumption to penny-pinching - thus, my "deflationary mindset." Advertisements are now being written to appeal to cost-conscious consumers - the words "in this economy" are uttered annoyingly frequently. Recent CES and various auto shows have been scaled back in comparison to the excess of better years. Corporations are canceling purchases of jets and corporate retreats as the media started to crucify any corporation that is still actually stimulating the economy. Though this frugality is good on an individual level, and was obviously absent from American culture over the past few years, this attitude will prolong the recession as consumers are reluctant to buy their next iPod (AAPL), car (TM, GM, F, NSANY) or computer.

For the vast majority of Americans that will retain employment during this recession, low prices on consumer discretionary purchases will make consuming fun. I don't expect a long Japan-like deflationary period (mainly due to the huge government money injections), so purchase your LCD TV reasonably if you want to snag the best price.

I may one day eat my words, but I am currently not afraid of the Big Bad Recession. Obama can attempt to scare the public into supporting a bloated stimulus bill, but the economic truths are likely not as bleak as he'd have you think. Right now, spending normally (though within your means) is the most patriotic thing you can do for your country.

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