Saturday, May 29, 2010

Deflation Is Real Today

Investopedia explains Deflation as declining prices, if they persist, generally create a vicious spiral of negatives such as falling profits, closing factories, shrinking employment and incomes, and increasing defaults on loans by companies, individuals, and possibly governments.  

Deflationary periods can be both short or long, relatively speaking. Japan, for example, had a period of deflation lasting decades starting in the early 1990's. The Japanese government lowered interest rates to try and stimulate inflation, to no avail. Japan’s zero interest rate policy was ended in July of 2006.

Let’s share a test to see if we can figure out if we have deflation in the United States. Can you answer yes to any of these questions?

Has the price of a single family home declined for several years?

When you adjust the return for the S&P 500 for inflation for the last 10 years has the return been negative?

Has the Fed Funds interest rate fallen to near zero percent?

Are mortgage interest rates now the lowest in your life?

Are CD interest rates the lowest you can remember?

Are money market mutual funds paying the lowest interest rate ever?

Do we have factories being closed?

In the unemployment rate high?

Have personal incomes gone down?

Have individuals defaulted on their loans?

Have companies defaulted on their loans?

Have property taxes gone down?

Has Wal-Mart reduced over 10,000 items in their stores?

Are there more and more deals, lower prices everywhere?

I don’t know your score but mine was 14 yeses for 14 questions. For some reason people are ignoring what is going on around them today and spending more time worrying about tomorrow. 

We just had a very scary month with the volatility of all the markets, stocks, bonds, commodities and currencies that reminds us of the Fall of 2008. The return for the month of May is on track to be the worst May since the mid 1960’s.  For people to ignore what is happening and to focus on what might happen next month or next year puts them in great peril. 

If in fact the Fed is on hold, as some now project till at least the middle 2011, I think longer, how long can people hold out making decisions with the money they have in money market mutual funds paying zero? What will investors do if in the first quarter of 2011 money market mutual funds start closing down and returning the money to shareholders?

Many people who are on the sidelines, in money market funds do not realize the price they are paying. Not only are they not earning anything but even with low levels of inflation they are losing money. Click on the link below to see the impact of the deflation on the real rate of return with money in a money market mutual fund.

I realize that in times of volatility it feels good to have a high percentage of assets in cash but you pay a very high price keeping your money there and many people have too much in money market accounts. Last fall you may remember that I conducted a seminar for people near retirement. I asked why people kept so much of their money in money market funds at close to zero return, the answer was then was that earning nothing is better the losing money. The chart shows that having money in the money market fund is in fact loosing money to inflation.

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