Always Tradeoffs


Inflation is a beast we want to mostly keep in his cage.  Some of us remember the remarkable days of the 1980’s when inflation was dropping the purchasing value of our savings in the bank by 10-12% per year.  That was ‘too hot’.

More recently, though happening in Japan for the last 15 years, is the other side of the coin called deflation.  In this scenario, your money buys more a year from now than it does now.  This is porridge ‘too cold’.

The ‘right balance’ that the world is seeking is mild inflation, nominally defined as 2-3% per annum.  Ahhh, just right.  But in this short piece I try to answer “Why?”.

Though like Shakespeare says ‘she protests too much’, let us emphatically state that governments of the world, the primary creators of debt in the past few years will very work hard to have inflation (everyone else is ‘deleveraging’, which means paying off loans more than taking new ones out, but I digress).  The problem that occurs if we have too much hot stuff is governments become concerned with popular unrest due to constantly rising prices (witness the country of Venezuela with 20% official inflation, unofficially ____%).  Outside-of-country investors don’t want to build new plants or otherwise put their money in for the simple reason they don’t know what it will be worth when they try to take it out.

However, an equally scary scenario, and we think the more unpalatable porridge, is too little inflation.  Governments don’t like it because they have to pay off debt with MORE expensive dollars; i.e. you have to pluck more off the poor tax-paying chicken.  Painful though that may be, the bigger issue is people are smart…and they won’t buy an asset today when they think they can buy it cheaper in 6 months.  Run this math through your bright brain and you can easily imagine a case where the consumer-led USA economy has consumer’s not spending – a condition not good for growing economies much less generating income for governments to tax.

In an insightful reality of how things can get distorted this way, two large European economies in the world are now posting negative interest rates for depositors.  In the past 3 months, if a person in Sweden and Germany[i] wanted to ‘stay safe’ in government bonds, they would have to be willing to get back less money than what they put in!  Theoretically this unique scenario will get people to spend, but I’ll just say you have to be very careful what you wish for here (for a variety of reasons beyond the scope of this communication).

When we were little boys, we mowed lawns and cleaned cow pens for money.  We would put my money in local bank and get 3% (whatever) interest on my money.  It felt good to have it there and see it grow, notwithstanding how minuscule it was, and we would later buy a bicycle with it, etc.  We’re NOT at the point of deflation in this country, but let me point out the dramatic change even here over the past 8 years.  In 2006, the average yield on a one-year CD was 3.8%.  Currently the national average for a one-year CD is 0.27%[ii].  If you are trying to live off 0.27%, you just aren’t going to feel a lot richer one year from today, and that will cause you to spend less.

The key to solving this riddle is growth.  Growth in the economy, which creates growth in jobs and wages.  Negative interest rates are a sign that monetary policy by itself is not working.  How to achieve the desired growth is also a topic of a whole different dialogue.  Yet the message here is simply that managing inflation involves tradeoffs, and either extreme of inflation is worse than somewhere in the middle.


[i] “Less Than Zero” (Jane Randow, Bloomberg QuickTake, April 13, 2015)

[ii] “Some Investors Can’t Wait for Rates to Rise” (Corrie Driebusch, Wall Street Journal, April 29th, 2015)