Inflation: Sometimes You Don’t Know What You’ve Got Until It’s Gone

There is an old expression which goes something like this: “Be careful what you wish for--your wish may come true!” For years, a number of people and policy-makers have been wishing for less inflation--if not its elimination altogether.

Well, guess what. Inflation has slowed considerably from its overheated pace of 10 years ago. As a matter of fact, in many sectors of the economy, inflation has not only disappeared, it has been replaced by deflation--in other words, falling prices.

Now some people are beginning to wonder if less inflation is all it’s cracked up to be. This is because the curbing of inflation has apparently produced a number of side-effects, not the least of which may be the difficulty that the economy is having in escaping from the clutches of recession.

Those who have been forced to accept inflation undoubtedly have no problem with its slowing. As a matter of fact, since no one likes to pay more for anything, those who look only at this aspect of inflation are not disappointed by its curbing. However, there’s more to inflation than simply what the buyer sees, and it is these other sides of inflation that warrant examination at this time.

Let’s start with one of the more publicized reasons for today’s sluggish economy--the need for consumers and business to reduce some of the debts they have taken on over the years. Many companies are trying to cut expenses in order to generate the cash flow to service the debts they assumed in the 1980s, when leveraging became the strategy du jour.

Cutting expenses means, of course, cutting costs. The most prominent cost--if not the largest--for any firm is the cost of labor. Not surprisingly, many companies have reduced their payrolls by substantial amounts--blue-collar and white-collar staffers alike.

These well-publicized layoffs have caused great concern for many people--not just those who have lost their jobs, but the great majority who are still employed but worry that they might be next. The result: Spending has been dampened. In turn, this has led to disappointing sales, causing yet additional layoffs in a vicious cycle.

Consumers now buy only what they believe that they must, from the cheapest nearby outlet; they oppose paying more--which, of course, affects the sales dollars that business rings up at the cash register.

And it’s not just the fact that people’s incomes aren’t growing that’s keeping them from spending. It’s also that the value of most families’ biggest asset--their home--is actually falling. This has not only left many households with less of a financial cushion than they might have planned on, it also has affected their attitudes, which, of course, has translated into reduced spending.

Needless to say, there are more than a few families who find themselves today owing more on their house than it is worth; these folks wouldn’t mind seeing inflation make a comeback.

Borrowers in general like inflation for several reasons. First, their loans are paid off with cheaper dollars. The longer the term of the loan, the cheaper the dollars--as long as inflation continues to erode the buying power of the buck.

Second, since borrowing permits one to buy something sooner than would otherwise be the case had one waited until enough money was saved to afford the purchase, a borrower is ahead in a period of inflation since buying sooner rather than later beats higher prices. Because of this, many people do not hesitate to go into debt, expecting to be bailed out by inflation.

Lenders also have a stake in inflation. For one thing, when it is easy for companies to hike selling prices, it is also easier for them to service their debts. In addition, since most loans are made on a floating-rate basis, when more inflation causes interest rates in general to rise, the rates on the banks’ existing loans will rise as well.

Another reason for today’s sluggish economy is that companies are trying to keep their inventory levels down. They are also holding off investing in new machinery and equipment--not only to cut costs, but because they don’t expect prices of these items to rise in the near term. Their strategies would be the exact opposite if they believed that prices of these items were about to rise.

If borrowers and lenders have learned to live with inflation, what about savers? No problem here as well, since savers have come to like inflation too.

This may strike the reader as odd, since inflation clearly erodes the buying power of existing savings. However, as any saver will attest, today’s low rate of inflation has also led to low interest rates. And with interest income twice as important to personal incomes today as it was 30 years ago, many people are finding that their actual buying power is worse off because inflation is low, rather than high.

Getting back to the business side, inflation helps management too, by allowing companies to raise their prices without fear of losing customers, since people are more likely to accept higher prices in an inflationary environment than when prices are more stable.

Real estate developers must be longing for inflation. Landlords have long inserted cost of living clauses in their leases, while buying properties with only the smallest of down payments and the longest of mortgages. Inflation enables these people to service their debts; deflation has made it more problematic.

One group with a major interest inflation is elected officials. Let’s start with the notion that many people equate inflation with prosperity and deflation with bad times--a reasonable thought in today’s low-inflation, but depressed, economy.

The Fed may be saying one thing, but it is doing another. Bank reserves adjusted for reserve requirements are today growing at one of their fastest yearly rates in five years, the money supply (excluding certificates of deposit) is soaring, and industrial raw materials prices have shot up more than 8% since February.

Unless the Fed reverses course, generalized inflation will return--accommodating perhaps even more people’s wishes in the process.