by Angela Sugimura

As the economy continues to show signs of improvement, some continue to look for signs of inflation. Typically the only ones who may cheer inflation are those who have borrowed longterm and will have the chance to repay in cheaper dollars. The rest of us could do without the beast.

Inflation is an insidious tax on future value for most consumers and investors. Our money doesn’t buy as much, the interest we earn on CDs and other fixed income securities is worth less, and retirement on a fixed income is downright frightening. The common perception of inflation is that it is caused by too many dollars chasing too few goods, forcing prices up. Basic economics dictates that wages would spiral up, putting further pressure on prices as inflation continued unabated.

We learned in the 1970s that inflation could be stimulated by sudden price increases in commodities such as oil and gas. We have also been barraged with the idea that our government can print money by spending more than it takes in from tax revenues. Government spending during the Reagan years created huge deficits, but strangely enough, inflation fell and has continued to fall from its peak in the early 1980s.

Now, the press is focusing on accelerating commodity prices, historically low interest rates, the falling dollar, rising shipping costs, and economic growth that exceeds its monetary potential—all forces that could cause prices to rise and bring a return of inflation.

During a period of downturn, we normally see disinflation (falling prices) result from declining consumer spending and subsequent lack of business investment. Producers lose pricing power. There remains a low level of resource utilization as businesses have excess capacity and unemployment exists. As the business cycle turns to the upside, inflation rates fall, as they have in five of the last six cycles during the first three years of a recovery. This decline is largely due to increased productivity as businesses become more efficient and do more with less.

Logic certainly tells us that productivity cannot continue going up forever, and we will not be able to ignore a long-term impact caused by the falling dollar or low interest rates. But for now, inflation is not a factor, and, barring outside events such as a mid-east shutdown of oil flow, inflation should not be a hindrance to our economic recovery.

For an early warning of possible impending inflation, watch the long-term bond market. Falling bond prices coupled with rising yields remains a good bellwether for inflation.

Angela Sugimura is a Senior Vice President/Investments and Branch Manager with Stifel, Nicolaus & Company, Incorporated, member SIPC and New York Stock Exchange, and can be reached by calling the firm’s Murrieta office at (951) 461-7220 or toll-free at (866) 894-2461.