Deflation fears reared again Tuesday after the Bureau of Labor Statistics (BLS) released the March Producer Price Index (PPI). The PPI, falling -1.2% in March, hadn't seen a monthly decline since December 2008. Then on Wednesday, the BLS said March CPI declined -0.1% on a monthly basis and, for the first time since 1955, -0.4% year over year. (The core index, stripping out volatile food and energy, has not seen a monthly or year over year decline yet.)
The Federal Reserve's prime concern over the last few decades has been inflation—a worry underpinned by the explosively inflationary 1970s. But after credit creation cratered during the 2008 financial panic, the velocity of money fell off dramatically.
Naturally, many investors worried the first significant deflationary period since the 1930s could be on the way. Yet, of all the government actions to date, perhaps the most appropriate has been the Federal Reserve's aggressive monetary policy. Beginning last fall, the Fed reduced rates near zero and pumped trillions of dollars into the economy—the Fed's balance sheet, or the assets it's exchanged for cash, has hovered around $2 trillion since late 2008.
All the added money has at least partially made up for stalled velocity, and instead of severely falling prices, the first quarter witnessed tepid inflation and a month of moderately falling consumer and producer prices. (Note: There's no sign of rampant inflation yet—even with the Fed printing new money.) Further, though risks remain, there is some evidence the financial sector is recovering—take for example recently announced first quarter banking profits or moderating interbank interest rates (LIBOR). As the financial system stabilizes, the enormous amount of new money in the economy will combine with increasing velocity to fill the hole left by the panic (instead of just preventing it from getting deeper).
Which brings us to a second concern. At some point, the deflationary hole dug by the panic will be refilled, and we could face an inflationary threat. But that's a risk down the road a ways, and nothing to worry about now. Why? For one thing, the hole left by the panic was pretty big. The Fed's current inflationary policy will be filling it for a little while yet.
When conditions warrant, the Fed should and likely will shift its policy. That could include reining in the money supply—whether sharply or less so will depend entirely on future conditions. For instance, productivity gains can reduce inflationary pressures too. Whether we get inflation down the road ultimately depends on how deftly the Fed navigates future economic conditions. There's just no point speculating yet.
So for the foreseeable future, investors should shun the sidelines. The monetary stimulus spark ought to safely fire the economic engine—and stocks will lead any revival.
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.