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Robert Huebscher
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Gary Shilling – Economic Forecast and Current Market Opportunities

April 28, 2009

Gary Shilling is President of A. Gary Shilling & Company, the economic consulting and investment advisory firm he founded in 1978. Dr. Shilling is well-known for his forecasting record, having correctly predicted major economic events over the past several decades. Beginning in 2002, he warned his clients that the housing market "has taken on self-feeding, bubble dimensions that will sooner or later collapse," and continued to sound this warning through 2007, when his predictions came true. Dr. Shilling publishes a monthly newsletter, Insight, which is available from his web site or by calling 888-346-7444. He is the author of several books, the most recent of which, Deflation, is available from the link above.

You’ve been forecasting deflation for some time, and the March CPI numbers validated these forecasts – the first deflationary month since 1955. Can you summarize the major forces in the economy that will continue to keep the CPI numbers in negative territory?

In the short term - for the duration of this recession, which will be at least another year - four very deflationary forces are at play. 

First is the ongoing weakness in commodity prices, which takes time to work its way through the system. Crude oil prices are translated quickly to pump prices, but price increases in petrochemicals - which are used, for example, to create plastic parts that go into consumer electronics - take time before their impact is apparent in finished goods. We are getting hit by the collapse of commodity prices, not just from crude oil, although that is the most conspicuous.

Second are excess inventories, which are the mortal enemy of price increases. Manufacturers and retailers must cut prices to get rid of inventories. Right now, merchandisers are cutting prices on spring goods before they are out of their boxes and on the racks. They over-ordered and didn’t anticipate demand would fall off a cliff.

The most interesting phenomenon, which we are now seeing for the first time since the 1930s, is wage cuts and shorter hours. In the post-World War II period, the only way employers could cut costs was to lay people off. Under high inflation, employers used another method of controlling labor costs, which was to freeze pay or raise pay less than the rate of inflation. Now, however, there is no inflation and we are back to the 1930s, when deflation reigned. To lower costs, you must get rid of people or cut hours. About 6% of employers have cut wages or hours in the last year, and another 10% plan to do so. This is less than the number of employers that have had layoffs, which in the 20% area, but it is growing and it is highly deflationary.

The fourth and final deflationary force is excess capacity in the economy. The Commerce Department has an interesting measure, which shows the excess capacity versus demand across the economy. An interesting and powerful relationship is apparent, which shows that excess capacity reduces the CPI with a six-month lag.

For the duration of this year, deflation is the odds-on bet.

Our fiscal and monetary policies are aimed at creating inflation, through further stimulus packages, expanded money supply, or debt monetization. Many say the government will continue on this path until it creates inflation. Why do you believe the government will be unsuccessful?

Your question implies that the government is trying to recreate inflation, and I don’t think they are. Paul Volcker and Federal Reserve Vice Chairman Donald Kohn have been debating this issue. Kohn said the Fed is targeting 2% inflation, and Volcker objected, saying that the Fed is "telling people in a generation they're going to be losing half their purchasing power." Volcker was saying you either want inflation or you don’t, but the Fed is saying it would rather risk a little bit of inflation. Our government has not achieved a clear consensus on whether it should create inflation.

Deflation becomes self-perpetuating. Consumers see prices decline and delay purchases, which forces retailers and manufacturers to cut back production and labor costs, which drives prices further down. This is the reverse of inflationary expectations.

As far as policy is concerned, the government is trying to resolve the financial crisis and is dealing with an unfolding list of problems as it tries to rekindle economic growth. So far, these efforts have not been very effective. Despite the stimulus, the economy is not growing, and public sector efforts are being offset by the private sector. 

Some believe the economy will take off, with consumers regaining confidence and resuming spending, excess liquidity triggering increased lending, and all this will fuel inflation. I don’t think this will happen, and I expect much lower growth in the economy. My estimates are GDP growth of 2% annually over the next decade, as compared to 3.6% during the big salad days of economic boom from 1982-2000.

Continue to finish reading the Gary Shilling's take on current market opportunities.

Robert Huebscher

www.advisorperspectives.com


Rating: 3.0/5 (6 votes)

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Sivaram
Sivaram - 10 years ago    Report SPAM
(original post deleted)

Nevermind.. there is a link ot the full article...

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