TORONTO — Traumatized investors who fled from the stock-market mudslide and are clinging to safety in cash or bonds may have set themselves up to be deluged by another hard-to-imagine disaster: a torrent of inflation.
The consensus among economists is that the main threat for the foreseeable future is not rising prices but the opposite: deflation amid worldwide sluggishness.
However, “I would suggest that the economic consensus look at all past episodes of these type of budget deficits, and all past episodes of 20 per cent-plus growth in the money supply when these deficits are monetized,” says Jeff Rubin, the iconoclastic chief economist at CIBC World Markets.
The danger is that central bankers print too much money, degrading the value of each dollar.
“History speaks very loudly on this issue and very unequivocally that reflation, not deflation, is the dancing partner to these size public deficits,” Rubin said in an interview.
Prices in Canada heated up 0.7 per cent last month, more than expected and reversing a five-month disinflationary trend. The year-over-year inflation rate edged up to 1.4 per cent — a long way from hyperinflation but perhaps significant, given the turnaround of direction.
Inflation anxiety is higher in the United States, where government deficits are deepening dramatically as the Obama administration girds itself to spend trillions of dollars on economic stimulus and bank aid, not to mention the spiralling costs of Social Security and other obligations, all on top of the normal swelling expenses of government.
The U.S. Congressional Budget Office projects a deficit of US$1.8 trillion this fiscal year and ongoing deficits totalling $9.3 trillion between 2010 and 2019.
“It means the U.S. borrows roughly another $11 trillion on top of the $11 trillion already spent,” comments Adrian Mastracci, portfolio manager at KCM Wealth Management in Vancouver.
In Canada, Finance Minister Jim Flaherty forecasts deficits of $33.7 billion in the coming fiscal year and a total of $50 billion in the following three years, but many observers expect Ottawa’s fiscal hole to be much deeper than that.
“These estimates ensure that all of us rediscover the real meaning of inflation,” Mastracci says.
“Savers and retirees will continue to pay dearly . . . younger generations will be saddled with mountains of debt and little to show for it.”
Not everyone shares this alarm.
“Inflation is kind of the least concern for the moment,” said Fergal Smith, market strategist at Action Economics. He predicts the headline consumer price index will turn negative by midyear and says worries about inflation are based on the assumption that growth will resume soon — which he doubts.
Says Smith: “The scale of all the initiatives taking place is really only to combat the deflationary forces that are taking hold.”
Conference Board of Canada economist Pedro Antunes says governments — at least in the U.S. and Canada — are unlikely to deliberately debase the currency to lighten their debt burdens, but he notes that monetary policy and fiscal stimulus take effect with long lags.
Antunes says the question is whether, as the economy recovers, “does it come back quick enough that they can’t turn off the taps before inflationary pressures start — and I think there’s a real concern about that.”
CIBC’s Rubin contends prices could spike upward “a lot sooner than most people think.” He points out that Korean War deficits jolted U.S. inflation from minus one per cent up to nine per cent within nine months.
“When this recession is over, I think the big surprise is going to be how quickly inflation makes a triumphant return,” Rubin said. He foresees a rapid rise to five or six per cent, and “we’ll see where we go from there.”
The recession’s legacies will include a U.S. federal deficit equal to 12 to 13 per cent of America’s total annual output, he said.
Additionally, “the minute the economy stops contracting, people are going to start filling up their tanks,” Rubin said. “We’re going to be looking right back at the same triple-digit oil prices we were looking at before this recession began. . . . That’s highly inflationary.”
For investors, “the No. 1 takeaway here is that the bond market is no sanctuary, especially long-duration bonds.”
Rubin predicts the future for North American fixed-income investors will be more like Argentina than Japan.
Clay Gillespie, vice-president and portfolio manager at Rogers Group Financial in Vancouver, echoes the inflationary concern.
“One of the best defensive positions in a stock market going down is to hold cash and money-type products — which of course are the absolute worst things to hold in an inflationary period,” Gillespie says.
“My fear is that people that have really got hurt in any type of real assets or equity assets are not going to want to move back.”
He is wary of gold as a shelter but notes that stocks and real estate tend to do well in inflationary times.
“I don’t know if now’s the time to do it specifically, but you definitely have to do it,” Gillespie says. “You want some equities in your portfolio.”