Essay. The World is on edge because there appears to be so much evidence of “deflation”, which is a low demand for consumer or producer goods and services and, therefore, falling prices, idle businesses and production-lines, rising unemployment and under-employment, and low or slow “economic” growth (Bloomberg, November 19, 2014, Fed Officials on Guard for Signs of Lower Inflation Expectations).
However, the cause of a deflationary environment is not its “measurement” – the cause is a high price for income which is measured by the prices for stocks, if there’s a buoyant equity market, as there is in China, the US and Euro-area countries, or the high price of buying viable businesses which is typical of much of the world.
In effect, money that could be spent on goods and services, is tied-up in property or equity investments that are paying 2% or 3% or 4% dividend yields, regardless of how productive is the company in terms of its earnings return on the shareholders equity – which is only really significant to the “owners” who have access to the actual earnings, and most likely no need to spend it.
The solution is not to raise the rate of interest on government bonds, but to let the liquidity requirements of investors devolve their investments in properties or equities, so that their prices might come down, although that is not necessarily the outcome – the price of investments could still be high in a buoyant economy, and not just a buoyant property or stock market of unproductive income-seekers.
However, if the government offers a higher rate of interest in effectively guaranteed coupons and guaranteed capital, then we should expect a flood of sales in equities – a “flight to safety” – but the money will not be spent – it will be used to buy the government bonds at a low price for income – effectively a cash price boosted by “unearned” capital gains – and the higher rates of interest will become a burden to businesses and cause a rise in the cost of goods and services, made higher still by lending the money to a profligate government; please see Exhibit 1 below.
Exhibit 1: The Price of an Income
The equation is: “High price for income” causes a deflationary economy, and “Low price for income” causes an inflationary economy.
Moreover, we can say, without having to measure anything, that a high price for income is the signature of a deflationary economy; and a low price for income is the signature of an inflationary economy.
For example, in a hyper-inflationary economy, “cash money” is worthless, and no investment is for sale, and all debts are paid – in worthless cash – a very low price.
On the other hand, in a deflationary economy, defined by falling prices, cash itself “earns” income, and the “price of cash”, as a loan, is a high rate of interest in excess of the rate of deflation, which is an extra burden to the borrower who needs to pay for it all, and pays a high price for the income of such money for investment or the purchase of a business.
As a consequence, this economy has been deflationary since early 2013 when the “market yield” was 7% or more, and it’s declined to the current 5.4%, and seems to have “stalled” there since June 2014.
The “market yield” is the inverse of the [P/E]-multiple, which is similar to the coupon rate on a bond, but its income is the dividend payout rate, which is currently 38.4% and tends to be at or above 36.8% (the inverse of the exponential), times the market yield, and it is currently 2.06% (38.4% × 5.4%); please see Figure 1.2 above on the right for a slightly “bigger” picture.
That might not be a popular argument with the economists, who will need to find a new source of income other than measuring inflation and deflation, but it’s one of the reasons that we are always defensive with respect to the prices of stocks, and only buy and hold the (B)-class companies because those prices can be defended regardless of the market’s delusions.
Please see our Post “(P&I) Deflation – Tinker, Tailor, Soldier, π” for more information.
And for more information on real “risk management” in modern times and additional references to the theory and how to read the charts and tables, please see our Post, The RiskWerk Company Glossary and “(P&I) Dividend Risk and Dividend Yield“, and our recent Posts “(P&I) The Profit Box” and “(P&I) The Process – In The Beginning“; and we’ve also profiled hundreds of companies in these Posts and the Search Box (upper right) might help you to find what you’re looking for, such as “(B)(N) TLM Talisman Energy Incorporated” or “(B)(N) ATHN AthenaHealth Incorporated” or “(B)(N) PETM PetSmart Incorporated“, to name just a few.
And for more applications of these concepts please see our Posts which rely on the Theory of the Firm developed by the author (Goetze 2006) which calibrates The Process to the units of the balance sheet and demonstrates the price of risk as the solution to a Nash Equilibrium between “risk-seeking” and “risk-averse” investors within the demonstrated societal norms of risk aversion and bargaining practice. And for more on The Process, please see our Posts The Food Chain and The Process End-Of-Process.
And for more on what risk averse investing has done for us this year, please see our recent Posts on “(P&I) The Easy (EC) Theory of the Capital Markets” or “(B)(N) The Easy (EC) Theory of the S&P 500“, and the past, The S&P TSX “Hangdog” Market or The Wall Street Put or specialty markets such as The Dow Transports & Utilities or (B)(N) The Woods Are Burning, or for the real class action, La Dolce Vita – Let’s Do Prada! and It’s For You, Dear on the smartphone business.
And for more stocks at high prices, The World’s Most Talked About Stocks or Earnings Don’t Matter – NASDAQ 100. And for more on what’s Working in America, Big Oil, Shopping in America or Banking in America, to name just a few.
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