Subdued inflation can be costly

In the wake of the U.S. Federal Reserve’s November decision to leave interest rates at historically low levels, this question is increasingly coming to light: Will loose monetary policy keep a dangerously heavy lid on inflation? Some economists and investment analysts claim that more inflation is just what the economy needs. In some respects, we tend to agree. While such sentiment might seem anathema to some, we believe an uptick in inflation may provide the type of purchasing power that businesses need. Of course, this assumes that inflation is rising for the right reasons (genuine improvements in economic activity, for instance).

Excess reserves at U.S. banks

Right now, significant excesses in labor supply and manufacturing capacity mean that two of the traditional routes by which inflation embeds itself — escalating wages and rising prices for finished goods — are absent. In addition, the dramatic monetary stimulus provided by the Fed is largely being kept out of circulation in the form of excess bank reserves (see chart). A third point to consider: Until consumers begin to believe that prices for expensive items (such as cars and appliances) will rise in the future, they have little incentive to purchase now, which presents a headwind to economic growth.

Slow economic growth has been a persistent problem here in the U.S., and it has been exacerbated by inflation levels that have remained too low for too long. A measured dose of inflation could provide an antidote.

The views expressed represent the Manager’s assessment of the market environment as of November 2013, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager’s views.

IMPORTANT RISK CONSIDERATION

Investing involves risk, including the possible loss of principal.

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