For myself, I continue purchasing shares of leveraged ETF’s with each massive hit on the market. Members of Congress, government advisors, banking officers, and investment analysts all have 401(K) plans that are taking big hits. Trust me, they are not going to allow the market to take their underwear. Things will get corrected and the people buying at the bottom will really be rewarded.

Dave: deflation is great if you have cash in the bank or no decrease in income.

In this sense a central bank can actively fight inflation because they can rise interest as high as the see fit, but is left weaponless against deflation. To understand how terrorizing deflation can be just study Japan’s economy during the 1990’s and 2000’s.

The worst thing about deflation is that people stop spending money because they anticipate a drop in the price of goods and services and when people stop spending money… well you get the idea.

Finally, inflation isn’t just caused by loose monetary policy, but is caused by a tight supply of goods and services.

Inflation in oil prices anyone? Commodities prices? This isn’t due to loose monetary policy but tight supply. Which translates into a certain amount of money chasing to a limited supply of goods.

The reason monetary policy can also create inflation is because it can cause too much money to chase to few goods.

This is why during times of inflation in helps to raise interest rates, which in turns reigns in the amount of money chasing the limited supply of goods.

Anyone can feel free to email me if they wanna take this chat offline.

Cheers.

Ethan

Your are getting the concept of inflation mixed up with the time/value of money.

Hope that helps.

Cheers.

Ethan

In the extreme case, someone in an environment of deflation could simply build up and live off their savings (which would be steadily increasing in real value). While that’d be a pretty sweet deal for the person in question, it deals the economy as a whole a double-whammy: neither the saver nor his money is working, and the goods and services the rest of us have to enjoy are decreased as a result.

Second, while debt and debtors have gotten a bad rap lately (not without reason), there are legitimate reasons to take on debt. Consider mortgages, for example; people are willing to take on debt that will require decades to pay off, in order to use that money to buy something that will increase in value over the years. But lately, house prices have been deflating as a result of the bubble bursting; the result is that many people are finding themselves in situations where their house is worth than they spent (or owe). New houses aren’t being built and many would-be homeowners are only considering buying now with the expectation that house prices will start rising again eventually.

Now, imagine this current housing situation wasn’t caused by an overinflated bubble bursting; what if housing prices DECREASED by 5% a year in the regular course of events? Who in their right mind would take out a thirty-year mortgage for a house that’d be worth half the starting value in fifteen years, and one-quarter the value in thirty? As a result, we have a situation where there is an incentive for people to avoid buying non-liquid assets, since they’re going to be worth less in the future than the amount of money needed to acquire them. Similarly, this deflation would cause companies to spend less money producing goods and providing services; it’d be harder for them to get a return on their money that made up for the risk of losing money running their business. And any loans they’d take out would have to be paid back with more expensive future dollars, adding a further burden on their sales.

Both of these situations lead to our third problem, the risk of a deflationary spiral. As noted by Wikipedia (http://en.wikipedia.org/wiki/Deflationary_spiral), what happens in such a spiral is that (a) declining prices lead to decreased demand (why buy it now when it’ll be cheaper next month?), (b) lower demand causes lower production (no need to produce as much if people aren’t consuming), (c) lower production leads to higher unemployment (fewer people are needed to make the goods that are actually consumed) and lower wages (unemployment increases competition for jobs, and people are willing to accept less for the same work since the deflated money stretches farther), and (d) less money coming in for consumers exacerbates the demand problem in part (a), dropping demand even further and starting the cycle again.

Don’t get me wrong, neither inflation nor deflation is wonderful. Inflation decreases the purchasing power of money, forcing you to take additional risks in order to offset the decline in the real value of your savings. Deflation leads to a decline in productivity and an increase in unemployment. Given those options, I’d take mild or moderate inflation any day, and simply invest my money in a way that provides a return above and beyond the rate of inflation, as Graham is describing.

I think you may have it backwards. Deflation is not erosion. It means you can buy more goods with your savings. It is good for savers. Also, you get deflation with productivity increases because we become able to produce things with less cost. During the industrial revolution, prices decreased, which was good for consumers and world progress.

Inflation means your dollars are worth less because of an increase in the money supply. This only helps debtors because their loans become easier to pay as they are worth less over time. For instance, when the U.S. was on the gold standard, there was a group of farmers and other debtors who wanted to switch to a silver standard because it was more plentiful and was being produced at a higher output, thus there would be a greater increase in money supply and more inflation – making their debts easier to pay. Inflation is due to the growth in the money supply, which is currently controlled by the government.

Just some thoughts…

“It’s a word I’ve never liked. It represents an erosion in everything we work hard for. It naturally devalues our investments, working against growth.”

Inflation is a natural by-product of growth and hard work. Inflation is caused by hard work, innovation, improvements, advancements in science, technology, service, etc.

While it is true inflation devalues todays dollars, it also guarantees more of tomorrows dollars for it’s offset.

While it is true that the cost of that gas when you were a kid has doubled and doubled and doubled, so have incomes. It is because that gas price rose sixteenfold that socital advancements that were not even available then are commonplace now.

Without inflation, there would be no innovation, no research, no advancement, because the underlying reason for those advancements is more profit. Profit equals inflation.

Inflation is not the problem. Not controlling or outpacing it is.

The erosion you are talking about – Deflation.

RA

Now, though, I’ve got a mix of stocks and bonds in my IRA. I can change that mix online, moving money around in seconds. Does it make sense to try to “beat the market”, shifting from bonds to stocks when I expect an increase, and from stocks to bonds when I expect a decrease?

Seems like, at worst, I’d match the short-term losses from having most of it in stocks and the short-term gains from bonds when I have most of it in stocks. At best, I’d match the short-term gains from stocks, and shelter it as bonds on the “bad days”.

I haven’t seen any sites that recommend this. Is this just too unpredictable? or is it so obvious that nobody’s thought it worth posting about? :)

Stocks are down so now should be a good time to buy. The problem is that every day brings a new lower price, so yesterday’s buy looks foolish today.

What about gold as a stable reservoir of value? And perhaps other such metals . . .

One fact that gets lost as the pundits watch the DJIA/ S&P 500 go down is…for all pessimism (by sellers who think that the current stock price is high enough to trade it for $$$), there is a precisely equal optimism on the buy side by people who view the stock price as low enough to trade $$$ for it.

Five or ten years from now…do you want to be the person who sold all their shares when the Dow was at 8,000; or the person who bought all their shares when the Dow as at 8,000?

I’m buying.

(Plus if Graham is using government numbers they’ve changed the formula between now and 1972 several times so you can’t really compare the two numbers – they don’t include the same things at the same ratios.)

For instance, assume Uncle Sam reported that new clothes increased 20% (across the board) in price from last year to this year. But used clothes doubled in price. For identical purchases, $1000 for new clothes now costs $1200 but $100 of used clothes is only $200. This is a dramatic increase in price, percentage-wise, but a smaller increase in actual dollars. This is how government tabulates inflation.

Let’s assume Uncle Sam reports new automobiles increased 5% over last year. But if a particular model automobile last year was in high demand, the dealer demanded full sticker price. But if market dramatically changed this year, it is now a low demand model that is discounted 30% in order to move excess inventory. In reality, that purchase represents 30% deflation in the new car market and considerably more if that model vehicle is used.

Self-sufficient and frugal families tend to be less affected by inflation due to their financial distance from the retail marketplace and savy buying habits.

This is a good article on the government’s CPI number:
http://www.shadowstats.com/article/56