Inflation versus Deflation: Two Experts Disagree

An important question for all investors is whether low inflation rates will persist or whether the economy is heading toward much higher inflation.   The answer to that question will dictate asset class allocations, portfolio construction and ultimately the rates of return investors should expect.

Two prominent experts took sides in this debate last week at a luncheon hosted by the Boston Security Analysts Society.  Ted Ladd, the chairman emeritus of Standish Mellon Asset Management, argued for higher inflation.  Predicting low inflation was Connie Everson, the managing director and co-founder of the Capital Markets Outlook Group, a Boston-based economic consulting firm.

We’ll look first at Ladd’s arguments, which represent the conventional wisdom, and then turn to Everson’s contrarian thesis.

Inflation as far as the eye can see

Ladd presented a number of factors, which he said will inevitably lead to higher inflation:

  • The Federal Reserve’s balance sheet has exploded, and it will have major difficulties executing an “exit strategy” when the time comes to withdraw excess reserves. 
  • When that time comes, the Fed will be too late because they are more focused on the employment situation, which is a lagging indicator. 
  • The Fed remains very fearful of a deflationary spiral, and inflation is still low relative to the Fed’s judgment of what it should be, and therefore it will continue to pursue pro-inflationary policies.
  • The Fed’s main strength in protecting us from inflation is its independence from the Treasury, Ladd said.  But that independence is being threatened by many in Congress, including Ron Paul (R-TX). 
  • There is no political will to deal with the huge federal deficit.  “The American electorate wants services it doesn’t want to pay for,” Ladd said.  He said that the present value of liabilities is approximately $86 trillion, of which $49 trillion is from the unfunded liabilities in Medicare and Medicaid.
  • The US is a huge international debtor, having borrowed nearly $3 trillion from foreign governments.  “If interest rates should ever go up back to anything we might consider normal,” he said, “the interest costs are going to eat us alive.”

“There is likely to be one direction and that is more inflation,” Ladd said, comparing the policies to those that led to the Argentinean debt crisis of the late 1990s and its subsequent defaults. “If you have Latino economic policies, you are going to have Latino financial economic outcomes.”