What QE2 and Inflation Means for Businesses

by Victor Cheng

I have a BIG problem with how inflation in this country ismeasured.  To put it bluntly, I think it’s a total scam.

And in a moment, I will explain how this will significantlyimpact your business in the months ahead.

But first, let explain my unusual perspective in what willhopefully be plain and simple English.

Inflation is generally considered to be measured by theconsumer price index.

And these days, inflation is measured by something called”core inflation”. Core inflation is an adjusted version ofthe Consumer Price Index excluding the prices of food and energy–which are basically goods whose prices tend to inflate.

(See the problem with this?)

So “core inflation” is really just a measure of the pricesof things that tend NOT to inflate.

So if the cost of filling up your car with gas skyrockets to$120 a tank and your grocery bill doubles overnight, there is no change to “core inflation”.

But, I think the problem is even more misleading.

The Consumer Price Index only measures the change in pricesof what American’s consume. This is NOT the only type ofinflation that can exist.

There is something called “Asset” inflation. In this caseassets are the deed to your house, stock prices, and theprices of commodities such as gold.

I think “true” inflation should really capture BOTH theprice of consumables and the price of assets.

Here’s why.

It’s a much more accurate barometer to use in terms of how to manage our economy.

For example, the traditional fear of stimulating an economythrough government spending or cutting interest rates is that it will trigger inflation.

And many will argue that Greenspan’s deliberate effort tokeep interest rates low from the early 2000’s leading up to 2008, did NOT create inflation– because core inflation was so low.

BUT, if you use my definition of “true” inflation which isprice of consumables + your assets. Then you’ll see that there was massive inflation.

The price of real estate skyrocketed during this time. Asdid the price of stocks.

In fact, I’d argue (especially in real estate) we hadrunaway inflation.

Now standard operating procedure to tame runaway inflationis to raise interest rates — thereby making money more expensive to borrow, and causing people to spend less of it.

If we used “true” inflation as our barometer, we as acountry would have noticed runaway inflation by around 2004.

If we had executed the standard operating procedure ofraising interest rates in 2004, it would have cooled off the runaway inflation in housing prices, slow down demand for buying automobiles (often using home equity to pay for it),and reduce the demand for rocket scientists on Wall Street to engineer better derivatives.

Instead, home prices would have topped out much sooner andthe additional 1 million construction workers in real estate, the 500,000 mortgage brokers, and 500,000 real estate agents that the economy didn’t really need and whose jobs have beenwiped out by the Great Recession would have had a lot more time to re-train their skills and look for work where work legitimately existed.

And those rocket scientist working on Wall Street, wouldhave been laid off and would be forced to find work in clean energy, mobile telecom, biotech, health care…and wouldhave been forced to invent the technologies that wouldprovide jobs for the next 30 years, instead of inventingnewer kinds of derivatives.

And those auto workers in Detroit, would have had a 4 yearhead start to find new work in other industries, perhaps relocate out of Detroit to other parts of the country thatvalued such skills but had nobody locally available.

In other words, all the extreme behavior leading up thecrash of the Great Recession and all the unraveling of unintended consequences would have been blunted.  
The transition from the old economy to the “new normal” economy would have taken place over half a decade, instead of in October 2008.

So why am I telling you all of this now?

Because, with the Fed’s announcement of QE2 – QuantitativeEasing 2 — we are essentially REPEATING the entire process that got us into this mess in the first place.

The justification for QE2 is this:

“Core” inflation is low, so we don’t have anything to worry about.

We need to stimulate the economy.

Lets’ do it by pouring money into the economy (by basically printing new money, to buy out those investors who have lent money to the US, so they now have more cash available to invest somewhere else in the US economy) to help it grow…

(Sounds a little familiar doesn’t it?)

And where is that newly freed up cash going?

In Greenspan’s era, it flowed into housing. We all know howthat ended up.

So in the Bernanke era, where is all this “stimulus” moneygoing?

Have you seen stock prices lately?

Have you seen the price of gold lately?

All this extra money floating around is artificial (justlike it was during the Greenspan era of really low interest rates that flooded the economy with cheap money and morespending power).

And where this extra money is being spent on assets likestocks and gold, the corresponding run up in prices will be in part fueled by this artificial “stimulus” — which atsome point will end.

What happens to those artificially fueled prices then?

So where is all of this going? What will happen? And whenwill it happen?

Truly, I have no idea. (So whatever you do, don’t make personal investment decisions based on what you think I’m recommending… my only argument is for how you mightwant to run your business differently because of this)

The only thing I’m certain of is this. While the economyrecovers (ever so slightly), it is also getting increasinglybrittle and fragile.

So with a fragile economy, moderate size economic problemsin other parts of the world (or even in our own economy) suddenly have a magnified impact on the US economy.

Normally, you would think that as an economy recovers (e.g.,grows and gets bigger), it gets more stable. I think because of all these government inventions, the opposite is true.

As the economy grows (due in large part to all this intervention), it is getting increasingly LESS stable.

(Note: I’m NOT arguing politically that we should or shouldnot pursue economic stimulus… though I do have an opinion on this.

I AM pointing out that there ARE natural consequences andtradeoffs involved that are not obvious to many people and I believe all decisions should be made or at least interpreted with the benefit of COMPLETE information.

And to the extent your information wasn’t complete, my goal was to fill in any missing gaps.)

So what does all this mean for you and your business?

Fasten your seat belt, and be prepared to respond QUICKLY to potentially a very fast changing economic environment and try to anticipate how it might impact your clients (not to mention your client’s clients).

With change comes both NEW headaches and NEW opportunities.(In the months to come, I will do my best to point out examples of both.)

You really do need to be on the lookout for both, and yourbudgets and business plans for 2011 should allow for the possibility of complete revision a the mid year point.

It has been my recent recommendation (as of a week or two ago)to schedule a mid year check in point for 2011 business planning.

Note this should not be some “stamp of approval” type mid-year review.

It should be a critical examination of whether the underlying ASSUMPTIONS of your business plan have turned out to be true.

And on a very much related note, as you finish up yourbusiness plans and budgets for 2011, you should EXPLICITLYlist the ASSUMPTIONS you are making about your market.

Then at the mid year strategic plan review, you’ll want tocritically examine not just your revenues, costs, and performance metrics, but also whether your ASSUMPTIONS have turned out to be true or dead wrong.

Very few companies explicitly state their marketplaceassumptions.

Even fewer deliberate assess the whether their assumptionshave turned out to be true and make potentially dramatic adjustments in their budgets if their assumptions proved to be false.

Don’t let your company be one of the companies that makesthese mistakes.

1) List your assumptions next to your plan and budget fornext year

2) Schedule a mid year CRITICAL review in June 2011 and evaluate whether your assumptions have turned out to be true or false.

This will help keep you one step ahead of your competitorsas we ride this roller coaster called an economic recovery.

 

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