In the Flations family — yes, I made that word up — there are a few siblings. The oldest child would be inflation. We are all familiar with inflation. When the price of what we buy goes up we are usually experiencing inflation.
The most frequent measure of inflation is the consumer price index or CPI. The CPI is really a basket of the more common things we consumers buy and the change of the cost of the basket of goods over one year is what we call the inflation rate. If the cost of our basket was $100 last year and this year it is $103, we would say the rate of inflation is three per cent.
Deflation is pretty much the opposite of inflation. This is when the cost of certain things goes down. For the most part, we see this in home prices. The black sheep of the family is stagflation. Stagflation occurs when we have high inflation and slowing or declining eco-nomic growth.
So what does all this have to do with our current state of affairs?
We have seen deflation in housing prices, especially in the U.S. and to some extent the resource market. Outside of a few areas we have not seen much inflation, but there are things in the mix that could easily change this.
In economics we look at a few things as the gas and brake pedals of an economy. If you want to slow things down you can raise interest rates, raise taxes or decrease government spending. If you want to speed things up you can do the opposite. There are other things governments can do, but these are the most common.
The central banks of the world have been lowering interest rates aggressively since the banking crisis of 2008-09 and right now the world is awash with cheap money. They have done this in an effort to help economies recover and grow.
Herein lies the potential problem. Low interest rates and or cheap money will at some point heat up the global economies, expanding growth. When this happens we will experience inflation and
interest rates will have to go up to keep inflation in check.
This has two substantial and potentially negative outcomes. Firstly, what happens to the already
depressed housing market when the cost of borrowing goes up? When that five-year mortgage rate goes from three per cent to six per cent, there will be a substantial drain on household incomes.
Secondly, those holding bonds should be prepared for some nasty surprises. When interest rates go up, bond prices go down. Right now we may be in a bit of a bond bubble as rates have done nothing but come down for around 30 years. Most people hold bonds as part of their portfolio as a defensive position and may not like to see values on statements falling.
Les Consenheim is a financial adviser with Raymond James - Consenheim and can be reached at 250-372-8117 or email@example.com.