Inflation, Deflation, What Is Going On?

Last week on my way home from work, Julie asked me to stop at the store for a few things. There are many reasons why Julie does not allow me to do the shopping that I will not get into here; however, if duty calls, it is often just a quick trip to pick up something we need at home. On Julie ’s list were milk, coffee, butter and bread. After throwing those into my basket, I swiftly made my way to the front of the store, I came to a halt as I saw my favorite snack, Cheez-Its, white cheddar, of course. Yup, they made it on Richard ‘s list.

I tend to be impatient when it comes to checkout lines, so I used one of those self check-out stations, which did not have a line. After using it, I understood why. Anyway, upon completion, the screen read $28.98! I could not believe the high food prices. Assuming there had to be an error, I reviewed the price of items on my list.

Now, I consider myself to be a frugal guy. I don’t drink that fancy Starbucks stuff; Maxwell House is fine with me. No organic milk for the Ehrlich family; regular growth hormone-enriched milk is fine for them. Store-brand butter works, so does store brand whole wheat bread. So when I read that I was paying about four bucks for a gallon of milk, I was not happy.

Driving home from the grocery store, however, my mood changed quickly. I stopped at the gas station for a fill-up. I could not believe that it only cost 25 bucks to fill my tank. As I handed over my credit card, I realized that with the drop in gasoline prices, a gallon of gas now costs less than a gallon of milk. According to AAA, the national average price of regular gas hit as low as $1.937 per gallon last week.

So, let’s talk about what is going on.

It really comes down to the most basic principal of economics: supply and demand. There is simply much more oil on the market than is being used. For years now, from the tip of Texas to North Dakota, the US has improved oil drilling techniques, called “fracking,” thereby flooding the markets with oil. US stockpiles are at their highest level in at least 80 years, but we aren’t the only country producing more oil, as Russia, Canada and Iraq, among others, are pumping more and more each year. Even with this abundance, producers in the US and abroad have not yet cut back production very much, despite the low prices. Now, the lifting of international sanctions against Iran could send even more oil flowing into markets that are already awash in crude.

However, it’s expected that this production will slow. As many of these drilling companies rely on investors to continue searching for new drilling areas and as the price of oil drops, the attractiveness of an investment in that industry drops as well.

To exacerbate the issue, many European (and Asian) economies are struggling, causing a weaker demand. And as China joins the “low-growth” club, the global slowdown may only get worse.

With both forces weighing on the markets, slowing demand at the same time that we have greater supply, oil and gas could remain low for years.

That spells long-term trouble for the oil patch. You see, when oil prices were high, lots of banks made loans to energy companies to finance the drilling in the MidWest. With the deflation of oil, oil companies’ cash flow is slowing because the margins have evaporated, making it harder for them to service their debt. Bankruptcies are rising, causing defaults on that debt. This factor contributes to the over 20 percent losses we have seen in the high yield bond markets. In fact, many financial experts attribute the recent erosion of the broader markets to both the rapid decline in oil prices and the slowing of the world economies, specifically China.

The stock market is having its worst start to the year in history. The overall markets are down an average of 10 percent in 21 days. However, if we look a bit deeper, the numbers get a bit darker. Since the middle of last year, international stocks are down on average 22 percent; small cap is the same, large cap about 12 percent, and commodities a whopping 55 percent. Even global bonds are down 15 percent.

Folks, while we may welcome the break at the pumps as the cost of living rises in other areas, we must ask ourselves . . . at what cost.
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