Inflation or Deflation?

One of the most tricky financial phenomena is INFLATION....

A continuing inflation of an average 2% or 3% devalues pensions and erodes saving accounts on the long run.

A sudden shock of inflation, hyperinflation, vaporizes the assets as well as the debts.

It could be (the only) way out of this sustainable crisis we seem to be dealing with. The other side, credit deflation, is also a potential 'Crisis Solver Candidate' for restructuring the enormous debt in our economy.

Which one will win?  Price (hyper)inflation or credit deflation? That's the key question....

Artificial

Just like the complete arsenal of asset classes in our financial 2012 society, price inflation is not (longer) a result of natural price mechanisms directly or indirectly based on supply and demand.

Worldwide, governments and central banks (FED, ECB, etc) are trying to control inflation  to keep economies as stable as possible and to create an economic environment with growth potential, while restructuring debt step-wise on the long run to 'acceptable' levels....

Historic Price Inflation

With the above formulated insights, let's take a look at how U.S. price inflation and deflation have historically developed on the long run:

A visual analysis of this inflation graph clearly shows the hyperinflation waves (most often) are followed by a hyperdeflation avalanche. However for more than 56 years on a row now, inflation has been only positive. So the key question stays: Are we heading for a major devaluation crash or a final hyperinflation scenario after which what (?) happens????

To get (visual) sight on this question, let's take a look at the 10Y and 50Y moving averages::

At first sight, one could visually conclude that it's most likely that inflation will rise again..... On the other hand, looking 'long term' deflation seems inevitable......   But who really knows?

Detail Figures

Maybe some quantitative information gives more insight:

From this we can conclude that the average arithmetic inflation (1.38%) as well as the compound (geometric) inflation (1.13%) is modest and the standard deviation (considering the low averages) is relatively high.

This calls for a period inspection:

Or in plain numbers:

Now we have a clear view! Until 1900 the average yearly inflation was around 0%. From 1900 to 2000 we suffered from an increasing inflation, mainly due to a number of crises. As from 2000 of, we try to push inflation down, with limited success.

Hyper Risk

All these charts lead to a better view on inflation, but what about the risk of 'hyper' inflation- or deflation.

A short look at the frequency table helps us to get a picture of the inflation risk distribution:

I'll leave it up to you, to draw your conclusions from this last chart.

Mathematica

More insight and feeling about how inflation correlates with some important economic variables can be developed by playing around with the next Mathematica Applet.

To work with the applet, allow the Mathematica plugin to download (it's safe).

This year (2012) inflation come out will be somewhere around 2.1%.

One of my next blogs will allow you to Mathemetica(lly)  'play' with inflation (including the 2012 inflation outcome), so you'll be able to grasp inflation finally.

Finally: Keep Cool!
Until then....., keep cool while watching the inflation balloon rise until it will (not) burst !!! , as researchers in a "Bursting balloons and anxious faces study"  concluded that a person is willingly to take more risk when a watching friend suppresses facial expressions of anxiety. "Such a finding has obvious implications for the interpersonal emotion regulation of advisors or counselors intervening in real world decision making situations". 

Links

- Excel Spreadsheet with inflation data and charts

- Inflation Wikipedia

- Study Bursting balloons and anxious faces