• Deleveraging continues apace and is expected to continue for many more years to come -- both nationally and internationally:
° Total domestic financial debt as a percentage of GDP has fallen 6.66 percent year-over-year through 9/30/12 and
° Total credit market debt of all types and for all sectors as a percentage of GDP has fallen 1.92 percent year-over-year through 9/30/12.
• Import prices (the prices of all the goods and services that we import into the U.S.) have fallen 1.6 percent year-over-year through 11/30/12.
• Nonfarm unit labor costs have risen only 0.1 percent year-over-year through 10/31/2012.
• The productive capacity of the U.S. economy remains heavily unused or underutilized, thus preventing price increases:
° The national capacity utilization rate is running at only 78.4 percent of total capacity as of 11/30/12 and
° Real industrial capacity (how much we could produce if we turned on all the factories) increased by 1.5 percent year-over-year through 11/30/12.
• The inflation pipeline already has falling prices baked into the manufacturing and distribution processes, i.e.:
° The producer price index of crude goods has fallen 1.8 percent year-over-year through 11/30/12 and
° The producer price index of intermediate goods has fallen 0.3 percent year-over-year through 11/30/12.
• Consumer price inflation as measured by the CPI remains dormant at only 1.8 percent year-over-year through 11/30/12.
• There remains an overabundance of unused or underused workers in the U.S.: The number of American’s with jobs as a percentage of the total population has fallen to 58.8 percent from a high of 64.7 percent reached back in February 2000 and the unemployment rate stands at 7.75 percent as of 11/30/12.
• The unemployment rate overseas places a hard ceiling on any future increases in employment costs here in the U.S. The unemployment rate in Europe (ex UK) was 11.7 percent as of 11/30/12.
• The U.S. Dollar has been appreciating, making it cheaper for us to import goods, thus avoiding domestic price increases. The trade-weighted U.S. dollar has risen 1.92 percent on a year-over-year basis through 11/30/12.
• Finally, demographic trends inside the U.S. are working strongly against any resurgence of inflation. Consider two different cohorts of Americans, those aged 20-24 and those aged 60-64. Today, the number of 20-24 year-olds minus the number of 60-64 year-olds is 4.7 million. But by 2021, this number will fall to 0.6 million. The affect of this change will place extreme downward pressure on inflation. The reason is simple. Americans aged 20-24 tend to be low-productivity and spend over 100 percent of their respective incomes. In contrast, those aged 60-64 tend to be some of the most productive workers and they are at their peak savings years. Thus, changes in the demographics of the American workforce between 2012 and 2021 will significantly enhance productivity and will decrease consumption -- both trends are deflationary.
• Moreover, no matter how fast the Federal Reserve prints new money, it is more than offset by an even more rapid collapse in the velocity of money. The year-over-year change in the velocity of money based on three-year smoothing has fallen 8.8 percent as of 11/30/12.
TIPS Are Grossly Overpriced
The unfounded fear of inflation has resulted in a relative stampede towards TIPS, driving their prices to ridiculously high levels. Recall that TIPS do not guarantee a profit, they only guarantee that their maturity value (and therefore their semi-annual interest payments) will adjust for inflation. It is just as easy for TIPS to become grossly overpriced as any old tech stock. As of the close of markets on 12/31/12, TIPS bonds were priced to yield the following:
• -1.37 percent for a 5-year maturity
• -1.09 percent for a 7 year maturity
• -0.67 percent for a 10-year maturity
• +0.15 percent for a 20-year maturity
These are all real yields after the CPI.