Deflation and Investor Psychology

In over two decades in the investment business, I never cease to be amazed by how psychology affects peoples' investing. Human beings have the nasty habit, as far as investing goes, of extrapolating the recent past into the infinte future.

Look at the current deflation expectations. Deflation expectations have become so embedded in investors' minds that they now see a deflationary pricing environment lasting for decades! This even exceeds the length of time for the deflation caused by the Great Depression.

These so-called investors believe that central banks and governments have so fine tuned their policies that inflation will not re-emerge or that if does the central banks will be able to smoothly reverse policy and quash it. Investors are expecting these "perfect" policies from the same dimwits who drove the economy into the ditch in the first place. Human psychology is amazing!

I expect to see inflation raise its head within the next year or so. Inflation will come as a result of the following items: once global deleveraging ends (soon), the US Dollar will resume its steady long-term decline; the flood of money created by the Fed will burst the dam and begin moving into the economy; and finally, there will be a sharp reduction in the supply of raw (commodities), intermediate and finished goods relative to demand due to the impact of the credit crunch on producers and retailers.