Is Inflation Gone Forever?

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One of the most fearsome phenomena investors have to face is inflation. It's deceptively slow, but steady erosion of purchasing power regularly hides the fact that safe investments with low returns aren't sufficient to preserve one's standard of living over the long run. Yet recently, inflation has been all but nonexistent, making investors think twice before buying iShares Barclays TIPS Bond , Vanguard Short-Term Inflation-Protected Securities , and other inflation-indexed bond investments. Is inflation really gone for good?

The latest on prices
From looking at the most recent readings on inflation in the U.S., it certainly seems inflation is well under control. In October, the Consumer Price Index dropped 0.1%, cutting the year-over-year rise in the CPI to just 1%. As has been the case repeatedly over the past year, falling gasoline prices played a big role in the decline, as a 2.9% drop in October alone contributed to the more than 10% decline in the price of gasoline since this time last year.

Yet looking across the spectrum of expenses, it's hard to find inflationary pressures anywhere. Even in medical-care services, which have routinely seen prices rise at faster rates than overall inflation, year-over-year increases of 2.9% are lower than what we've seen in past years. When you take out volatile food and energy prices, core inflation rose 1.7% -- below the Federal Reserve's targeted 2% level.

When you look at prices at the wholesale level, the threat of inflation seems even more remote. A 0.2% drop in the Producer Price Index brought the year-over-year change in the index to just 0.3% for finished goods. Intermediate and crude-goods prices, reflecting stages earlier in the production process, have actually fallen over the past 12 months.

Implications for investors
Many policymakers have debated the ideal level of inflation, suggesting that too little inflation can be just as bad as too much. Certainly, the Fed and other central banks around the world have done their best to counter any risk of deflation, as the corresponding impact on deferring purchasing decisions in search of lower future prices could send the economy into a downward spiral. Yet that hasn't stopped prices of many commodities from plunging recently. The drops in SPDR Gold , iShares Silver , and other investments directly linked to commodity prices attest to the impact that a lack of inflation can have on certain niches in the financial markets. Moreover, the exodus of investor funds from SPDR Gold, iShares Silver, and similar funds suggest investors are increasingly convinced inflation won't help gold and silver return to their bull-market runs over the past decade.

But economists for the most part don't believe that inflation is gone for good. In fact, they're quick to point out that in emerging markets like Russia, China, Brazil, and India inflation rates are running above their 2012 averages, with GDP-weighted inflation across those economies, plus Indonesia and South Africa coming in about 1 percentage point higher than last year. In many ways, developed economies have benefited from lower prices in emerging markets, and inflation there could eventually pose a threat to the growth that developed markets have seen.

For now, though, spreads on the bonds that iShares Barclays TIPS Bond and Vanguard Short-Term Inflation-Protected Securities own suggest inflation should stay in a subdued range below 3% for the long run. If that comes to pass, it'll represent a major victory of monetary policy over what has in the past been one of the biggest threats to investors' well-being.

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