Inflation Or Deflation?

The Iran War is causing energy prices to spike world-wide.  Energy is the most important cost element in consumer price inflation, since it effects everything from transportation, heating/cooling, fertilizers, food, chemicals, to building materials and pharmaceuticals. 

Therefore, cost driven CPI will inevitably go higher if things do not normalize in the Persian Gulf in the immediate future.

• Inflation for Goods: A spike is to be expected in consumer good prices, particularly for staple necessities such as fuels, natural gas, food and housing costs.  Let's call these "inelastic" expenses, although consumer behavior may shift after a few months of prolonged high prices (this may happen faster than before because in the US, particularly, a very large portion of households live hand to mouth and will have to cut spending even for necessities (the K-economy).

But what about assets such as equities, real estate, private credit and equity, junk bonds, precious metals, cryptos, collectibles?  Prices for these depend on spending and saving patterns by the top 10% of US households who control 80% of wealth.  How will they react to a war that drags on?  I make the following assumptions:

1. Risk premiums will re-adjust across all markets.
2. Short term interest rates may go higher, putting downward pressure on equity and precious metal valuations, on top of risk premium adjustment.
3. A squeeze in disposable income will lower discretionary spending for luxury goods and services, including travel, vacation homes, collectibles. Valuation for their respective assets will be marked down.

• Deflation for Assets: As risk appetite recedes, asset prices will be marked down.  Coming into an already highly elevated market for all risk assets, markdowns may be very substantial.  

Therefore, Inflation for consumer goods and Deflation for risk assets (if the Gulf War drags on).

One final possibility: the US may have to rework its tax policy in order to raise revenue to support the "bottom" 80% part of the K-society.  I will not be surprised to see President Trump announce a "temporary, wartime" wealth tax.  After all, the war is already costing around $1 billion per day and the tariff window has been firmly shut by the Supreme Court. Mr. Trump may, in fact, be the only President who could propose and pass such a tax (he is a populist, after all).

 The negative effect of a wealth tax on all risk assets is easy to predict, while long Treasury bonds and the FX value of the dollar may benefit.