Thursday, September 18, 2014

The Global Battle Against Deflation Continues

Despite years of easy money policy by Central Banks all over the world, the evidence seems to indicate that the battle to stave off deflation is still in full force. Deflation is a worst case scenario for Central Banks. With sovereign debt at record levels around the world and memories of the global financial crisis of 2008 still fresh, neither governments nor Central Banks can afford to let deflation take hold. But can they stop it? In this Bloomberg article , we get more evidence that China is ramping up the fight.

Let's review the most recent news events to see if a trend is emerging:

- the lastest US labor reports indicate new weakness

- the lastest US housing reports indicate new weakness

- the price of oil and gold has been falling

- Foreign Affairs runs an article calling on Central Banks to give out free cash to people

- the sanctions against Russia are hurting global GDP and may compound economic      problems in Europe especically

-  the FED announces interest rates will stay low a long time due to ongoing concerns about the labor market and also says inflation is running below the FED target rate

There are plenty of additional similar articles if you just do a simple google search on "global deflation". This is a situation we must watch very carefully. Keep in mind that Central Bankers are expected to exhibit confidence at all times. They realize that anything they say that spooks markets can start an unintended reaction. So for them to talk this openly about about deflation suggests this is a very real concern.

I am finishing up Jim Rickards book The Death of Money right now (and I will be doing a review of it soon here on the blog). There is an entire chapter in the book devoted to potential problems in China. Jim lists a crisis in China as one of the key signposts to watch for that could lead to an end to the current "rules of the game" in the present monetary system. 

He also explains why Central Bankers fear deflation more than anything else on earth. Not only do they lose tax revenue in a deflating economy, it makes the sovereign debt problem even worse as paying off the debt becomes impossible. Bond markets would realize that fact at some point. Simply put, they cannot allow deflation to win without suffering a major crisis in a financial system that is debt based and totally dependent on perpetual inflation to sustain itself.

If deflation is coming, we can expect that Central Banks will do everything in their power to fight it. This situation could lead to a lot of volatility as markets try to guess whether deflation will win or efforts to stave it off might lead to very large inflation instead. If you see Central banks start adopting policies to try and force money into circulation (negative interest rates for example) or other radical proposals, it likely means there is very deep concern.

So far the Central Banks have managed to keep things reasonably calm even if growth has been very weak. Perhaps that will continue. But it is clear they are concerned about deflation. If they are, we need to watch it as well. 

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