Friday, August 20, 2010

Deflation versus inflation the problem choice will not go away


There is growing a battle between the economists and investors who think we are or will have deflation problem versus those that think that inflation may be around the corner. For the G3, the deflation crowd seems to have a strong argument.

Looking at the actual inflation numbers, the globe can be broken into the developed world that is on the cusp of deflation and the emerging market world which is in the grip of rising inflation. On a 10-year rolling basis, the inflation rate is the lowest in 41 years. for the US. Inflation expectations by businesses shows rates below 2% which has been the long-term target. Break-evens between TIPS and nominal bonds have also started to contract which is another sign that inflation is unlikely. Emerging market inflation is over double that number even though it is less than what we have seen pre-crisis.

Monetary policy, whether through driving rates to zero or using QE, has caused limited or no increase in inflationary expectations. Price levels have fallen since the beginning of the year and we are supposed to be in a recovery.

The most likely scenario in the near-term is a bifurcated world of emerging markets battling inflation and a languishing developed world of no inflation. This will continue until the global growth story finds a clear direction. However, this may not be until 2011.

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