The specter of deflation returns

With the strong sell-off in economies after the Great Financial Crisis, central banks around the world engaged in massive quantitative easing to halt any deflationary fears and expectations. The battles were not directly expressed as one to stop deflation but rather as still trying to hit inflation targets. In a leveraged world, deflation is an economy's worst enemy. However, central bank actions of increasing credit offset these risks. Financial assets were bid up eliminating financial asset deflation. Money was increased, so credit was available to stop the erosion of general prices and allow for leverage to be adjusted slowly. Central banks were successful with their goal, or so they thought. In a world where output still exist, normalizing monetary policy is not easy.

In 2014, the specter of deflation is again scaring markets even though inflation from currency devaluations is also a potential problem for selected countries. The inflation rate for the EU is well below target. It is also below target in the US. The IMF has sounded the alarm for deflation in the developed world. The attempt to return to normal by the Fed has sent emerging markets into a growth scare. Any global growth slowdown says that economies are still fragile and means prices can be biased downward. Currency devaluations increase import prices but a global slowdown will also have a negative impact on commodity exports and lead to a negative feedback on EM growth. 

The G20 meeting in Sydney will be critical to trying to address the new deflationary pressures around the world. But it is unlikely we will make any progress on deflationary discussions. The Fed has not any desire to include international considerations in monetary policy. Central bank coordination has not been a theme that has interest. There is much more focus on staking of positions within an uncoordinated G20.