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The War on Deflation Continues

Sean Hyman (June 18, 2009)

Thursday, June 18, 2009

Where We Stand on the Inflation vs. Deflation Question

Also In Today’s Letter…

By Chuck Butler You know, ever since I became a professional Forex trader, it’s been difficult to turn my brain off and stop pondering the next move in the financial markets.

It’s only gotten worse in the last 18 months as this recession spun out unprecedented events on a weekly basis.

Case in point: The other day, I was out riding my Suzuki Hayabusa (that’s me in the picture with my motorcycle). I was flying down the highway at 80 miles an hour and I started thinking about deflation, of all things.

Has the deflation story really played out? Where do we stand on all of this stimulus pouring into the global economy (stimulus that’s now estimated at over US$2 TRILLION)? Will the G-8’s meeting actually help or hurt matters?

Questions worth pondering – so let’s start with the G-8 meeting. This past weekend, the G-8 met with their Finance Ministers and outlined an agenda for their central bankers in July.

What was on the agenda? Reversing the global stimulus.

Now, on the one hand, that’s a vote of confidence for the global economy. That gesture alone says the finance ministers believe the economy is back up on its feet, or else they wouldn’t even be considering draining all this extra liquidity.

However, on the other hand, there are still pockets of deflation looming around the world, while inflation is creeping up in others.

How can I tell? Remember that deflation is defined as a “drop in prices,” not just a slowing of price increases (which would be disinflation). So I can turn to two things to check this out: 1. Year over Year (YoY) CPI and 2. The CRB Index.

(Now, please keep in mind that none of the data the government spews out is 100% accurate – but the numbers can still be helpful as estimates.)

So what does the inflation picture (as defined by CPI) look like? See the chart below.

CPI Gives a Mixed Picture at Best!

If you look at it this way, then we look like we’re at least partway out of the woods. New Zealand, Australia and the U.K. are showing signs of inflation. So are the Eurozone and Canada. However, after that is where we still see some problems.

The U.S. and Japan (two whopping economies in the world) both still have mild deflation and Switzerland still has quite a bit of deflation as well.

Now, there’s another way to view inflation. You can gauge inflation based on the rise or fall of a basket of commodities (the CRB Index). If you check out the CRB Index, then it appears that inflation is making a small comeback. See theits chart below.

The CRB Index Shows Signs of Inflationary Life

Now this, on the other hand looks a bit more promising as far as the “return to inflation” goes.

But please keep in mind that prices will have to eventually rise further still to dig us completely out of the deflationary hole.

This initial turn in commodities has been due to China’s recovery and all the governments printing money like mad all around the world. Many of these governments have engaged in quantitative easing to pick up any slack left over. (In fact, I wrote to you a few months ago about all their efforts. You can read the article for yourself here.)

Consumers Will Decide Where We Go From Here

Governments can help the initial turn around but they can’t sustain a turnaround. Who has to do that? The consumer has to step in and take it from there.

They can only do this is sentiment improves and if credit is extended once again. For now, both sentiment and credit is starting to improve, so we have a shot at sustaining this.

However, the ball is now largely in the consumer’s court. What will they do with it from here? Will they step up and fill in the gap as the governments begin to slowly withdraw the stimulus later on this year? Only time will tell.

Part of it will be on the consumer’s willingness to spend and part of it will be on the consumer’s ability to get loans (which depends upon the bank’s willingness to lend).

In the meantime, listen in next month on July 10th -12th when the G-8’s central bankers gather together. Let’s see what they have to say and see when they will start withdrawing the stimulus. I know I’ll be watching, and I’ll be back here in FX University to give you my take on the latest question of inflation vs. deflation.

Happy Trading,
Sean Hyman, aka Professor FX

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