Friday, 30 July 2010

Is The US Heading For Deflation?

Over the last decade there have been several warnings about the possibility of deflation in the world's developed economies. Its not unknown. Actual price declines were quite frequent in the 19th Century reflecting large improvements in productive capacity. In the 1930's prices declined, more than wages during the Depression, and asset prices such as houses and share prices dropped 90%. Following its bubble, Japan saw deflation for more than a decade during the 1990's, and continues to see periods of deflation, despite huge amounts of money printing by Japanese authorities alongside massive fiscal stimulus.

Its probably fair to say that without the kind of massive money printing we have seen by developed economies over the last 30 years, actual consumer prices would have fallen, a reflection of the shift of much manufacturing production to very low cost producers in China and the rest of Asia. In the US, the huge injections of liquidity, alongside its massive fiscal stimulus, managed to bring its recession ot an end quickly, and saw prices begin to rise. But, the effects of the stimulus appear to be wearing off, and there are rumours that the federal reserve once again sees the risk of deflation ahead.

Now a former Federal Reserve inflation hawk, James Bullard, has told CNBC that he now sees deflation as a much more serious threat than inflation.

The US is different to the UK, or other European countries. The UK is a small economy, which is dependent for many things on imports. As I've pointed out previously, I see a strong potential for an asset price deflation, particularly houses, reversing the previous bubble, at the same time as a spurt of consumer price inflation, fuelled by loose money, and the rising costs of imported goods from China. But, the US is a huge economy in its own right. Although it imports a large amount of goods from China, the US still has a considerable manufacturing base, as well as a large agricultural sector, not to mention its high technology industries. The US has a potential to avoid the kind of imported costs and prices that the UK, and other European countries do not. Its ability, on the other hand, to avoid deflation is not so clear. Ben Bernanke has said they could drop dollar bills from helicopters, but to be honest, the amount of money already pumped into the economy is coming close to that anyway.

Some US soothsayers think even that might be the least of the US's problems.Bob Prechter the well-known Elliot Wave theorist who predicted the 1982 on, Stock market Boom, and the 87 Bust believes that the Dow Jones could fall from its current 10,000 level down to just 1,000! He thinks that the US and Europe are in for a period of deflation and depression, which will be the worst in 300 years. Despite massive dollar printing, he believes the deflation will leave paper dollars, wherever they are appreciating in value against other assets.

The other well-known Bear Marc Faber responded in his Boom, Doom and Gloom Report to Prechter's analysis. Faber On Dow 1,000

I agree with Faber that, if the Dow falls significantly, or there are other similar shocks, Central Banks will step up their money printing. But, money printing on its own, as keynes said it would, has proved inadequate. It takes Governments to introduce large fiscal policies to spend some of that money, to get the economy going, so that the private sector will begin itself to begin to borrow and spend. The problem for Faber's position is that what is in the interests of Capital, and what the Capitalist State attempts to do, still have to overcome the problem of Governmental power. We are witnessing that in the EU now, with the inability of the European Capitalist Class to get the political backing for an EU State that is necessary for the EU wide economic solutions to work, and in Britain and other countries, where right-wing Governments having got elected on the basis of populist policies of cutting the size of the State, find themselves hostages to fortune, and having to now implement those policies against the interests of capital, and in the face of opposition from sections of the State.

We are living in interesting times as Faber's suggestions about what to do if the DOW did hit 1,000 suggest. One suggestion from Faber is buying a self-sustainable farm in the middle of nowhere surrounded by high voltage fences and barbed wire and equipped with booby traps and an arsenal of machine guns, hand grenades and armed vehicles guarded by vicious Dobermans. Workers might want to be thinking about their own solutions!

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