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  1. Wealth
September 20, 2010

Inflation? Deflation?

By Spear's

The problem is that inflation and deflation are both present. How can this be?

While the world keeps its fingers crossed in the hope of sustaining the recovery, the central bankers cannot work out if inflation, requiring higher interest rates, or deflation, requiring low interest rates to continue, rules the roost, so they don’t know which way to go. The problem is that inflation and deflation are both present – an inflationary spiral within a deflationary vortex.

How can this be? Some prices, such as oil, energy, food and certain services such as water, are experiencing inflation, while others, such as cars, computers, telecoms and certain services such as newspapers, are experiencing deflation. So what’s a central banker meant to do? That very much depends on which currency is involved.

The Anglo-Saxon economic model is much driven by property lending, too much driven in fact, which was the main cause of the Global Crunch and the ensuing banking crisis. Perversely, any rise in house prices is seen as a good thing, as bank’s balance sheets get stronger on the back of rising prices.

This issue is to the fore in the US, UK, Iceland, the PIGS and East Europe, where property prices are actually falling, especially in the US, despite every effort of Obama’s government with props and subsidies; this administration’s gamble that recovery would cause house prices to rise is the economic equivalent of a soufflé that can’t keep its end up, and further asset price deflation is on the menu. So interest rates will need to be held low in these economies to prevent deflation, and avoid/defer Banking Crisis II.

A different problem exists in the eurozone, where the sovereign debt crisis in the PIGS has reduced the value of the euro, much to the pleasure of Germany’s exporters, but shortly Germany will find itself importing inflation. Indeed the only country doing well in the West at the moment is Germany, where they are not pre-occupied by house prices and know what economic discipline really is: when inflation courtesy of Club O’Med reappears, however, they’ll rue the day they sacrificed the DeutschMark, so that Nick the Greek and a Spanish girl called Siesta could bask longer on their beach in the autumnal sun.

Ireland, itself in the eurozone, shows up the problem of an Anglo-Saxon economic model within the single currency/single interest rate/”one size fits all” regime governed by German economic considerations: Irish commercial property is off 60% and still falling, while Anglo Irish Bank announces another €8.2 billion of first half losses, another €8.0 billion injection from the government and a new forecast of €25.0 billion total bail-out for just this one stupid bank.

Is it worth it? Should the taxpayer be impoverished by those that got bonuses for bankrupting the system is the moral question Capitalism faces, which has not been answered yet, by anyone.

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On the other side of the world, Australia’s Capitalistic BHP Billiton is bidding $40.0 billion for Canada’s Potash Corporation in the belief that the price of food and fertilizer is set to rise and therefore the price of potash is set to rise in the long term too, all due to increased demand – (provided war and disease don’t interfere).

Indeed the Russian potash producer BPC is aggressively raising world prices by 8%, while Potash Corporation’s share price remains firmly higher than the bid price. All of which shows just how powerless central banks are these days in the global market to address the domestic issue of imported inflation.

The West, apart from Germany, is heading towards the dreaded double-dip, which will mean more QE. Interest rates are set to remain low as long as the threat of debt-deflation stalks the property markets, which it most definitely still does. Eventually, interest rates will have to rise significantly, but not before some time in 2012.

Then the increases required could rise rapidly if hyper-inflation gets going, but that, perversely, is the quickest and surest way to repay the West’s debt mountain! Perhaps that’s the agenda anyway, and management of public perception the only true issue left in town.

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