Deflation Stalks the Globe
Crude oil trading at less than $60 a barrel for the first time in five years means lower gasoline prices and more money in consumer's pockets, right? And the knock-on effect of driving down consumer prices is great for everyone, correct? And the global economy needs all the help it can get as it drags itself out of recession, so what's not to love about lower inflation?
Plenty of people are alarmed by the prospect of deflation, which can snuff out growth by making consumers reluctant to spend and companies unwilling to invest. Many of them work at the world's central banks. Most of their opponents subscribe to the Austrian school of economics, which is allergic to central banks' manipulating markets and asset values, and embraces the current trend. Next year may prove which view is correct.
The euro region looks to be most at risk of sliding into deflation early next year. Consumer prices rose just 0.3 percent in November, a far cry from the European Central Bank's 2 percent target. And the ECB's preferred measure of where the collective intelligence of financial market participants says inflation is headed -- the five-year rate on inflation swaps in five years' time -- heads lower all the time:
Deflation prospects are also evident in the world's government bond markets. In the U.S. Treasury market, dealers have dissected the securities into so-called STRIPS -- Separately Traded Interest and Principal Securities -- at a pace that's swollen the market to $211 billion, its biggest since 1999. Strips, which lose value quicker than just about anything else if inflation accelerates, have instead posted returns approaching 50 percent this year, Susanne Walker reported for Bloomberg News this week. U.S. bondholders are so relaxed about inflation that they're almost horizontal.
And in Germany, investors are paying for the privilege of stashing their cash in government debt -- another sign that they don't expect inflation to erode the value of their returns:
Some countries are already in deflation. In Sweden, consumer prices dropped for a fourth consecutive month in November, prompting the central bank yesterday to commit to keeping its main interest rate at zero until the second half of 2016. Spain, which is at the mercy of the ECB's policies, has seen deflation for the last five months, with prices dropping by 0.4 percent in November.
Even in the U.K., where the economic recovery is relatively robust, figures yesterday showed inflation at its slowest in more than a decade, with November consumer prices rising just 1 percent. That helped drive the yield on 30-year gilts to a record low yesterday:
There's a genuine and interesting debate among market watchers and economists about deflation. Ben Bernanke's famous November 2002 speech, "Deflation: Making Sure 'It' Doesn't Happen Here," provided the playbook for most of what central banks have done since 2008 to stop the wheels from coming off the global economy. If deflation becomes a reality in 2015, we may find out whether it's an evil to be avoided at all costs, or a boon to be championed.
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