Deflation: The other risk

Posted: June 27, 2013 in economy
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WHILE many gold bugs fear that quantitative easing will eventually lead to hyperinflation, that is far from the only possibility. Japan has had poor demographics and a sluggish economy for 20 years and has suffered from persistent mild deflation. Central banks can expand the monetary base, but this may not lead to broad money accelerating. In Britain, M4 is hardly racing along at 4.8% year-on-year growth; exclude securitisations and it is actually down on the year. In the euro zone, where QE is not yet a policy, euro zone money supply growth decelerated to 2.9% in May from 3.2% in April and lending to the private sector was down 1.1% year-on-year. While central banks may be trying to create money, commercial banks are still shrinking their balance sheets; if you like, the central banks have turned on the tap but the commercial banks have pulled out the plug and the bath is not filling.

Albert Edwards of SocGen used this chart in his latest research note. The core PCE number is only 1% – a modern low – and the Dallas Fed, which uses a trimmed mean number (eliminating the outliers), actually recorded a small fall in the latest numbers (see the definition here). Given the fall in inflation, the puzzle is the recent reaction of the bond markets. Of course, it’s down to the Fed statement; perhaps a 1 percentage point rise in yields is the market’s best guess at the …

via Economic Crisis


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