Deflation vs Inflation - the current global debate

[james_57]

I don't know about you folks but i am having a really hard time getting my mind around the concept of deflation, and yet its probably the number one economic debate for the last year in the blogospere.

I'm starting a thread devoted to the issue, because i know there are sophisticated investor-minds here that understand this debate far more than i do, so i'm hoping to hear some opinions, and gain a better understanding of the issues.

Thanks in advance for sharing your opinions and knowledge!

(submitting exhibit A to kick off the discussion)
Drop in Inflation Expectations Has Gone Global

[andrewf]

What are you confused about? What is it? What causes it? What its consequences are? How to avoid it?

[Addy]

Originally Posted by andrewf

What are you confused about? What is it? What causes it? What its consequences are? How to avoid it?

How to embrace it?

[james_57]

Originally Posted by andrewf

What are you confused about? What is it? What causes it? What its consequences are? How to avoid it?

Ok, that's a fair question. Quantifying it, and qualifying deflation, first, as it pertains to the current global picture, (as this article above does with respect to inflation). Just exactly how the US credit market is deleveraging (the principle ways), and where that's going to lead, and what happens to the numbers overall when US RE comes off another 15% to 20% as many analysts are predicting, given there is 18 months supply in the pipeline (at least) and the anticipated fallout to our economy, (which does not operate in a fishbowl); and how deflation is liable to express itself in US equities markets. Those are just a few quandaries persisting in my mind.

Its more of a macro operational picture i am trying to grasp. Does that make sense? I feel like i understand bits and pieces of the global and regional picture, but i can't somehow frame it into a complete understanding of all the working parts. (emphasis on falling RE markets and impact of failing mortgages to credit-supply, liquidity-traps, asset class deflation, etc)

[james_57]

Exhibit B

By MarketWatch July 14, 2010, 3:11 p.m. EDT ·

WASHINGTON (MarketWatch) -- It could take five to six years before the U.S. economy is fully healed from the Great Recession of 2008, officials at the Federal Reserve said Wednesday.

More years of high unemployment. More years of skirting with deflation. More years of ultra-low interest rates, and more years of deleveraging.

The Federal Open Market Committee released its economic forecast on Wednesday, and it was dismal. While the officials are relatively upbeat about growth, they don't see the unemployment rate falling very quickly, nor do they think inflation is going to be a problem any time soon. See full story on the FOMC minutes.

That means there is no rush to normalize interest rates any time in the foreseeable future.

[Cal]

Technically couldn't we get both.

Asset deflation for RE and big ticket items.

And price inflation for gasoline, groceries and smaller everyday items.

[HaroldCrump]

Originally Posted by Cal

Technically couldn't we get both.

Asset deflation for RE and big ticket items.

And price inflation for gasoline, groceries and smaller everyday items.

That is exactly what we are witnessing.
Also, IMO, this is the new "normal".
Inflation and deflation are relative to current price levels.
However, we may need to adjust our mindset and expectation to a new normal of current employment levels, current price levels and current rate of returns/growth of equity levels.
Japan has been dealing with this type of "new normal" for decades now.

[james_57]

Originally Posted by HaroldCrump

That is exactly what we are witnessing.
Also, IMO, this is the new "normal".
Inflation and deflation are relative to current price levels.
However, we may need to adjust our mindset and expectation to a new normal of current employment levels, current price levels and current rate of returns/growth of equity levels.
Japan has been dealing with this type of "new normal" for decades now.

I'm no expert in Japan's economy, but if JP's now two lost decades are the corollary, then should we be expecting 1,500 on the DOW anytime soon?

Then there's the fact that JP had a functional, and for all intents and purposes healthy manufacturing industry pumping away exports underneath a dysfunctional financial layer and government monetary policy (right?). So that's different.

Japanese were savers, loaned to the Gov, then there was the carry trade business, etc etc. Many differences including the fact that this is the worlds base currency we are talking about, with gold reflecting the fact that all is not well in the kingdom. We could be comparing white swans with a sick black swan, (excuse the mixing of metaphors).

[Belguy]

Does the old maxum, "invest during periods of maximum pessimism" apply in the current environment?

You don't make money by investing during periods of 'maximum euphoria'. That is how you lose money!!

It is a difficult and confusing time for investors--especially older ones like me with a diminishing time line.

Something else that I recall reading is "never invest money in the stock market that you cannot afford to lose".

What to do????

One solution might be to not look at our portfolios for the next ten years or so.

[HaroldCrump]

Originally Posted by james_57

Then there's the fact that JP had a functional, and for all intents and purposes healthy manufacturing industry pumping away exports underneath a dysfunctional financial layer and government monetary policy (right?). So that's different.

Japanese were savers, loaned to the Gov, then there was the carry trade business, etc etc. Many differences including the fact that this is the worlds base currency we are talking about, with gold reflecting the fact that all is not well in the kingdom. We could be comparing white swans with a sick black swan, (excuse the mixing of metaphors).

Yes, there are key differences between Japan and current state of the US (North America), as you have rightly pointed out.
My intent in using the example is that we may not experience significant inflation or deflation in the near future.
By its very nature, stagnation can last for decades.
The capitalist boom-and-bust cycle requires an external stimulus to break out of.
The US economy emerged from the recession of the 1980s (fag end of the Reagen era and the Bush Sr. era) through the dot com bubble.
Then we had a relatively small recession of about 3 years and the real estate boom lifted the economy.
Now that it has burst, we must wait for the next bubble.
Capital is waiting on the sidelines for deployment into the next big thing.
It could take only a couple of years or it could take decades for the next big thing to arrive.
For Japan, it was manufacturing and finance.
They are still waiting for their next big thing.

We may have to get used to single digit returns on investment, 2% or so inflation, relatively low interest rates, low employment growth, modest increases in salaries and standard of living for a long time to come.