Outlook: World-wide deflation: is it fact or fiction?

The threat of global deflation - a la 1930s - has suddenly become the fashionable thing to worry and talk about at City lunch tables. Is this just a passing fad, a bit like the new economic paradigm of a few months back (whatever happened to that theory?) and more an alarmist symptom of the present wave of stock market turbulence than anything else, or should we be genuinely concerned?

For stock market bears, the theory has become a very handy way of re- justifying their stance. In recent times stock market corrections or bear markets have generally been caused, at least in the Western world, by deteriorating liquidity as central banks raise interest rates to combat inflation. Plainly there's a bit of that going on in Britain right now. After yesterday's clutch of economic indicators, it rather looks as if last week's quarter point on interest rates won't be the last. Even so, this hardly justifies the present bout of jitters. Inflation is still in abeyance in most of Europe and North America.

Instead, the turbulence in Western markets has been caused by the opposite thing - the fear of deflation. The contagion has spread, moreover, not from Wall Street into the rest of the world, as it usually does, but from the Far East, from the developing Pacific Rim economies into Japan and then into the US and Europe. One feature of this phenomenon has been a tendency for bond and equity markets to decouple, for bond prices to rise even as equities are falling, much as they have done in Japan since the stock market bubble burst at the end of the 1980s. This is highly unusual, for the two normally track each other, and a clear indication of deflationary forces at work, the argument runs.

Taking the real economy, the deflation theory works like this. The crisis in the Pacific Rim economies may not be of critical importance to the US and Europe, but it is to Japan, half of whose exports go to Asia. Here there's a double whammy for Japan's already weakened economy. Nobody will be buying on past levels and even if they were, Japan's competitiveness has been severely undermined by currency devaluation in the region. What's more, the consequence of excessive investment in the region is overcapacity and too many goods looking for a market.

Still reeling from the after effects of Japan's own speculative stock market and property bubble, Japanese banks now have a whole new raft of bad loans to come to terms with. No wonder Barton Biggs, Morgan Stanley's stock market guru, is advising clients to quit waiting for a recovery, cut their losses and bail out of Tokyo.

With no Asian market to turn to, Japanese companies and their counterparts in the region will fix their efforts on the one big growth market left, the US. In the words of Andrew Smithers, of the London based investment boutique Smithers & Co, "a weak yen would be part of the general devaluation of Asian currencies and would exacerbate the growing disparity in the US between the rise in costs of labour and services and the price of traded goods. This would pose a major threat to the profits and cash flow of US corporations." A fall in the yen thus becomes the trigger for a further fall on Wall Street. In a worst case scenario, there's a trade war, pressure for protectionism, and, hey ho, it's the 1930s all over again.

Compelling isn't it? But actually rather unlikely, at least in this form. Here's the other side of the coin. World capacity and output have not been growing at an unusually fast pace; investment spending is at around, or below, its long-run average relative to OECD and world GDP, although it is at a cyclical peak in the US. There are gluts and falling prices - but only in a handful of commodities, in particular in semiconductors, steel, possibly chemicals and cars. Because they are high-profile they exercise a tyranny over popular thinking.

Although some OECD countries have high unemployment, this is structural. Others - the US, UK, and the Netherlands - have unemployment rates at 20 or 25-year lows; wages are rising faster than inflation across most of the OECD. The Asian slowdown will affect the rest of the world; but world GDP growth is still expected to be 3-4 per cent, well above the post-war trend. Asian growth forecasts have been cut from 8 per cent plus to 6 per cent, or about 4 per cent excluding China - still not a slump.

Commodity prices, the bottom of the price chain, are not falling. Outside Japan, real interest rates are relatively high; if there were any evidence at all of a troubling economic slowdown, central banks could easily tackle it by cutting interest rates. This is not to argue for complacency. The repercussions of the Asian crisis are still far from clear, and it does seem highly likely there will be real economic damage both to Japan and the US. But that it will cause a slump, or even a recession in the US looks at this stage rather improbable. A reduction in US economic growth? Certainly. An end to Wall Street's bull market? Very probably. A big Wall Street correction? Possibly. But worldwide deflation? Mmmm.

Suggested Topics
News
John Travolta is a qualified airline captain and employed the pilot with his company, Alto
people'That was the lowest I’d ever felt'
Life and Style
healthIt isn’t greasy. It doesn’t smell. And moreover, it costs nothing
News
i100

Other places that have held independence referendums
Arts and Entertainment
Jack Huston is the new Ben-Hur
film

It scooped up an unprecedented 11 Academy Awards when it was first remade in 1959

PROMOTED VIDEO
Life and Style
fashion

Olympic diver has made his modelling debut for Adidas

Arts and Entertainment
Blossoming love: Colin Firth as Stanley and Emma Stone as Sophie, in 'Magic in the Moonlight'
film

Actors star in Woody Allen's 'Magic in the Moonlight'

News
news

News
peopleThe Times of India said actress should treat it as a 'compliment'
Arts and Entertainment
Maxine Peake plays Hamlet at Manchester's Royal Exchange
theatreReview: Maxine Peake brings emotional ferocity to Shakespeare's starring part
News
London's New Year's Eve fireworks event is going to be ticketed this year for the first time at £10 a head
news

Revellers will have to pay to see New Year's Eve fireworks in London

News
news

Watch this commuter wage a one-man war against the Circle Line
Property
Home body: Badger stays safe indoors
lifeShould we feel guilty about keeping cats inside?
News
ebooksAn unforgettable anthology of contemporary reportage
Travel
travel

...and the perfect time to visit them

Sport
Jonas Gutierrez (r) competes with Yaya Toure (l)
football

Newcastle winger reveals he has testicular cancer - and is losing his trademark long hair as a result

News
A male driver reverses his Vauxhall Astra from a tow truck
news

Man's attempt to avoid being impounded heavily criticised

Life and Style
tech

Try putting that one on your Christmas list
Arts and Entertainment
While many films were released, few managed to match the success of James Bond blockbuster 'Skyfall'
filmsDaniel Craig believed to be donning skis as 007 for first time
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Trainee Recruitment Consultant - Birmingham - Real Staffing

£18000 - £23000 per annum + Commission: SThree: Real Staffing are currently lo...

Recruitment Consultant - Soho - IT, Pharma, Public Sector

£20000 - £25000 per annum + OTE £35,000 first year: SThree: The SThree group i...

Sales Executive

£20 - 24k (Uncapped Commission - £35k Year 1 OTE): Guru Careers: We are seekin...

Payroll & Accounts Assistant

£20 - 24k + Benefits: Guru Careers: This is a great opportunity for an enthusi...

Day In a Page

Mystery of the Ground Zero wedding photo

A shot in the dark

Mystery of the wedding photo from Ground Zero
His life, the universe and everything

His life, the universe and everything

New biography sheds light on comic genius of Douglas Adams
Save us from small screen superheroes

Save us from small screen superheroes

Shows like Agents of S.H.I.E.L.D are little more than marketing tools
Reach for the skies

Reach for the skies

From pools to football pitches, rooftop living is looking up
These are the 12 best hotel spas in the UK

12 best hotel spas in the UK

Some hotels go all out on facilities; others stand out for the sheer quality of treatments
These Iranian-controlled Shia militias used to specialise in killing American soldiers. Now they are fighting Isis, backed up by US airstrikes

Widespread fear of Isis is producing strange bedfellows

Iranian-controlled Shia militias that used to kill American soldiers are now fighting Isis, helped by US airstrikes
Topshop goes part Athena poster, part last spring Prada

Topshop goes part Athena poster, part last spring Prada

Shoppers don't come to Topshop for the unique
How to make a Lego masterpiece

How to make a Lego masterpiece

Toy breaks out of the nursery and heads for the gallery
Meet the ‘Endies’ – city dwellers who are too poor to have fun

Meet the ‘Endies’ – city dwellers who are too poor to have fun

Urbanites are cursed with an acronym pointing to Employed but No Disposable Income or Savings
Paisley’s decision to make peace with IRA enemies might remind the Arabs of Sadat

Ian Paisley’s decision to make peace with his IRA enemies

His Save Ulster from Sodomy campaign would surely have been supported by many a Sunni imam
'She was a singer, a superstar, an addict, but to me, her mother, she is simply Amy'

'She was a singer, a superstar, an addict, but to me, her mother, she is simply Amy'

Exclusive extract from Janis Winehouse's poignant new memoir
Is this the role to win Cumberbatch an Oscar?

Is this the role to win Cumberbatch an Oscar?

The Imitation Game, film review
England and Roy Hodgson take a joint step towards redemption in Basel

England and Hodgson take a joint step towards redemption

Welbeck double puts England on the road to Euro 2016
Relatives fight over Vivian Maier’s rare photos

Relatives fight over Vivian Maier’s rare photos

Pictures removed from public view as courts decide ownership
‘Fashion has to be fun. It’s a big business, not a cure for cancer’

‘Fashion has to be fun. It’s a big business, not a cure for cancer’

Donatella Versace at New York Fashion Week