Thursday, July 28, 2011

Competitive inflation or deflation?

It has been widely asserted that the only way for the Western world out of its debt problems is competitive inflation.  But it is hard to get an inflation going during a debt deflation.  If we are on the verge of a deflation, what will the competition involve?

Deflation is the reverse of inflation.  Therefore, if winning involved having the fastest inflation rate in competitive inflation, then the country with the slowest fall in prices should win, as, just like inflation, it will relatively reduce the value of its debt the best.

Europe stands a pretty good chance of deflation if the EU fails and debt loads collapse economies (see Simon Johnson’s analysis here).  Europe’s debt problems are worse than America’s.

And, as always in deflations, commodities fall, U.S. Treasury interest rates fall, risk premia rise, stocks fall, and the vastly neglected real economy tanks yet again.  More people lose their jobs, and more children go hungry in the emerging banana republics of the developed world.

Then a bigger war and the big inflation begin, if history rhymes.

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